No one loves the idea of student loans. But they're often a necessary evil—the only option for financing college, which (despite some debate of late) remains the best route for good jobs and rewarding careers. That being said, there are smart ways and not-so-smart ways of borrowing money.
Below are six major student loan faux pas to avoid—before you get the money, while you have the money, and after you have to start paying the money back.
- Don't lie on your student loan application.
- Use your student loan money for educational essentials, not extras.
- Choose a repayment plan with the highest payments and the shortest term that you can afford.
- Look into refinancing your loan or consolidating multiple loans.
- Don't skip loan repayments, even if you intend to "make them up" the next month.
- Avoid defaulting on your loan at all costs; contact your lender if it looks like you can't make your repayment.
1. Falsifying Your Application
Lying on your student loan application is the first misstep you can make. Get caught misrepresenting anything (and there's a high possibility you'll be busted, as some schools audit all financial aid applications), and you'll not only lose your loan and incur fines, but you may also be charged with fraud and be sentenced to prison—where you'll receive your education for free, but likely not the prestigious degree you were hoping for.
2. Spending Money on Wants, Not Needs
Using loan money to pay for an education that will be with you forever is good debt. Using loan money to buy the latest mobile phone or ultra 4k TV that will be obsolete a decade before you're done paying for it is very bad debt.
An occasional splurge is ok—you're only human—but mortgaging your future to pay for the fleeting pleasures of today is poor money management. You either don't understand how to differentiate between needs and wants, or you just don't want to make those tough decisions.
In other words, when employing these funds, think tuition, not treats; budget for books, not booze. And if you receive a higher loan amount than what you actually need to survive, save the excess cash in the highest interest savings account you can find, and use it to begin paying back your loans when you graduate. Or see if you can apply the funds to interest payments on the loan, even while you're still in school.
3. Choosing the Wrong Repayment Plan
It's tempting to choose the repayment plan that demands the smallest monthly sum. But the payment plan with the lowest monthly payment also has the longest repayment term, which increases the total interest you will pay. Income-based or “Pay As You Earn” plans sound great—who wouldn't want to have 25 years, rather than a decade, to settle a debt?—but they ultimately cost you more overall. Basically, you should opt to pay the highest amount you can afford each month.
So what is that? Some experts suggest that your monthly student loan payment should be no more than 10% of your expected salary. Start by calculating your monthly loan payments (including interest) based on a 10-year repayment schedule—which tends to be the standard option.
If your loan payments will be higher than 10% of your pay—we all know about entry-level salaries—then consider a longer, less expensive program. But promise yourself you'll take another look if and when your financial situation improves.
4. Overlooking Refinancing
Speaking of taking another look, if there's been a significant drop in interest rates, look into refinancing your loan. What was a competitive rate years ago might be on the higher side now. Or, if you’ve taken out multiple loans, consolidating them can lower your monthly payment and reduce the total amount of interest you’ll pay.
Of course, interest rates and loan terms can vary considerably among lenders. Be sure to compare and crunch the numbers carefully to make sure you are, in fact, getting a better deal. If you have a federal student loan, bear in mind that, by refinancing, you are exchanging it for a private loan. That means you are exiting the federal loan program and its income-based or loan forgiveness options. But those plans might not be feasible for you, anyway.
Even if you can't refinance the entire loan, it's not against the law to make an extra payment from time to time or to pay more than the minimum amount each month. Even the occasional gesture can add up, shortening the lifespan of your loan. Just make sure your student loan servicer applies the additional payment or amount to your principal balance, thus impacting the interest, vs just applying it to the next month's payment.
5. Missing Payments
Many a student has bounced a payment with the idea of paying double the next month. That's a big no-no. Every missed or late payment is a black mark on your credit report that'll ding your credit score, whether you catch up that payment or not. And it can stay on your credit history for years, affecting your ability to take out other loans.
If your repayment schedule is more than you can handle, talk to your lender to find a solution before you start skipping monthly payments.
6. Defaulting on Your Loan
Failing to make payments on your loan for more than 270 days will send your loan into default, and your financial life into a tailspin. Don't dodge your lender. They will find you, and the penalties for non-payment are steep. Unlike credit card companies, who really can't do more than threaten, the federal government (the loan guarantor on most student loans) has the ability to keep your income tax refund or garnish your wages to pay back the loan, plus any collection costs.
Again, before you get into dire straits, contact your lender or loan servicer. If your problems stem from unexpected misfortune—like being laid off—you might be able to work out a deferment or forbearance arrangement to buy some breathing room. But just stopping payments, without explanation, is the worst thing you can do.
The Bottom Line
A student loan is often the first large sum of money a young adult must manage themselves. Avoiding common money mistakes when it comes to financing your college education is crucial to graduating with only good debt, and as little of it as possible.