Money makeover: In debt after college

Recent university graduate Amy Horwath has grasped the golden ring in this weak economy: a job in her chosen field.

Just one problem: She’s $50,000 in debt, mostly student loans.

“Sometimes it seems overwhelming,” said Horwath, 23, sitting in her small apartment, where her Cornell University diploma for hotel administration hangs on the wall. “I feel like I’m barely treading water.”

Horwath belongs to a generation of college graduates who traded debt for degrees. Graduating seniors leave college with an average of $23,000 in student loans, according to FinAid, a student financial aid website.

“Amy is emblematic of the struggles young people have coming out of college, certified financial planner Lara Lamb said. “They have a load of student debt and at the same time they’re trying to become financially independent.”

Horwath earns $48,200 annually as a program manager for a luxury hotel in Southern California. She puts about 9% of that toward savings and has accumulated approximately $3,600 in what she calls her “uh oh” emergency account. She also has $1,600 in her 401(k).

Her main debt is the nearly $34,000 owed on her student loans. She also owes about $16,700 on her car. One bright spot: She has no credit card debt.

Horwath basically lives within her means, splitting her $1,700 monthly rent on an apartment in Malibu with her boyfriend. They each pay half of the cable bill and grocery costs.

But at the end of each month, Horwath has little left over, making her wonder whether she’s handling her money as well as she could be — especially for the long term.

She wonders, should she pay down her debt beyond her minimum monthly obligations, or save more for retirement? How much should she save? Should she get rid of all her debt before going to business school, which she plans to do within five years?

“You hear so much conflicting information,” Horwath said. “It’s very confusing for someone who just graduated.”

In some ways, Horwath still lives like a student. Her boyfriend’s bike leans against a bookshelf in the living room of their one-bedroom apartment. Only recently did she ditch her dorm-room futon for an Ikea couch. And her parents still help with her bills, contributing about $3,700 a year.

Horwath has a long history of helping to support herself. At age 14 she was working 16 hours a week at an assisted living facility. At Cornell, she waited tables in an Italian restaurant to help pay her room and board.

“She really does want to stand on her own two feet,” Lamb said.

Lamb takes a hard line on savings. She wants Horwath to put 15% of her pay toward her debt payments, retirement account and emergency fund. One of the goals is to cut the financial umbilical cord to her parents.

“In general, savings rates for everyone should be worked up to between 15% and 20%,” Lamb said.

Horwath can put more money aside by changing her federal and state tax withholdings and cutting expenses. Changing her withholdings, for example, would give her another $280 a month toward paying down debt.

Lamb recommended that she use that money to start a “snowball” debt program. To make this work, Horwath should apply the $280 toward her car loan, which carries the highest interest rate of all of her debts. That way, she’ll pay off the car in two years.

When that’s done, the total amount Horwath spends each month on debt payments shouldn’t decrease: She should redirect all that she was paying on the car to her highest-rate student loan. When that’s paid off, she should follow the same scheme on the loan with the next-highest rate, and so forth. Her payment on her top-priority debt would snowball, getting bigger with every loan she pays off.

Lamb estimates that Horwath could save nearly $5,000 in interest and pay off all her debt in about four years that way.

Another savings: Horwath, a self-proclaimed foodie, believes she can cut about $80 a month out of her budget mostly by eating out less and scrimping on pricey wine and blue cheese.

To stay on budget, Lamb recommends Horwath divide her paycheck into dedicated accounts for special expenses. One account should be for clothing, an area where Horwath tends to overspend. Another could be for irregular expenses such as vacations, gifts and auto maintenance. The goal is to make sure money is available when needed.

Creating the accounts also limits splurges, such as the overspending Horwath did at Christmas when she racked up $500 in credit card debt on gifts and clothes. And when she got a $2,500 tax return, she bought a DVR and a new couch.

Lamb cautioned her to keep her costs at 50% to 60% of her income, and not commit to any higher fixed expenses. For example, she should stick with her used Nissan Altima rather than taking on increased debt for a spiffier car.

“Delayed gratification is hard to swallow for this generation,” Lamb said. “But the last thing you want to do when you’re in debt is add more debt.”

This is especially true for young people who need to save more for retirement. Lamb wants Horwath to increase her 401(k) contributions from 3% to 5%.

If Horwath invests $188 a month (along with her employer’s $120 matching contribution) in her 401(k) for the next five years, the account as it stands at that point will grow to $447,443 by the time she turns 65, Lamb said. (This presumes an 8% compound interest rate.)

Horwath seems up to following Lamb’s advice. She likes the idea of snowballing her debt payments and squirreling away money for clothes. Then she won’t feel so bad when she buys an Ann Taylor suit, she said.

Lamb also told her she might not have to go to business school. “In five years, she may be making so much more money” that she might not feel the need for another degree, the planner said.

Horwath seemed convinced she’d need the degree to break into upper management. But she acknowledged that her plans could change. After all, she said, “I’m only 23.”

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