Personal Finance for PhDs

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Why You Should Apply for Fellowships Even If You’re Fully Funded

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PhD students are funded by a variety of sources: research assistantships, teaching assistantships, graduate assistantships, training grants, and fellowships. It’s typical to be funded by two or more of these difference sources over the course of your PhD, and the funding source can change year-to-year or even semester-to-semester. While the differences among these funding sources are sometimes subtle, one stands apart from the others: Being funded by a fellowship, particularly a nationally recognized one, is in many ways superior to other forms of funding.

Last week, there was a very interesting conversation on The Grad Cafe about the various ways PhD students are funded. Ultimately, the original poster asked: “Why are fellowships so highly sought after? I am assured full funding (around $30,000) at every school I’m looking at. As someone who isn’t even in grad school yet, is this something I should be concerning myself with?”

I believe every prospective and graduate student should apply for at least one fellowship per year (assuming you are eligible for any). I recently compiled a list of nine portable, broad, lucrative fellowships that prospective PhD students can apply to. Many on that list plus more fund 1st- or 2nd-year PhD students, and there are fresh funding opportunities for PhD candidates with a clear research focus or who are nearing the ends of their dissertations.

Further reading: How to Find, Apply for, and Win a Fellowship During Your PhD or Postdoc

apply for fellowships

Why Fellowships Are a Superior Funding Source

At the graduate level, fellowship funding is usually preferable to assistantship or training grant funding.

1) You Don’t Have to Work

This point may seem unclear until you understand the definition of “work” being used. Assistantships are a part-time job and typically require the assistant to work 20 hours/week. Fellowships are a type of award, which means that they are not tied to a specific work requirement. Fellows are still required to make progress toward completing their degrees, which will of course involve classwork in the early years and research throughout the PhD. But students who receive their full stipends from fellowships are excused from doing an assistantship.

The advantage of being paid by a fellowship rather than an assistantship is more pronounced in some department than others.

The ideal situation for a PhD student, and what a fellowship provides, is the ability to put 100% of your effort toward achieving your professional goals (mostly working on your dissertation).

Teaching assistantships confer extra duties that take away from your available time for dissertation work. (Gaining teaching experience may be an additional professional goal, in which case some types of teaching assistantships may be beneficial to you.)

Research assistantships are a mixed bag. In some fields, such as STEM fields, research assistants spend all their time conducting research that will become part of their dissertations (the topic of which is guided by the projects/funding available in the advisor’s lab). In other fields, the research that a research assistant conducts will not become part of his dissertation, so again that is time taken away from dissertation work.

Basically, for teaching and non-dissertation research assistantships, you have to work on your dissertation above your 20 hr/week job, while fellowships and dissertation research assistantships allow you to devote your full working time to your dissertation.

2) They Often Pay More

Most external fellowships provide a specified amount of money for your stipend plus money to go toward your tuition and fees (either to pay them fully or up to a certain amount). For example, the stipend specified by the National Science Foundation Graduate Research Fellowship Program is $34,000/year, by the National Defense Science and Engineering Graduate Fellowship is $102,000/3 years, and by the Department of Energy Computational Science Graduate Fellowship is $36,000/year.

The stipend provided by an external fellowship is usually higher than the stipend you would have received from an assistantship or training grant. Even if the fellowship stipend is lower, some departments will supplement the fellowship stipend up to or above the departmental base stipend. It’s unusual, though not unheard of, for a fellow to receive a lower stipend than his classmates funded by assistantships or training grants.

Further browsing: PhD Stipends

An external fellowship also confers rare negotiating power to you. Negotiation is likely to be most effective when you are a prospective graduate student with multiple offers to (tactfully) play off one another. The fellowship stipend might be supplemented by a department every year, or the department might pay a one-time bonus to the fellow. If you receive a fellowship while already enrolled in a PhD program, you can also ask for a supplement or bonus. (Be sure to ask other fellows in your department if any extra money was conferred to them.) Something else you can negotiate for is additional years of guaranteed funding after the fellowship ends.

3) Fellowships Give You More Autonomy

Because fellowship money is separate from your advisor’s grants, it can in many cases increase the control you have over your own research pursuits. It may allow you to shift the focus of your dissertation away from the main thrust of your advisor’s research, facilitate a collaboration with another group, or add a side project to your dissertation that isn’t aligned with your advisor’s grants.

4) Fellowship Sometimes Pay Above Your Stipend

In addition to paying your stipend and (part of your) tuition and fees, some external fellowships award you additional money for conference travel or professional development.

A Former Downside

Up through 2019, fellowship funding had one major downside: It was not eligible to be contributed to an Individual Retirement Arrangement (IRA) (unless it was reported on a Form W-2, which was rare). However, starting in 2020, fellowship income is eligible to be contributed to an IRA, eliminating this one major downside.

Further listening: Fellowship Income Is Now Eligible to Be Contributed to an IRA!

Why You Should Apply for at Least One Fellowship (Even If You Don’t Win)

While the best result of applying for a fellowship is that you’ll actually win it, there are positive side effects even if you don’t.

1) Shows Initiative/Effort

Applying for fellowships when you’re not required to (like you have a guarantee or reasonable expectation of funding) shows you are willing to take initiative to further your training and career. You are trying to provide for yourself instead of depending on your department or your advisor. Even if you are not successful, this is an admirable quality; your advisor or potential advisors will probably be impressed at your effort.

2) Good Practice

Applying for fellowships somewhat resembles applying for grants, although usually abbreviated. If you are going to be a career researcher, you will have to develop the skill of successfully pitching yourself and your ideas to funding agencies. Applying for fellowships and predoctoral grants is good practice for the larger grants you’ll apply for later.

The Most Compelling Reason to Apply for Fellowships

The most compelling advantage to winning a nationally recognized fellowship is not its superiority as a funding source or how the process benefits you or your advisor, but rather its role as a CV-booster. Winning a prestigious fellowship early on in your career sets you up well to win larger and more lucrative awards later on. While it is of course possible to win fellowships and grants later in your career without winning one in graduate school, it is advantageous to have been favorably evaluated in the past by another agency. Winning a fellowship in graduate school is an early step in creating a track record of obtaining funding for your research, which is something hiring and tenure committees look for.

Prospective graduate students should apply for at least one large, multi-year fellowship (assuming eligibility) so you, if nothing else, can tell the PIs you’re interviewing with that you did it. If you’re in a STEM field, the NSF GRFP is likely to be your first stop. Once you’re enrolled in graduate school, you should consult with your advisor about which fellowships to apply for, at apply to at least one more in your first and second years and any later years in which you are eligible.

How to Pay Tax on Your PhD Side Hustle

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One of the biggest challenges associated with a side hustle is paying the right amount of tax on your PhD side hustle at the right time. Understanding your tax due and tax benefits can be even more complicated for PhD side hustles because of the unusual pay structure and benefits that some grad students and postdocs receive.

tax PhD side hustle

If you haven’t yet, read last week’s post on the best financial practices for PhD side hustles, and pay particular attention to how to categorize your side hustle (employment, self-employment, neither) because that designation plays a very important role in taxation. The assumption that your side hustle income is much less than your stipend/salary holds here as well. This post is also US-specific.

What Kinds and How Much Tax You Will Owe

The two types of tax on your PhD side hustle that you should be prepared to pay are income tax and FICA tax.

Income Tax

The income tax on your PhD side hustle income will be equal to your side hustle pay for the year multiplied by the marginal tax bracket your primary job tops out in (e.g., 10%, 15%, 25%). The exception is if your side income bumps you into the next higher tax bracket, in which case part of the income will be taxed at your previous marginal tax rate and part at the higher marginal tax rate.

FICA Tax/Self-Employment Tax

The FICA tax rate for each person is 15.3% (12.4% for social security and 1.9% for Medicare; in 2017, social security is not taxed on the portion of your income that exceeds $127,200). If you are an employee, you pay half of that rate (7.65%) and your employer pays half. If you are self-employed, you pay both halves, which is called self-employment tax.

(Graduate students do not pay FICA tax on their stipends because they either fall under the student exemption or their income is not considered wages and is therefore not subject to FICA tax. Postdoc fellows and other fellows also may not pay FICA tax because their income is not considered wages.)

How to Pay Your Tax throughout the Year

If you have tax withholding set up accurately at your primary job, it will only cover the tax due on your primary income. You will additionally need to send the IRS regular payments for the tax on your PhD side hustle income.

Withholding

If you are an employee in your PhD side hustle, you will file a W-4 with your side employer to have income and FICA tax withheld from that paycheck. The simplest thing to do is claim “0” allowances on your side hustle W-4 and the appropriate amount of allowances on your primary job W-4 (if you have one). For a more detailed calculation, complete the Two-Earners/Multiple Jobs Worksheet on the second page of the W-4.

Further reading: 3 Tax Considerations for Those with Multiple Jobs

If you are self-employed in your side hustle and have tax withheld at your primary job, you can increase your withholding at your primary job to cover the additional tax on your PhD side hustle by filing a new W-4 with fewer allowances and/or an additional dollar amount to be withheld from each paycheck. This is a good strategy if your side hustle income is very regular.

Quarterly Estimated Tax

If you are self-employed with an irregular side income and/or you do not have tax withholding on your primary income, you will probably be required to file quarterly estimated tax.

Quarterly estimated tax payments should be familiar to most PhDs who at some point received non-compensatory income such as from a fellowship or training grant. If you currently receive non-compensatory pay and are making quarterly estimated tax payments, simply adjust your calculations on Form 1040-ES to account for your PhD side hustle income.

For those not currently making quarterly estimated tax payments, the process is relatively straightforward. You use Form 1040-ES (page 8) to estimate your income, tax due, and existing tax withholding for the year. If you will owe more than $1,000 in additional tax and don’t fall into an exception category, you are required to pay that additional tax over four payments taking place in April, June, September, and January. A quick way to take care of this if your tax withholding at your primary job is accurate (you didn’t receive a large refund or owe a lot of additional tax on your return last year) is to calculate your additional income and self-employment tax due for each quarter when the quarter ends. Multiply your income for the quarter by 15.3% plus your marginal tax rate and use that amount as your estimated tax payment.

Further reading: Paying Income Tax throughout the Year

How to Prepare for Your Tax Bill

Whenever you receive side hustle income into your personal bank account (whether that is directly from your client/customer or via your business checking account), you should set aside the appropriate fraction of that income to go toward your tax payments. The best practice for doing this is to set up a separate, dedicated savings account that you solely use for future tax payments. From each bolus of income (or once per month), transfer into your dedicated savings account the fraction of your income that will go toward your income (and self-employment) tax, as calculated above.

Tax Benefits to Having a PhD Side Hustle

One of the best perks of having a PhD side hustle is that it might qualify you for tax benefits not conferred by your primary job, especially if you are a grad student or fellow.

Self-Employed People Can Take Business Deductions

If your PhD side hustle is self-employment, even more tax benefits become available to you, such as business deductions. Keeping your personal and business account separate, as discussed in last week’s post, is also extremely helpful for keeping track of business deductions. You should pay for expenses that have solely a business purpose directly from your business checking account.

Of course, not all business expense deductions apply for every type of business, but some of the common ones that freelancers and contractors can take are:
• travel
• mileage and gas
• home office
• computer
• phone
• internet
• domain fees and hosting
• meals

One step to take when you become self-employed is to diligently track your usage of anything that has both personal and business purposes. You might decide to take a business deduction on the fractional use of those resources.

For example, you should track the mileage in your car, noting the miles used for business. Your internet usage is another deductible expense, again for the fraction of the total time it was in use. If you buy a new computer in a year that you are self-employed, you can deduct part of the cost, but you’ll need to track the fraction of the time that you actually use it for your self-employment work vs. other purposes.

Self-Employed People Can Sometimes Contribute More to Retirement Accounts

Self-employed people are eligible to create retirement accounts for themselves that take the place of a workplace-based retirement account and greatly increase their contribution room above that provided by an IRA.

The additional retirement contribution eligibility is especially beneficial for grad students and postdoc fellows who don’t have access to a workplace-based retirement account (e.g., their university’s 403(b)), and in some cases the self-employment retirement account is a superior alternative to the workplace-based retirement accounts available to PhDs with Real Jobs.

Self-employment retirement accounts come in a few versions, and the best choice is dependent on the number of employees you have, your income, and your desired savings rate. The most common self-employment retirement plans are the individual 401(k), Simplified Employee Pension (SEP), and Savings Incentive Match Plan for Employees (SIMPLE IRA).

Further reading: Avoiding an Expensive 401(k) Plan through Self-Employment; Retirement Plans for Self-Employed People

How do you pay tax on your PhD side hustle? Has your side hustle conferred any tax benefits that you didn’t already receive through your primary job?

Best Financial Practices for Your PhD Side Hustle

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Whether you started your PhD side hustle to fund your basic monthly budget, pay for lifestyle upgrades, or further your career, you must put in place a few foundational financial practices to ensure that you use your money effectively and stay on the IRS’s good side. These steps are simple, easy and take only a short time once the habits are in place.

Further reading: Side Income

PhD side hustle

This post assumes that your PhD side hustle income is much less than your stipend from your grad student position or your salary from your postdoc/Real Job. If your side hustle income becomes quite regular and compares with your primary income, you should extend your financial and business planning beyond the steps outlined in this post. Regardless, this is a great place to start!

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Today’s post is about general financial best practices, and next week’s post is all about taxes: how much tax you’ll pay, how to pay tax, and the extra tax benefits such as retirement account contributions. The next section of this post is US-specific, but the rest of the sections are widely applicable.

Determine Your PhD Side Hustle Categorization

Your PhD side hustle will fall into one of three categories: employment, self-employment, or neither. The category will affect your tax rate and eligibility for certain tax benefits.

If you are an employee, that relationship should be made quite clear by your employer. Foremost, you’ll receive a W-2 at tax time, so when you start your position you can simply ask, “Will my income be reported on a W-2?” At this type of side hustle you would probably have regular hours, even if they are only part-time. Examples include a retail job, nannying, or an on-campus work-study job.

More likely, your PhD side hustle will qualify as self-employment. Performing similar services for multiple clients, determining when and how you work for a single client, or selling a product directly to customers are all indications of self-employment. Examples include freelance work, babysitting, and tutoring.

Further reading: Am I Considered Self-Employed?

Finally, you might on occasion receive income that is neither employee nor self-employment income, such as from a one-off activity like participating in a clinical trial. In this case, the activity wouldn’t really rise to the level of being considered a PhD side hustle and it’s not necessary to put the following practices in place (aside from paying income tax).

Further reading: Self-Employment or Other Income?

Track Your Time

It may be hard to believe if you’re in the training stage of your career, but your time is valuable. It may not be valued monetarily by your university, but you should value it. While it may be a bit depressing to calculate the hourly rate you are paid for your work as a grad student or postdoc, it’s still a useful baseline. You should look for a PhD side hustle that pays you a much better hourly rate than what you receive at your primary job. But be sure to include all the travel and administrative time it takes to perform your side hustle, not just your “billable hours.”

One of the best reasons to keep track of the time you devote to your primary job vs. your PhD side hustle is to make sure that your side hustle does not encroach upon your primary work time. The benefits of pursuing a PhD side hustle dramatically diminish if it prolongs the time you spend in training.

Further reading: Can a Graduate Student Have a Side Income?

When you track your time and know definitively what you are earning per hour, it makes decisions about how to use your time that much easier, whether it’s on your research, PhD side hustle, or personal pursuits.

Give Your PhD Side Hustle Earnings a Job

If you mix your PhD side hustle earnings (net of taxes) in with the rest of your money, it very well might disappear into the ether like unbudgeted money tends to do. A better practice is to link a financial goal directly to your side income. That way, every time you work on your PhD side hustle, you know exactly what the money you earn will do for you.

For example, if your side hustle money is going toward lifestyle upgrades, you could funnel it into a savings account dedicated to travel, entertainment, or shopping. You could withdraw it as cash and make it your “blow” money for the month to be spend on anything. Assigning it to a necessary budget category like food would also work well if you have a good degree of control over how much you earn and are just trying to motivate yourself to work more/faster. Another common issue that a PhD side hustle can help with is un-/under-funded summers; the more you earn during the academic year and summer, the less stress you’ll experience when you’re drawing down your savings. Finally, assigning your PhD side hustle money to debt repayment is a great way to accelerate your debt payoff.

Maintain Separate Business and Personal Accounts

Creating a separate business checking account is just about the first step you should take when you become self-employed. If you are a sole proprietor, your PhD side hustle earnings will be reported on your personal tax return on a Schedule C, so at the end of the day it’s all really your money. However, keeping a separate business checking account that you use for only business transactions helps tremendously with bookkeeping and tax records. It’s also advantageous when you want to save up your income for a business investment, such as a piece of equipment or professional development.

Maintaining separate personal and business accounts is also a reasonable step for anyone with an irregular income to take, even if it’s not self-employment income. Instead of receiving variable amounts of income directly to your personal checking account, you can create a degree of separation with a business checking account. If you let a balance build up for a couple months, you can set up an auto-transfer of a regular amount of money from your business account to your personal account that is less than your average income – just like a paycheck – which is easier to incorporate into your budget than a variable income.

What financial best practices have you put in place for your PhD side hustle?

Fighting Financial FOMO During Your PhD or Postdoc

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Perhaps you’ve never put it in these terms, but you’ve likely experienced some degree of financial fear of missing out (financial FOMO) during your PhD training, such as when you:

  • peruse Instagram photos from your friend’s latest vacation
  • read about young professionals maxing out their 401(k) contributions
  • receive a LinkedIn notification about your college classmate’s recent promotion
  • congratulate a friend on buying a home

Becoming a PhD-level researcher takes a lot of time. The PhD itself is usually at least five years long (the average in the US is closer to 8 years), and then you might do a multi-year postdoc (or two) before you finally get a Real Job, inside or outside of academia. And in all that time – for many students, the bulk of their 20s and into their 30s – you see your friends and former classmates walking down your Road Not Taken. Namely, they’re earning more money than you. Perhaps you start thinking that even though you’re both aging at the same rate, they are progressing financially while you are not. And that gives you financial FOMO.

financial FOMO

PhD-Induced Financial FOMO

You can’t live the same lifestyle on a grad student stipend or postdoc salary that you could on a real job salary. Frugality is going to be your constant companion until you’re done with your training! So there are some obvious day-to-day sacrifices that you make to pursue your academic goals.

On top of that, if you’re becoming savvy about personal finance, you know the importance of paying off debt and beginning to invest early in life. As a PhD student, not only do you lack the income to save tens of thousands of dollars each year, you don’t even have a 401(k) or 403(b) in which to save it! Some postdocs have access to 403(b)s, but have a similar problem on the income side as PhD students when it comes to saving.

Further reading: My Realistic Earnings Expectations Push Me to Save Aggressively

So yes, objectively, you are almost certainly missing out on some income that you would have earned if you had worked a real job instead of going to grad school. But that does not mean you should let financial FOMO overwhelm you or cause you anxiety.

Below are five simple steps to take to fight financial FOMO through mindset changes and good financial practices.

Don’t Dwell on Facebook/Instagram/Pinterest Jealousies

“Comparison is the thief of joy.” – Theodore Roosevelt (attributed)

“Don’t waste your time on jealousy. Sometimes you’re ahead; sometimes you’re behind. The race is long, and in the end, it’s only with yourself.” – Baz Luhrmann

If looking at other people’s picture-perfect (for the amount of time it took to snap the picture!) homes, vacations, toys, etc. bums you out, stop looking! It’s a waste of time and detrimental to your mental health.

End Grad School with A Higher Net Worth than the One You Started with

When it comes to building wealth, how much money you earn doesn’t matter; what matters is how much money you put to work for you. A 10% savings rate on a $30k/year salary amasses more than a 0% savings rate on a $1M/year salary. So don’t worry about people who have higher salaries – unless you talk about it, you have no idea if they are actually building wealth.

To the extent that you are able (and still live a reasonable lifestyle), use part of your income to repay debt or invest. Investing even modest amounts of money during your training can have a massive effect on your net worth in your golden years. If you can end grad school with a higher net worth than you started, even by a small amount, that is financial progress.

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Practice Percentage-Based Budgeting

The best thing I did to alleviate my financial FOMO during grad school was to practice percentage-based budgeting. Basically, instead of paying attention to the amount of money I was putting into my Roth IRA (my primary financial goal), I tracked its percentage of my gross income. My initial goal was to save 10% of my gross income, which sounds a heck of a lot better than $200/month. By slowly inching up the percentage over time, my husband and I increased our combined savings rate to 17.5% by the time we finished our PhDs, and then we continued to save at that percentage rate as our income increased as we transitioned out of academia.

The great thing about percentage-based budgeting (loosely based on the Balanced Money Formula) is that it scales with your income. So if your overall goal in life is to save X% of your income (or pay off debt, etc.), practice that during your training as well as after, even though the amounts of money will be quite different. You’re creating the firm habit of saving, which will serve you very well now and throughout your life.

Build Your Career (Don’t Just Work on Your Dissertation)

Just because you’re a grad student or postdoc doesn’t mean you’re not also a career-building professional. You do not have to limit your professional growth during your training to academia-sanctioned activities like publishing papers and attending conferences (though you should definitely do those). You can also gain real work experience and network, which increase your ability to land that first post-PhD Real Job.

Two excellent activities to engage in are a side job and networking.

Side job: Your eligibility for side work depends on your contract or the terms of your fellowship, so check on that and consider your advisor’s stance on outside work before you jump into anything. You will fight your financial FOMO if you can devote a few hours each month or each week to a part-time or freelance job that gives you new skills or an opportunity to demonstrate your existing skills, a larger/better-quality network, and additional money.

Further reading: Can a Graduate Student Have a Side Income?

Networking: Networking doesn’t have to be unnatural or awkward. One easy-access high-quality network is to befriend (or at least be friendly with) and keep up with your peers who exit academia before you, e.g., your labmates/groupmates, other trainees in your department, peers you interviewed with on your prospective students visit weekends, and people you meet socially through the university. (Keep in mind that some people who are “behind” you in training – undergrads, master’s students, and PhD students who started after you – may exit academia before you!) You will have indirect access to the networks they build when they get Real Jobs.

Remember What Brought You to Grad School

Perhaps the most powerful step you can take to fight your financial FOMO is to do some introspection. Identify and reflect on your top life values. Something within those values pushed you to pursue your PhD training. Perhaps it was: making a difference, curiosity, achievement, learning, growth, creativity, service, or knowledge.

Your values are what you hold most dear, presumably more dear than lifestyle elements or wealth (unless those also play into your values). You must find something about your research or career path more compelling than the perks that a Real Job would confer. If not, your issue is not financial FOMO, but rather you need to re-evaluate why you are continuing your training at all.

You can also take some time to enumerate the good things that grad school or your postdoc have brought into your life, such as friends and colleagues, your city, and gratifying (elements of) work. A gratitude journal is a great way to shift your mindset away from experiencing financial FOMO.

How to Establish Credit in the US

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One of the most common issues international grad students face when they start grad school in the United States is how to establish credit. The US credit system draws its data only from debts incurred in the US, so whatever credit you had in your home country won’t transfer. Although your options for establishing credit are limited when you first arrive in the US, if you take the right steps, you will build credit quickly.

It’s important to note that in the US your credit is all about debt. The chief reason you want to have good credit is so that you will receive favorable lending terms on any future debt you want to take out. (A secondary reason is that potential landlords and employers sometimes check your credit score to verify your trustworthiness or check for conflicts of interest.) To have good credit, you have to have previously demonstrated that you can manage your debt well. Counterintuitively, having a lot of money to your name or paying your non-debt bills (rent, utilities) on time does not positively affect your credit score. Therefore, to establish your credit for the first time, you have to take out a form of debt, even if that is totally unnecessary for your finances.

What is a credit report and credit score?

A credit report is a list of all the financially-related accounts you have used in the past seven years. There are many different institutions that track this data, but the three main ones are Equifax, Experian, and TransUnion. Your credit report will include data on these accounts, such as how long they have been open, how much outstanding debt you have, and whether you have made any late payments.

A credit score is a number from 300 to 850 that summarizes how ‘credit-worthy’ you are. Another way to say that is how risky it would be for an institution to lend to you. Similarly to the credit report, each credit bureau will calculate its own credit score for you, but they will all be similar as they draw from the same data. A credit score above 750 is considered quite good.

FICO credit score range
Image by CafeCredit under CC 2.0

Lenders will look at your FICO credit score, but your attention should be on the accuracy of your credit reports. You can order one free credit report from each bureau once per year through annualcreditreport.com. Once per year (ideally on a 4-month rotation), you should order your credit report from each bureau and check its accuracy. Report any mistakes back to the bureau, and of course if you catch any identity theft, take steps to ameliorate that.

Further reading: “I Want a Credit Card, But I’m Scared”, Don’t Buy the Pro- and Anti-Credit Card Hype

How is my credit score calculated?

While the exact formula each credit bureau uses to calculate your credit score is proprietary, the components are widely recognized at a general level: payment history (35%), amounts owed (30%), length of credit history (15%), account mix (10%), and new credit (10%).

FICO credit score breakdown
source

The way to optimize your credit score is to:

  • make every single payment on time
  • pay down your outstanding debt
  • keep your debt utilization ratio (the percentage of your credit limit that you actually use – both for individual credit cards and all your accounts together) below 30%
  • keep your oldest accounts open (e.g., your first regular credit card)
  • let time pass (to lengthen your credit history!)

In rare situations, taking out a new, un-needed installment loan for the purpose of increasing your credit score might be a reasonable strategy, but you should conduct heavy-duty research that option before taking such a step (i.e., don’t let a bank representative/salesperson talk you into it).

While applying for new debt will have a small, short-term negative effect on your credit score, you should probably only consciously avoid taking out new debt for this reason in the months leading up to applying for a large loan such as a mortgage.

Further reading: Building Credit as an International Student

How can I establish credit for the first time in the US?

Step 1: Sign up for a secured credit card.

A secured credit card operates similarly to a regular credit card, but the lender holds an asset of equal value to the line of credit extended to you. You give the lender an amount of money (e.g., $500), and that amount is the limit of what you can borrow at a time. Use the secured credit card for purchases, then pay it off on time and in full the way you would a regular credit card (or be charged interest, which only harms you). After several months of using the secured credit card properly, you should have a high enough credit score to qualify for a regular credit card.

Be selective about which secured credit card you sign up for. Community banks and credit unions usually offer better products and customer service than national chain banks. Also examine the annual fee on the card and the interest rate (if there is any possibility of you not paying off the card in full every cycle) to minimize your out-of-pocket costs.

Further reading: What Is a Secured Credit Card? How Is It Different from an Unsecured Card?

Step 2: Close your secured credit card and open a regular credit card.

You can ask your lender to upgrade your secured credit card to a regular credit card, or apply for a new regular credit card and, once approved, close your secured credit card. When you upgrade or close your secured credit card account, your deposit will be refunded (assuming you had no balance due).

Continue to use your credit card perfectly, paying off the balance in full before the due date every month. Keep your utilization ratio low. You will probably have a low credit limit on this first card, so if necessary you can pay off the balance multiple times per month.

You should plan to keep your first credit card open for at least seven years, so choose one without an annual fee, even if it doesn’t offer the most lucrative rewards program.

Further reading: How International Student and Immigrant Workers Can Get a Credit Card

Step 3: Take out an installment loan (e.g., auto loan) or open additional credit cards.

This last step is optional, but helpful for building credit faster. After using your credit card perfectly for several months or a year, your credit score should be increasing gradually. At this point, you are eligible for debt with better lending terms than before.

If you want to buy a car, it should be possible to get an auto loan if you can’t pay for the car outright. If you do take out an auto loan and make payments on time, it will continue to improve your credit score. Similarly, if you open more credit card accounts, your credit score will temporarily dip, but your utilization ratio should also become lower to raise your credit in the long term.

But keep in mind why you are trying to build credit in the first place, and don’t harm yourself (e.g., by paying interest on an unnecessary loan or getting in over your head with credit cards) just for the sake of improving your credit score.

How do I build credit over time?

The best ways to build your credit after you first establish credit in the US are to:

1) Continue to pay all your bills on time and in full.

2) Allow time to pass, which will more firmly establish your track record as a responsible borrower and lengthen your credit history.

3) Pay down outstanding installment loans (though not necessarily off completely) and keep your credit utilization ratio low. (It is a myth that you have to carry a balance from month to month on your credit card for it to improve your credit score; in fact, this strategy will depress it.)

International students are not the only graduate students without credit; some domestic students who have avoided student loans and credit cards face the same issue. Just keep in mind your ultimate goal that motivates your desire to establish credit (e.g., qualify for a lease, borrow money for a car at a good interest rate), and don’t take unnecessarily extreme steps with your borrowing simply to achieve a high score. Making on-time payments, holding on to minimal amounts of debt, and time are the best boosters to your credit score.

Why I Didn’t Pay Down My Student Loans During Grad School

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Today’s post is a personal story on why I didn’t pay down my student loans during grad school, though I had the opportunity to. There are several factors you should consider when you make the decision of whether to pay down student loan debt during grad school. In my particular situation, based on both the math of the situation and my personal disposition, it made more sense to contribute money to other financial goals during grad school.

When I graduated from undergrad, I had $17k of student loan debt, $16k subsidized and $1k unsubsidized. I chose to defer my student loans during my postbac fellowship and PhD, and I didn’t pay down my student loans in that period. Although my stipend afforded me the flexibility to make progress on my loans if I wanted to, I had higher financial priorities than making payments on debt that was effectively at 0% interest.

I didn't pay down my student loans during grad school

My Debt Was Not Pressing

I’ll make a slight edit to my statement that I didn’t pay down my student loans in grad school: I kept my $16k of subsidized student loans throughout my training period, but I paid off the $1k unsubsidized loan during the 6-month grace period following my graduation from undergrad. I didn’t like the fact that it was accruing interest, unlike my subsidized loans, so I paid it off as soon as I could.

Because the rest of my loans were subsidized, not only did I not have to make payments during their deferment, they were not accruing interest. I was effectively borrowing money at 0% interest. While in some cases it would still make sense to prepare to pay down or off the loans when they came out of deferment, in my case I had higher financial priorities.

I Had Higher Financial Priorities

I can divide my seven-year training period into three sections: my postbac fellowship, my first two years in grad school, and my last four years in grad school (after I got married). My financial priorities were different in each of these periods, but in all of them paying down my student loan debt was a low one.

Postbac Fellowship

Right after I finished undergrad, I helped my parents pay down their parent plus loans from my undergrad degree, which were accruing interest. I gave them $500/month throughout the year, which at first was a rent-equivalent because I was living with them, but even when I moved out I continued to send them the money.

I also contributed $200/month to my Roth IRA (10% of my gross income) because I had started learning about personal finance and found that to be commonly given advice.

After contributing to my Roth IRA, sending my parents the loan repayment money, and paying for my living expenses, my stipend was exhausted. Thankfully, I was released from the relational obligation of sending my parents money shortly after I started grad school.

First Two Years of Grad School

Starting grad school brought a new kind of debt into my life: an auto loan. I still had the attitude that any loan that was accruing interest was one worth paying down first, so I decided to send $200/month to that loan to pay it off in two years. I was still contributing 10% of my gross income to my IRA, and I also started tithing. After fulfilling those monthly obligations and paying for my living expenses, I didn’t have a lot of discretionary money remaining, and I didn’t even consider using it to pay down my student loans.

Last Four Years of Grad School

My husband, Kyle, (also a grad student) and I got married after my second year in grad school, and combining our finances meant a complete reset of our financial status and priorities.

Kyle had been living an effortlessly frugal lifestyle (unlike me – my frugality took a lot of effort!) and also had only started contributing to his Roth IRA a year before we got married, so he actually had a good amount of cash sitting around. After paying for our portion of our wedding expenses, we found that we were left with about $17k. We created a $1k emergency fund and set $16k aside as my student loan payoff money. Our top financial priorities became maxing out our Roth IRAs every year (which we didn’t quite manage to do, but we slowly incremented our saving percentage up to 17% by the end of grad school) and building up the balances in our targeted savings accounts.

We could have paid off my student loans with Kyle’s savings when we combined our finances, but instead we decided to experiment with investing.

I Wanted to Experiment with Investing

Kyle and I were already investing for the long term in our retirement accounts, but we were curious about mid-term investing.

It’s pretty hard to pin down precise advise for how to invest for a goal 3-5 years away. Many financial people will tell you to keep your money completely in cash, while others will say bonds are best, and still others perhaps a conservative mix of stocks and bonds.

Our goal was to grow our student loan payoff money during the remaining time they were in deferment, but still have a fairly good chance of not losing any of the principal. Our plan was to pay off my loans right when they came out of deferment. We were averse to paying any interest on debt, yet wanted to take some risk with the money for the chance at growing it modestly.

After wasting about a year waffling over our choices, we ultimately decided to keep part of the payoff money in a CD, put part into mutual funds that were a conservative mix of stock and bonds, and put part into all-stock mutual funds/ETFs. We treated this as an experiment, the goal of which was to learn more about mid-term investing and also about ourselves as investors.

As this period of mid-term investing (2011-2014) coincided with the post-Recession bull market, our investments did earn a decent positive return, so we retained both the $16k student loan payoff principle and made about $4,500.

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Hindsight: Would I Make those Same Decisions Again?

The math of why I didn’t pay down my student loans during grad school is stark. The $1k unsubsidized loan was at a fairly high interest rate, so I would definitely pay it off ASAP again. It’s also pretty hard to argue with the 0% interest rate on the subsidized loans making them a low priority.

My personal disposition toward debt changed over my training period. I started off fairly insensitive to interest rates. Interest accruing on my debt bothered me – so the subsidized loans didn’t register as a priority – but I wasn’t bothered in proportion to the rate itself. Now, I am much more careful to consider how the interest rate on any debt compares with 1) the long-term average rate of inflation in the US and 2) the possible rate of return I’m likely to get on investments. So I would still choose to not pay down my subsidized student loans during grad school, but I would pay more attention to the interest rate they would reset to when they exited deferment.

If I had it all to do over again, I would still pay off my unsubsidized student loan and keep my subsidized student loans throughout grad school, preferring to prioritize long-term investing.

With the hindsight of knowing about the continued bull market and low interest rate environment, it would have turned out better for our net worth if we had aggressively invested most of the payoff money, keeping somewhat safer only the money needed to pay off my highest interest rate (6.8%) subsidized loan immediately upon graduation. (The rest of my subsidized student loans, being at variable interest rates, have stayed at about 2-3%, which to us is low enough to keep around.) But as no one can predict the future and at the time we expected to pay off the loans right after graduation, I think it was a fine decision to hedge our bets and invest conservatively in the time period that we did.

But this decision was right for us only because we were willing to invest and not too concerned about the student loans. Other people are disposed to be much more risk-averse, so for them the right decision could be to pay off their student loans during grad school, even if the loans are subsidized or at a low unsubsidized interest rate.

Where does paying off subsidized student loans rank on your list of financial priorities? Are you paying down your student loans during grad school, and if not what goals are you working on?