7 tips for dealing with college debt
Now that you have the degree, learn the best ways to repay student loans
If you're a new college graduate or about to become one, you've probably figured out what your first job will really be: figuring out how to get out from under tens of thousands of dollars in student loans.
Seven in 10 college graduates borrowed money to get that degree, with an average student loan debt of $29,400, according to a report from the Project on Student Debt at The Institute for College Access and Success. Total student loan debt in the United States has soared to $1.2 trillion (that's 12 zeros) and now exceeds both credit card debt and auto loan debt. But don't let that debt crush you.
"Don't panic. You're not going to have to pay this off tomorrow," says Reyna Gobel, author of "CliffsNotes Graduation Debt: How to Manage Student Loans and Live Your Life."
If you can slip back into student mode just a bit longer, you can learn how to pay off student debt as easily as possible. Class is now back session -- with seven lessons for student loan repayment.
1. Start saving during your grace period.
Depending on the loan, you may not owe payments for six months for federal Stafford Loans, or nine months for federal Perkins Loans. There's one caveat: interest on the subsidized Stafford Loan begins accruing during the grace period, says Mark Kantrowitz, senior vice president and publisher of Edvisors Network and author of "Filing the FAFSA."
On other loans, including private loans, terms vary, so it's important to check with your loan servicer. But overall, "This is a great time to look at all the repayment options and really figure out what you can afford," Gobel says. During your grace period, use a online student loan calculator to see how different repayment plans would affect your budget. Then start making pretend student loan payments ... into a savings account, Gobel says. Not only do you make room in your budget for your loan payment, but you also build up an emergency fund that can help you stay out of credit card debt, she says. "If your student loan payment would have been $300, you can amass $1,800 in that time," Gobel says. "It's a nice starter."
2. Crunch the numbers: lower payments versus less interest.
Standard repayment for federal student loans involves making fixed monthly payments of at least $50 for up to 10 years. If you can make 10 years work, you'll pay less interest than if you stretch payments over a longer term. "The rule of thumb is, if your total debt at graduation is less than your annual starting salary, you should be able to pay the loan back in about 10 years," Kantrowitz says. "I encourage borrowers to choose the shortest repayment plan they can afford. Let's say you do extended repayment and you increase the term from 10 years to 20 years. The monthly payment will go down by about a third, but the total interest you pay over the life of the loan will more than double." But if your debt exceeds your annual income, you're going to struggle to repay the loan, he notes. "The scariest thing is to try to repay a loan too quickly on a 10-year plan," Gobel says. "Don't worry about how fast you're paying it off. Worry about the affordable payment." If your payment plan is not working for you, call your loan provider and see what programs you qualify for, she says. You are allowed to change plans once a year, she says. "If there's one thing I would tell people, it's 'You have options,' " she says. (Student Aid on the Web, a site from the U.S. Department of Education, offers a list of all repayment plans.)
3. Link payment to your income.
The federal government offers several repayment plans that limit the size of your monthly payments based on your income. Here are some options:
- The Income-Based Repayment plan limits your payments to 15 percent of your discretionary income, defined as the amount your adjusted gross income exceeds 150 percent of the federal poverty level, Kantrowitz says. After 25 years, you're finished paying even if you still owe a balance. If you have loans before 2007, this can be a good option.
- The newer Pay as You Earn plan limits your loan payment to 10 percent of your discretionary income, also defined as the amount your AGI exceeds 150 percent of the federal poverty level, Kantrowitz says. After paying for 20 years, you're done paying. "With Pay as You Earn, your monthly payments can be one-third lower than the Income-Based Repayment plan and your remaining debt can be forgiven five years sooner," Kantrowitz says. But there are restrictions: you have to have at least one loan after October 2011 and no loans prior to October 2007, he says.
- For those who don't qualify for the other two plans tied to income, a third option is the Income Contingent Repayment Plan, Kantrowitz says. But the terms aren't as generous. Discretionary income is defined as the amount AGI exceeds 100 percent of the poverty line; your loan payment will be 20 percent of that discretionary income; and the remaining debt won't be forgiven until you've made 25 years of payments, he says.
"Income-based repayment represents a pretty good safety net for borrowers who are overwhelmed by their federal loans," Kantrowitz says.
4. Serve your way out of debt
For some borrowers in public service fields, there are options for erasing part or all of a federal student loan. Working for programs such as AmeriCorps (options include teaching and working in public health), a year of service now gets you about $5,645 toward your loans, Gobel says. Also, working in certain public service jobs limits your loan payments to 10 years even if you still owe money, Kantrowitz says. Eligible public service jobs include: public school teachers, firefighters, government workers, public librarians, public university professors and employees of nonprofit organizations, Kantrowitz says. The rule of thumb is, if your total debt at graduation is less than your annual starting salary, you should be able to pay the loan back in about 10 years.
You don't want to use [forbearance] because you'd really like to go on vacation.
|-- Reyna Gobel|
5. Get smart about payments
Make savvy decisions about your payments and you can pay your loans off more quickly and save thousands of dollars, experts say. For example, Kantrowitz says, you can diminish your debt by signing up for direct-debt where monthly loan payments are automatically deducted from your bank account. Not only are you less likely to be late with your payment, but many lenders offer slight interest rate deductions (typically 0.25 percent or 0.50 percent) to borrowers who sign up for direct-debit, he says. Next, find ways to pay extra. "Every little bit helps," Gobel says. She recommends looking for painless ways to save, such as trimming $15 off a monthly cellphone bill or shopping for a better deal on car insurance. She also recommends using the SallieMae site Upromise.com when doing regular shopping to get cash back rewards toward your student loan. One borrower, she says, was able to get $300 a year in rewards by booking travel for work and printing and using grocery coupons from the site. "That's a payment a year," Gobel says.
6. Don't overuse forbearance or deferment. Forbearance, which typically is easier to get, allows you to put off or reduce payments for three years or even longer, Gobel says. Deferment allows you to temporarily stop making payments for a certain period in specific situations, such as a return to school, unemployment or having a baby. You must still pay the interest, either during the deferment or forbearance, or later, except for a deferment on a subsidized federal loan. Use these options only if you're in a real jam, experts say. "You don't want to use it because you'd really like to go on vacation," Gobel says. If you do use them, don't overdo it. "I don't recommend using them for more than a few months because interest continues to accrue, digging you into a deeper hole," Kantrowitz says.
7. Be careful about consolidating.
Consolidation can make sense, experts say. For example, if you want income-based repayment and your lender doesn't offer it, if you want a no-hassle way to remove a co-signer from a private loan or if you're juggling many loans. However, keeping loans separate also has benefits. "It allows you to accelerate repayment," Kantrowitz says, by paying down several smaller loans at once rather than making one payment a month toward one large loan. If you're trying to decide which loan to pay extra on right now, though, he says you should add about 4 percentage points to the interest rate of a variable-rate private loan, when comparing it to a fixed-rate federal loan, to factor in future rate hikes. He says: "If you've got extra money, you want to be able to target it to the highest-rate loan. That will save you more money in the long term."
Ultimately, the goal of all seven tips is to avoid default. "You don't want to default on federal student loans because it won't do you any good," says Kantrowitz. He notes that except in rare cases, you can't get rid of student loan debt via bankruptcy. The federal government can intercept tax refunds, garnish as much as 15 percent of your disposable pay without a court order and even take a cut of your Social Security check, he says. "Just the garnishment will be higher than what you would be paying under income-based repayment," Kantrowitz says, "so there isn't any financial benefit to defaulting."
Instead, if you're in serious trouble, Kantrowitz recommends tracking what you spend, then slashing all nonmandatory expenses such as cable, cellphone and restaurant meals, and even moving back in with mom and dad if necessary. He says: "These are tough love types of choices."
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