Paying for college: Managing debt after school (Part 3 of 3)

Children, Education, Family/Kids, Money

The first article in this series covered how to pay for college before going and the second covered how to pay while attending. In the third and final installment, we look at how to pay for college after graduating, by handling student loan debt.

Know what you are dealing with

The first thing to do is to assess what you are dealing with, says Tisa Silver Canady, the associate director of financial education and wellness at the University of Maryland, Baltimore. “Don’t wait until graduation to take a look at your student loan history,” she advises.

Visit the National Student Loan Data System website or to see a list of your federal loans; contact the lenders of your private student loans to get information. In addition to knowing the balance of each loan, Canady recommends keeping track of each loan’s grace period, early payment policy, and options for forgiveness.

Once you have a clear picture of what you need to pay back, consider ways to reduce, discharge, suspend, consolidate and manage debt, and take steps to prevent defaulting on your loans.

Reducing or eliminating student loan debt 

Certain borrowers with federal loans can take advantage of programs offered by the government to reduce student debt or eliminate it altogether.

Borrowers who secure jobs in teaching, the military or the public sector may qualify for student loan forgiveness programs, which can significantly reduce the life or size of the loan.

Loans will be discharged entirely in limited number of extreme circumstances, like upon closure of the borrower’s school or upon death of the borrower.

Individuals with parent loans for undergraduate students, or PLUS loans, should note that the death of the child is grounds for a discharge, as is parental death or permanent disability. Some other considerations, such as cases involving deception or school closure, may qualify for a complete or partial discharge. Otherwise, the loan must be repaid even if the child did not complete his or her education. 

Putting payments on hold 

Even if you do not qualify for loan forgiveness or discharge, you may qualify for deferment or forbearance.

Deferment allows the borrower to suspend payment on the loan for up to three years while attending school, serving in the military, participating in the Peace Corps or during a period of unemployment or economic hardship. For certain loans, the federal government may even pay the interest while payment is deferred.

For borrowers who do not qualify for deferment but nonetheless cannot pay their loans, forbearance may be an option. Forbearance allows the borrower to suspend or reduce payments for up to 12 months. The federal government does not pay interest in cases of forbearance, so interest will continue to accrue.

Forbearance may either be discretionary, meaning that the lender can decide whether or not to allow it based on circumstances, or mandatory, meaning that the lender must grant it. Borrowers with private student loans can sometimes negotiate for forbearance, but the suspension of payments typically only lasts 2 to 3 months. 

Whatever the circumstances, borrowers must apply for these programs and continue making payments until they know that the deferment or forbearance has been approved.

Consolidating student loans

When it comes to consolidation, federal loans and student loans operate differently.

Consolidating multiple federal loans in a direct consolidation loan simply combines separate loans into one, making repayment more manageable for borrowers who may have graduated with a dozen or more separate loans. Instead of making multiple separate payments every month, they can make just one.

The drawbacks include losing eligibility for some programs or benefits or increasing the total amount of money paid if payment terms are extended. Look into all the consequences for your situation before proceeding.

Consolidating private loans is similar to a regular consolidation, where a new loan is procured and a new interest rate is calculated based on the borrower’s current credit score.

The best time to consolidate private loans is a few years out of college, says Mark Kantrowitz, senior vice president and publisher of Edvisors. By then, as long as the borrower has maintained good financial habits like paying debts on time and managing credit responsibly, his or her credit score will be higher than it was upon graduation, and he or she will be more likely to receive a favorable interest rate on the new loan.

Make sure to do the math, counsels Kantrowitz. “Consolidation isn’t always a money-saving proposition,” he warns. If you have multiple loans with very different rates, consider paying off the loan with the highest debt separately and consolidating the others, he suggests.

Since you must apply to determine the rate you would get and since the application is not binding, the first step is to apply for consolidation. Next, run the numbers on a student loan repayment calculator. Compare the overall amount to be paid if all loans were included in the consolidation to the amount for separate payment of the high-interest loan and remaining loans. See which option comes out to your advantage.

Managing student loan debt

Adopt a strategy that works for credit card debt and student loan debt alike: pay off the loan with the highest interest rate first, says Kantrowitz. After making minimum payments on all your loans, apply extra money to the highest interest rate loan to pay it off more quickly. Note that the federal government does not charge fees for early repayment.

“It’s a good idea to include a cover letter with the extra payment to the lender,” suggests Kantrowitz. Indicate the exact loan you want the money applied to and clarify that it should be applied as an extra payment to the principal. “If you don’t tell the lender, they’re going to treat it as next month’s payment,” he warns.

Kantrowitz also suggests saving money by making a student loan interest deduction on your taxes and by using an auto-debit method to make your payments. Many lenders, both federal and private, provide an incentive for borrowers to make automatic payments by reducing interest rates by 0.25 to 0.5 percent. 

Choosing smart repayment terms

The standard repayment plan for federal loans lasts ten years and saves borrowers the most money in the long run. However, the monthly payment is also the highest. For that reason, borrowers who think they may not be able to sustain the monthly payment should consider alternatives like the extended repayment plan or various income-driven repayment plans.

Income-driven repayment plans, namely the income-based repayment plan, the “Pay as You Earn” repayment plan and the income-contingent repayment plan, do not look only at the amount of money borrowed but also take into account the borrower’s household and financial circumstances.

A formula determines the new, lower monthly payment, which is usually somewhere between 10 to 20 percent of discretionary income. The new repayment terms last for 20 to 25 years, after which any remaining outstanding debt is discharged. Be sure to note that because the repayment term is so long, these plans cost more in the long run due to accrued interest.

The terms of these payment plans are closely tied to life circumstances such as marital status and adjusted gross income and, therefore, can change often. “If you have some type of substantial changes to your income or your household, you should call your loan servicer and let them know so they can rerun the formula,” says Canady. The formula is also set to automatically run every 12 months to accommodate for changes. In the meantime, if you have extra money, you can apply it to your loan debt and accelerate the repayment process without penalty.

Reyna Gobel, Forbes education contributor and author of “CliffsNotes Graduation Debt: How to Manage Student Loans and Live Your Life,” agrees that borrowers should not be so quick to accept the federal standard repayment plan. She sees many new graduates eager to pay off student loans as quickly as possible, but they may not realize that committing to the high monthly payment will stretch their budget too thin.

Instead, new graduates should take time to figure it out. “Practice making payments until your grace period is over,” suggests Gobel. This helps you look at your budget and determine a realistic amount of money you can pay every month, giving you the knowledge to pick the repayment plan that will work best for you. 

Avoiding Default

The default rate on federal student loans is somewhere between 9.1 and 14.7 percent, depending on the cohort of graduating students, according to the Department of Education.

Like other kinds of default, student loan default can wreak havoc with your credit score and have long-lasting effects on your ability to borrow. It can also damage you professionally. In addition, student loan debt is one of the few kinds of debt that cannot be discharged in bankruptcy, except in very rare cases.

Defaulting on a federal student loan is a bad idea, says Canady. “With federal student loan debt, there are so many ways the government can make things difficult for you. It’s not like skipping out on a credit card bill.”

Some of those ways include garnishing 15 percent of your wages, withholding tax refunds and terminating eligibility for many of the debt payment programs listed above. Upon default, the entire loan with interest is due immediately. Collection agency charges of up to 18.5 percent are added to the outstanding balance as principal, which can add thousands of dollars to the overall cost of the loan.

The good news is that the federal government makes it easy to stay away from defaulting by offering many options for repayment, suspension and discharge. For a loan to go into default, it takes 270 days of non-payment on a loan paid monthly and 330 days of non-payment on a loan paid less frequently.

Private loans are not nearly as forgiving. They generally go into default after a single missed payment. Private lenders can sue you for the money you owe and if they win, they can garnish your wages and take other actions against your accounts.

But, despite all this, defaulting is not the end of the world. Gobel defaulted on a loan after she forgot to include it in her consolidation. She graduated with 16 separate loans and says she simply lost track. After nine payments, the default came off her record.

Gobel believes that it is important for people with student loan debt to know they have ways to get out of student loan default, including loan rehabilitation or consolidation, and the option to pick the repayment plan that best fits them.

Getting help

With so many options, it is hard to know where to start. “Don’t be intimidated by the wealth of information on the federal government’s website,” stresses Canady. She says you can likely figure out how to tackle your debt on your own with some focused reading. “The information is all there,” she reminds.

You can also turn to your financial aid officer if you need advice or contact your alma mater to see if they offer student loan repayment counseling for alumni. Borrowers with private student loans can contact their lenders directly to discuss repayment options. Stick with your payment plan, and in time, you will have paid off your debt.

And what to do when that glorious debt-free day arrives? “Don’t give yourself a raise,” says Sean Moore, certified financial planner and president of SMART College Funding. Instead of spending the money on a lifestyle upgrade, consider taking the monthly payment and putting it into a 529 plan to start saving for the next generation’s education.