A Rough Guide to Repaying Student Loans
There are certain aspects of personal finance that I've never had to deal with. Student loans are one of these. But student loans are a huge concern for many people. This guest-post from SJean is an introduction to repaying these debts.
There are really two things to know about student loans: How to get them, and what to do when you have to start paying them back. I'm going to write about the latter, as I am more experienced with that aspect. It seems everyone can figure out how to get student loans (whether or not they are getting the best deal), but paying them back can be more confusing.
Most federal student loans come with a grace period of six months during which you are not required to make payments. That means if you graduated in May of this year, your grace period is coming to a close and you have some decisions to make.
What do I owe?
The first step is to find out how much you owe and to whom. Your financial aid office can help you with this, as can this site.
There are three major types of federal loans you may have: Federal Subsidized Stafford, Federal Unsubsidized Stafford, and the Federal Perkins loan. Some people may also have private loans, which I'll cover at the end of this article. (They're a different beast than federal loans.) For now, let's focus on the federal loans. According to the U.S. government's Student Aid site:
During the grace period on a subsidized loan, you don't have to pay any principal, and you won't be charged interest. During the grace period on an unsubsidized loan, you don't have to pay any principal, but you will be charged interest. You can either pay the interest or it will be capitalized (added to your principal loan balance, thus increasing the amount you'll repay).
Can someone PLEASE make these go away?
You may feel overwhelmed by your loans and wish that they would just go away. Actually, there are a few ways that they can be diminished without you paying them, but these are special cases. Most of us are going to pay back every dollar we borrowed. And more.
If you are interested in volunteer work, check out the benefits provided by joining the Peace Corps or AmeriCorps. (For strictly financial reasons, you are probably better off getting a job and paying back the loans, but there are other reasons you may want to consider volunteering). If you are planning to be a teacher, join the military, or work in the legal or medical profession, there are some loan forgiveness programs you might be able to take advantage of.
Other than that, your student loans are going to be with you until you pay them back. Even bankruptcy will not destroy them. (But if you die, they are forgiven.) If your best shot of getting out of your loans is death, you probably should start working on a plan to repay them.
Consolidation: What is it?
Consolidating your federal student loans may lower your total monthly payment, but note this is primarily because you are extending the terms of your loan and paying more interest in the long run. If you can afford your monthly payment, and would rather not have a loan for 20 years, you still should consider consolidation. You also can stick with a standard repayment if you know you can afford it and don't think you are disciplined enough to make extra payments. There are no prepayment penalties in consolidation loans and there are a lot of benefits.
Consolidation: Can I consolidate?
Before you concern yourself with whether you should consolidate, you should check to make sure you are eligible. If you haven't graduated yet, you cannot consolidate your loans. (This was not true a year ago!) You must either be in your six-month grace period or in repayment. You must have eligible loans, usually totaling over $7,500 (you may be able to find some lenders who will do it for less). You can consolidate a single loan, as long as the loan being consolidated has not previously been consolidated. You can't consolidate with your spouse anymore, but that was usually a bad idea anyway.
Consolidation: Should I do it?
Student loan rates are adjusted annually on July 31st, based on the 91-day T-bill rates.
Years ago, rates were very low (as low as 2%!), and consolidation was a no-brainer. When I consolidated, they were around 4.5%. As of today, you can probably consolidate at 6.62% (before discounts) if you are in your grace period. If you don't consolidate, that rate will jump to 7.22% when the grace period ends.
Students who received Stafford Loans on or after 01 July 2006 have a fixed 6.8% rate of interest for the life of their loan. The rate on previous loans will continue to be adjusted annually. If you have loans that were dispersed both before and after that date, the interest rate is averaged and weighted accordingly.
The decision isn't as clear cut as it once was — it's something you have to decide for yourself. But my opinion is that for most people, consolidation makes a lot of sense. If you aren't happy with the current rates you could wait for lower rates, but who knows when they will be coming? In the meantime, you'll be subject to a variable interest rate. Consolidating now may result in lower payments and a lower fixed interest rate immediately.
Consolidation: How do I do it?
From the day I graduated (and even before), my mailbox was filled with offers to consolidate my student loans. Why does everyone want to help me with this? I was surprised to learn that my student loans are backed by the US government. If I default on my loan, the government will pay it, then try to get the money from me themselves. This means that the companies are essentially guaranteed to get their money back! Because of this, you will have plenty of offers to choose from. In reality, most of the offers are nearly identical, but pick wisely — this is a relationship you may have for a long time!
Remember, if you consolidate during your grace period, you can lock in your interest rate 0.6% lower and still not make any payments until your grace period ends. If you graduated last May, your grace period is probably ending very soon. Don't hesitate!
Here are some important things to consider when choosing a lender:
- interest rate (will likely be the same for all lenders)
- discounts for auto-payment
- discounts for on-time payments
- website and user interface for payments
- ability to pay with credit card with no fee (to get cash back bonus, not to convert to credit card debt!)
- ability to use Upromise rewards to
pay back the loan (Sallie Mae)
I chose Wells Fargo because my other banking is there, making it really easy to make extra payments. I wouldn't exactly recommend them (a lot went wrong during the consolidation process), but now that everything is consolidated, they are working out just fine. Honestly, I wasn't as well informed as I should have been, and if I could do it again, I'd do more research.
Here are some sites to get you started on your research:
- FinAid.org advice
- More research at the Kiplinger's forums
- FinAid.org List of lenders
What if I can not afford my payments?
If you are unable to pay the monthly bill, there are a few things you can do, all starting with talking to your lender.
- You can usually arrange an alternative payment plan, where you pay less now and payments increase as your income increases.
- You also may qualify for a deferment, where you are not required to make payments for some set period of time (interest will still accrue though!). Your credit score will not be hurt, but these require special circumstances.
- As a last resort, there is the option of forbearance. This is similar to deferment, but you don't need qualifying circumstances, and it will negatively impact your credit score.
I can pay them… and more! Should I pay them back quickly?
The general advice on this is no, as long as the interest rate is low. This does make sense if you are investing the difference of what you can pay and what you are paying. By the math, you should hang on to them as long as the term allows. Personally, my loan is for 20 years, and I just don't think I want to have them around when I'm in my 40s. Mathematically sound or not, I will be paying them off a bit early, but they are the lowest priority of my financial goals. The Get Rich Slowly philosophy “Do what works for you” certainly applies here.
The most often cited reason for not repaying student loans early is that the interest is generally tax deductible and you don't even have to itemize to take this deduction. Also, if you have a government loan, your money usually can make more for you elsewhere, though there is often more risk involved. If choosing between a Roth/401k or paying off loans early, I would recommend investing in your future.
What about private loans?
Private loans usually aren't low interest, and they don't have as many nice benefits as federal loans. If you consolidate, you typically aren't locking into a lower rate, just switching lenders. There may be some benefits, but be skeptical and don't consolidate them with your federal loans, as you will lose some important benefits. The best way to handle private loans is to pay them off as soon as possible.
Among the reasons private loans should be repaid as soon as possible:
- You cannot defer payments on a private loan consolidation if you want to go back to school.
- You cannot forbear payments in case of economic hardship.
- You cannot apply for forgiveness on a private loan consolidation.
- If you should pass away, private loans are passed to your next of kin. Federal loans are forgiven.
- Private loan consolidation very often has variable rates, which means you cannot lock in today's current historic low rates. Those rates may be tied to volatile indexes like the Prime Rate, which can jump as high as 13%.
My private loans were somewhere around 8%, and I paid them off in about six months. I focused all of my financial energy on them, and even did a balance transfer to a 0% interest card, but paid it off as quickly as I could.
For more information on anything about student loans, visit FinAid! This site is excellent and should answer all of your questions.
You can read more from SJean at Stacking Pennies.
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