More than 40 million Americans currently carry college debt, and there are more than 30 million households with children under 18 who will likely apply to college. Today, the average college student graduates with a staggering amount of accumulated debt. Very few students–less than 20%–are able to complete their post-secondary education without amassing some level of student loan debt.
The average student will graduate with a whopping $40,000 in student loans, but for those who pursued graduate or higher degrees, switched majors, or went back to school, that number can be significantly larger. In fact, according to the Federal Reserve Board Survey of Consumer Finances, almost 19% of borrowers owe $50,000 and above with 5.6% owing over $100,000. (For more, see: Student Loan Debt: What Every Borrower Should Know.)
In order to deal with the student debt issue, it can be a wise choice to establish a plan for repayment. This can be a daunting exercise as all loans are not created equal and it is not just a simple decision about refinancing to a lower rate. Below I have laid out some of the parameters that need to be addressed to identify what kind of loan you have and then some of the options available for repayment.
1. Take Advantage of Your Grace Period
Depending on your loan type, your lender may have granted you a grace period after you graduate (or stop attending the college) where you don’t need to make any payments towards your loan. Avoid the tempting option of simply ignoring your debt during this period. If you still have the luxury of a grace period, now is the time to fully understand your loans, make a game plan and if possible, start making those payments you’d normally be making anyway. For example, if your loan payment is going to be $250 per month, take that $1,500 at the end of six months and apply it towards your loan. Not only will it reduce your loan, but you’ll already be in the habit of putting that $250 aside.
2. Understand Your Loans
Even if your grace period is long gone, the first step in dealing with your student loans is to really understand what you’re dealing with. (For more, see: The World of College Rebate Programs.)
Federal vs. Private Loan Costs
- Federal student loans - There are two major sources for student loans, the federal government and the private sector. Federal student loans should be every college student’s first choice. Federal loans can have lower interest rates than their private sector counterparts, and offer much more student-friendly repayment options. Many federal loans also offer deferment plans, which allows for a grace period following graduation before the borrower must begin repayment. That being said, not all college-bound students will qualify for a federal loan. Federal student loans are determined on the basis of financial need and not all students will meet the criteria. Even those students who do qualify for federal loans may find that they are still left with a significant amount of unmet need. That’s where the private, or alternative, loan comes into play.
- Private student loans - Unlike federal loans, private student loans are decided solely on the basis of credit history. This can present a problem for many college students, as they may have little or no credit history to show for themselves. Many private lenders will allow students to engage a cosigner, either a parent or a guardian with a solid credit report, in order to secure the necessary loans for college. Private student loans come at a higher cost than federal loans. They typically have higher interest rates, application fees, penalties for early repayment, and much more restrictive repayment options. While private lender student loans help thousands of students every year find the money they need for college, they can place a significant burden on borrowers.
Students are advised to pursue federal student loans before considering any private lender loan agreements. Unfortunately, due to a lack of proper financial aid guidance, many students turn to private lender loans before exhausting all of the federally supported financial aid opportunities. Before taking on any high cost private students loans, be sure to apply for any government sponsored financial aid programs for which you may be eligible. (For related reading, see: Using 529 Plans to Save for College.)
It’s easy to turn your brain off, make your minimum payment (if you can even afford it) and go on. But to actually make an impact, you also need to know how your loan works. Here’s how to understand your student loan debt.
Step 1: Find your loans
It would seem crazy to someone that never had a student loan, but yes, it is very possible and extremely common to not be aware of all your loans after graduation. Since you can’t go back in time to tell 18-year-old you to keep track of every detail of each loan you take out, you’ll have to put in the leg work now. For starters, check the National Student Loan Data System to find any federal loans. To check what you owe to private lenders, contact them directly. Another option is to order a free copy of your credit report to see who your lender is.
Step 2: Understand your payment options
Some loans offer the chance to switch to a payment plan based on what you’re earning. If you’re unable to make your payments at all, you can apply for a temporary deferment.
Step 3: Familiarize yourself with each loan’s details
If you’re dealing with multiple loans, as many people are, then try to first tackle the loan that you’re paying the most interest on every month. Besides the interest rate of each loan, understand what the minimum payment will be and which loans would qualify for things such as a deferment, loan forgiveness, and a better payment plan. (For more, see: The Advantages of Automating Your Financial Life.)
3. Choose Your Best Payment Plan
As I mentioned above, you could have the option of choosing a better payment plan, such as an income-based repayment or pay-as-you-earn. These options give you a more manageable minimum monthly payment based on what your current income is. You may also wish to explore student loan consolidation if you are having difficulty keeping track of multiple loans at once. (For related reading, see: How to Use Your Credit and Debit Cards Safely.)
Let’s examine the menu of repayment terms available with many student loans. Keep in mind that arrangements to pay smaller amounts will cost more in the long run.
Monthly payments often can be lowered for students entering jobs with low salaries or for parents who may still be paying tuition bills for other siblings.
- Income-Based Repayment (IBR). With IBR, payments are capped at 15% of the borrower’s discretionary income and can be as low as zero for those below 150% of the federal poverty level. Any excess interest is capitalized, with no maximum limit on negative amortization, but any remaining balance is forgiven after 25 years. This was cut to 20 years and a 10%-of-income cap for new borrowers starting July 1, 2014. In order to qualify for IBR, the borrower must have a “partial financial hardship.”
- Pay As You Earn (PAYE). Under PAYE, a student loan borrower’s monthly payments are capped at 10% of discretionary income. Again, excess interest may be capitalized in some circumstances (but is capped at up to 10% above the original principal amount). Also similar to IBR, if the borrower still has a balance after 20 years of payments, the balance is forgiven. PAYE is a more recent program and older student loans may not be eligible.
- Revised Pay As You Earn (REPAYE). REPAYE has terms similar to PAYE, where monthly payments are again capped at 10% of income, and it again allows forgiveness after 20 years (or 25 years for graduate school loans). However, negatively amortizing interest charges with REPAYE accrue at only 50% of the unpaid interest and capitalize only if you leave the REPAYE program.
- Public Student Loan Forgiveness (PSLF). One challenge to IBR, PAYE and REPAYE is that any loan balances that are forgiven are taxable income to the borrower at that time. However, the PSLF program, which can apply on top of any of these programs, turns the forgiven loan from being taxable to non-taxable, and loan forgiveness periods can be as short as 10 years. However, PSLF is available only to those who work full time in the public sector, which generally means working for the government, a 501(c)(3) charity or certain other qualifying non-profit organizations.
Online Private Repayment Options
Cyber lenders may offer better rates on some loans, but you may still face higher payments if you refinance fixed-rate loans into variable-rate ones. This is especially true if your credit score drops or you lose a job. Remember that it may not make sense to eschew federal repayment options to refinance into a private loan – even if the rate and monthly payments are lower.
Once a client leaves the federal program by choosing private financing, the flexibility of repayment options is lost, as is the likelihood that certain kinds of loans may be forgiven.
Here are some online private lending providers:
- Citizens Bank: Current rates range from 2.8% to 7.9%.
- CommonBond: Offers phone support. Rates range from 2.1% to 7.5%.
- DRB: Rates range from 2.1% to 3.5% with programs focused on professional/graduate loan repayment.
- Earnest: The portal offers a dashboard for monitoring loans and offers rates from 2.1% to 3.5% APR.
- LendKey: Also refinances home loans. Student refinancing rates range from 2.1% to 3.5%.
- SoFi: A broad-based portal that goes beyond student debt. Rates range from 2.1% to 7.5%.
4. Deduct Your Student Loan Interest
Once tax season rolls around, don’t forget to deduct your student loan interest. You can reduce your taxable income by up to $2,500 on any interest you’ve paid for that tax year. Your lender should send you this information, but you can also request it or get it online. It may not make a huge difference, but any little bit helps.
5. Get Help At Work
A number of companies, including Fidelity Investments and PwC, are offering help to pay down student debt. This is becoming a more mainstream perk and is worth looking into with your current employer and keeping in mind if you are looking for a job. While only about 3% of employers are offering this assistance now, it will gain steam as companies work to attract and retain Millennial workers carrying heavy debt loads.
This list does not cover every option available and there are more considerations regarding refinancing student loans. The intent was to provide a road map and plan of attack. The worst thing to do with college debt is to ignore it. It will damage you credit score and make future debt management even more difficult. (For more, see: 3 Financial Planning Questions for 30-Somethings.)