How to blitz your college debts

By Liz Pulliam Weston

The average college student is now more than $20,000 in debt at graduation. The average salary for a newly minted graduate, meanwhile, is $30,000.

No wonder so many grads say "the heck with it" and simply take on more debt -- buying new cars, carrying credit-card balances and paying back as little of their student loans as they can get away with.

If you're smart, though, you'll make a concerted effort to get out of debt now -- while you're still young enough to make it count.

Why should you care about debt? Well, for one, every dollar you spend on interest for credit cards and loans is a dollar you don't have for other, better uses: saving, investing, spending on something fun.

More trouble down the road

And the longer you put off erasing your debts, the more interest you'll pay. Make the minimum payments on the average graduate's $3,262 in credit-card debt, for example, and you'll end up paying more than twice the original amount by the time you send in the last payment -- 18 years later. Is the pizza and beer you charged last month really worth nearly two decades of payments?

Debt can cause you problems later in life, as well:

• The more debt you have when you're ready to buy a home, the smaller the mortgage you're likely to get. That may mean settling for a smaller house in a less desirable neighborhood than you'd like.

• You may not be able to save enough for retirement.

• If you get behind on your payments, you could wind up with a trashed credit rating, which will make your debt even more expensive.

But why now?

Don't you deserve to kick back and have a little fun, now that you're finally making some money? Of course. But there will never be a better time for you to make a real dent in your debt. Here's why:

• You're used to living on the cheap. If you can refrain from upgrading your lifestyle, even for a few years, you can make a big dent in your debt and put your finances well ahead of those of your peers.

• You're flexible. You're probably willing to do stuff, like have a roommate or take the bus, that would make you crazy when you're older.

• You don't have a mortgage to pay. Your income will rise in the future, but so will your expenses -- and many of those expenses will be pretty hefty, like your mortgage, braces for the kids or payments on the minivan.

• You'll get used to living within your means. Sound boring? It's the key to a successful financial life, but many people never learn it. They live paycheck to paycheck their entire lives and never get ahead.

The sooner you're debt-free, the faster you'll be on the road to financial success -- and the less you'll have to worry about living a starving-student lifestyle when you're middle-aged.

First things first

Your biggest debt is probably your student loans. The good news is that rates on these loans are low. Your best bet is to pay the minimum possible on these loans while you tackle other, more expensive debt. That could mean consolidating your loans into a 15-year or 20-year repayment plan, or using alternative payment schemes such as Sallie Mae's "income sensitive" or "interest only" options.

Once you've got that in place:

• Pay off your credit-card debt. Get rid of this expensive albatross before you tackle anything else. Pay off the highest-rate card first, and work your way down until your lowest-rate card is paid off. Don't charge anything new -- you can't get out of a debt hole if you keep digging. Once the debt is gone, charge only what you can pay off each month.

• Look at your other, non-mortgage debt. Personal loans and anything you financed, from furniture to your car, should get retired as soon as possible. If your car loan doesn't charge prepayment penalties, consider making extra payments until you own the vehicle free and clear. If your loan does penalize you for paying early, just make the regular payments -- and remember to shop for a more flexible loan next time, or better yet pay for your car with cash.

• Build up an emergency fund. You should have at least three months' worth of expenses tucked away in a savings or money market account. This little nest egg can save you from having to charge unexpected expenses and can tide you over in case you lose your job.

• Save for your retirement. Start, right now, putting aside 10% of your income for retirement. The best place is probably a 401(k), particularly if your employer matches your contributions, but you can also contribute to an IRA or Roth IRA.

Getting an early start means you'll have a lot more money, and a lot more financial flexibility, when you're older. Here's how it works. Suppose you invest $3,000 in an IRA every year from age 22 to age 32. You could then stop saving entirely, and your IRA could grow to more than $550,000 by the time you're 65, assuming 8% average annual returns.

If, on the other hand, you put off saving for those first 10 years, you would never really catch up. Make $3,000 contributions annually every year between age 32 and age 65, and your IRA would grow to just $437,000.

In other words, you would have more by contributing for just 10 early years than you could make by contributing during 33 later years.

What the market's doing now shouldn't affect your savings and investing plans, either. After all, you're not going to tap this money for 30 or 40 years. By then, the market should have had plenty of time to recover, and the prices you're paying now for stocks will probably look like bargains.

Dump the student loans

If you've gotten this far, you should be feeling pretty financially fit. You're free from consumer debt, you've got an emergency fund going and you're saving for retirement. You're also used to living below your means -- a key skill if you want to get ahead financially.

This is the time to consider sending in extra payments on your student loans. Talk to your lender about the best way to go about it. Most would be happy to set up an automatic payment plan for any amount you specify, as long as it's at least the minimum you're required to pay. (Automatic repayment plans, which take your monthly payment directly from your checking account, can also qualify you for a 0.25% interest rate break, depending on the lender.)

Play with the Bankrate.com calculator; you can see how long it will take you to pay off the loan by adding different amounts to the minimum payment.

Add $100 a month to the $203 minimum on a $20,000 loan, for example, and you can be debt-free in six years, rather than 10. Double your payment and you could have something to brag about at your college's five-year reunion.

Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.