Five Options For Grads With Student Debt But No Job
David K. Randall, 05.28.10, 3:00 PM ET
Taking out student loans is as common among college students as posting pictures on Facebook. But as recent graduates try to find their gainful employment at a time when one in five under-24-year-olds is unemployed, making monthly payments on student loans can range from tough to impossible.
True, the Department of Education requires that students sit through a counseling session before taking out a federal loan. But these sessions often amount to little more than a 10-minute Web tutorial and multiple-choice quiz. By the time students reach graduation, many have forgotten what little they may have learned.
With that in mind, here’s a crash course in student loan repayment.
Why Repay? Quite simply, because you have to. That’s not a moral statement but a factual one. Student loans are one of the stickiest types of debt around. Unlike credit card debt, mortgages and most business loans, the money you owe on your student loans won’t be forgiven, even if you file for bankruptcy.
If you don’t pay, a damaged credit score will haunt you for years. You’ll find it hard to get a mortgage, car loan or even a credit card. What’s more, student lenders can go after your tax refunds or garnish your wages. If your parents co-signed for your loan, their assets may be in jeopardy too.
Here, then, are the most common ways to repay your loan, in order of increasing unpleasantness:
Repay as Scheduled
This is the best-case scenario. You get a bill every month, pay it and eventually the entire balance is retired. In the meantime you’ll likely get a generous tax deduction for the interest you’re paying. Some lenders, like JPMorgan Chase and Wells Fargo, will cut your interest rate after you make a certain number of payments on time. Others will reduce rates if you sign up for automatic withdrawals from your checking account. Few private student loan originators charge pre-payment penalties, so you can pay off the loan early and save on interest costs.
Consolidate Your Loans and Lengthen the Payment Schedule
Consolidation is a way to package multiple loans into a single payment. Unfortunately it is unlikely to lower the interest rate you pay on federal loans. If you have private loans, you’ll need to consolidate those separately.
The standard repayment plan for federal loans is 10 years. If you consolidate you’ll be able to qualify for extended repayment, which is exactly what it sounds like. You can stretch out the payments on federal loans to as long as 30 years, depending on how much you owe (You’ll need to owe more than $60,000 for the 30-year plan; owe less than $20,000, and you’ll have 15 years.) The downside: You end up paying more interest over time.
Here’s an example of how extending the repayment period works. Say you owe $25,000 and are paying 6.8% interest. For a standard repayment plan you’ll owe $287 a month and pay about $34,000 over 10 years. Stretch it out to 20 years, however, and you’ll lower the payment to $190 a month but will end up paying about $45,000 overall. If you want to see how extending the repayment option will affect you, check out this calculator from FinAid.
If you’re having trouble making your payment now, you may want to extend the schedule, then pay more than your monthly payment once you start making a higher salary.
This is only available for federal loans and caps monthly payments at 15% of the amount by which your income exceeds 150% of the federal poverty level (that currently works out to $16,245 for an unmarried individual).
Let’s say you have an adjusted gross income of $30,000. That means your pay exceeds 150% of the federal poverty level by $13,755 a year, or $1,146 a month. Under income-based repayment, you’d owe 15% of that amount, or $172, per month, regardless of your total outstanding loan balance.
Any debt that you haven’t repaid after 25 years will be forgiven. That’s not as great as it sounds. The federal government will regard the forgiven balance as income. If you have $10,000 forgiven, Uncle Sam will expect you to pay federal taxes on that amount of income. Those who work in public service can have their debt forgiven after 10 years and won’t have to pay taxes on any forgiven balance. (For an estimate of how much you’ll owe under income-based repayment, check out this calculator from Forbes.)
Deferment or Forbearance
Here’s where we get into what happens when you struggle to pay back your loans. The first, best move is to talk with your lender and explain your situation. You may want to ask for a deferment, which can be granted for reasons like economic hardship, unemployment or graduate school. Under a deferment your lender allows you to skip payments, generally for up to one year. Interest may accrue during this time, however, and can be added to the principal once you resume making payments.
Like deferment, forbearance results from your reaching an agreement with your lender that allows you to skip payments for a set period of time. Interest continues to accrue on all types of loans during this period.
The big difference is that with forbearance the period in which you are not making payments counts toward the total counted in your repayment period. Why should that matter? Say you agree to repay the loan in 10 years, but go into forbearance for your first year out of college. Even though you aren’t paying, the date by which you’re on the hook to finish repaying your loan won’t change. Your payment schedule will be adjusted with the aim of having you pay off the entire amount by the original deadline. To get there, you’ll have to make bigger monthly payments or a large lump-sum payment at the end of the period.
You will default on your federal loans if you haven’t made any payments in 270 days (private lenders have their own time frames, but they are generally half of the feds’). Avoid defaulting at virtually all costs.
Should you default, your loans may be turned over to a collection agency, your wages may be garnished, your credit score will plunge, you’ll be ineligible for deferments and you may be barred from renewing a professional license.
Despite such nasty consequences, the weak economy is forcing more former students to default. The Department of Education currently expects close to 7% of all federal loans to go into default–nearly double the rate of a few years ago. Sallie Mae and Citigroup, meanwhile, have seen the default rates on their private loans almost double to about 3%.
If you have defaulted, you’ll need to make arrangements with your lender for a loan rehabilitation plan. Lenders may offer to reduce your monthly payment. Generally you’ll need to make at least nine out of 10 payments voluntarily and on time during your rehabilitation period for your lender to consider your account in good standing.
If you aren’t able to make those payments, your loan may be turned over to a collections agency. Then you’ll be stuck not only paying the amount you owe, but also the collection agency’s costs, which can be as high as 40% of your outstanding loan balance. Ouch.