Learn how to manage what you owe
How did U.S. students rack up a staggering $1.5 trillion in college debt? The answer is shining a blinding light on the need for financial education. One of your jobs while pursuing higher education is to fully understand how student loans work. That means sharpening your financial literacy both to avoid unnecessary debt and to position yourself to comfortably repay your loans once you’re out of school.
According to a 50-state study by the online platform LendEDU, the median student loan debt per borrower rose by $9,047 between 2007 and 2017. “Whether you look at it on the local school level, state level, or nationwide level, student loan debt has changed dramatically over the past decade, and most of that change has been in the negative direction,” says LendEDU analyst Michael Brown. “The situation has worsened the most for students attending public schools and historically black colleges and universities.”
A number of factors have contributed to the escalating student loan crisis, but the key causes include borrowing more than necessary, agreeing to unfavorable loan terms that result in unmanageable debt, and failing to make a realistic repayment plan.
COMPOUND INTEREST 101
Compound interest involves charging interest on interest, according to financial advisor Joe Arns, who cautions that debts based on compounded interest can increase to amounts that are significantly higher than the original loan. Arns says all borrowers need to understand interest basics.
Simple interest is based on the principal of a loan. If your student loan balance is $10,000 and the annual interest rate is 5 percent, the simple interest due after one year is $500 ($10,000 x 0.05). Compound interest is based on the overall loan balance, including both principal and accrued — but unpaid — interest. When the interest isn’t paid as it accrues, it can be “capitalized,” or added to the balance of the loan. If your loan balance is $10,000 at a 5 percent rate and the interest after one year is capitalized, the new loan balance becomes $10,500 ($10,000 + $500) and the interest accrued in year two is $525 ($10,500 x 0.05).
KEEP COSTS AND LOANS DOWN.
Experts agree that before borrowing, you should investigate all your other financial aid options, stick to a strict education budget, and borrow only what’s needed to cover your expenses. Here is some guidance for keeping costs under control.
Complete your Free Application for Federal Student Aid (FAFSA). The FAFSA will determine your eligibility for need-based financial aid such as federal grants, student loans, and work-study jobs. The form should take less than an hour to complete once you’ve gathered the necessary information. Even if you’re unsure whether you qualify for aid, you should complete the FAFSA so you don’t miss out on government help. “It’s a good idea to submit the FAFSA as soon as possible after October 1 because some colleges award their aid on a first-come, first-served basis,” advises Anna Serio, a student finance expert at Finder.com. “You will also be in a better position to plan because you’ll find out where you stand for aid awards faster and may receive financial aid award letters from schools earlier.”
Carefully evaluate your school choice. The school you decide to attend will be a significant factor in determining your college costs, so it pays to comparison shop. According to the College Board, the average cost of tuition and fees for the 2017–2018 school year was $34,740 at private colleges, $9,970 for state residents at public colleges, and $25,620 for out-of-state residents attending public universities.
If you want to attend college but aren’t ready to make a big financial commitment, consider attending community college first, then transferring to a four-year university. Another increasingly popular option is heading north to Canada, where tuition can be cheaper. “Most of the universities in Canada are publicly funded, which helps keep tuition down while offering a high-quality education,” says Melanie Howard, director of Aboriginal Access to Engineering at Queen’s University in Kingston, Ontario. (If you’re a Canadian student, she recommends the Canadian nonprofit Indspire for resources on Indigenous scholarships.)
Be a disciplined borrower. When you build a budget, be sure to include all school-related expenses. Beyond tuition, that means books, technology, transportation, food, health care, and housing if you’re attending a school away from home. Once you have a clear financial picture, assess the full range of possibilities for generating funds. Have you applied for all the grants or scholarships available to you, including from your tribe? Can you find any internships or part-time jobs to help cover expenses?
Your financial aid package will likely have a loan component, and this amount might be larger than what you actually need. Remember that you will be paying back whatever you borrow with interest. A good rule to follow is borrowing a total amount that would keep payments to approximately 10 percent of your estimated monthly income after college. You can use a student loan calculator on a website such as NerdWallet.com to estimate loan payments.
FIND THE RIGHT LOAN AND TERMS.
Finding the right student loan can be an intimidating process, so let’s start with the basics. Generally speaking, it’s good to have a low interest rate, multiple repayment options, and borrower protections. The lingo can be dizzying, so here’s a breakdown.
FEDERAL LOANS
Federal loans have fixed interest rates that are usually lower than those for private loans. Repayment options include income-driven repayment and certain opportunities for loan forgiveness.
Direct Subsidized Loans
• For undergraduate students with financial need
• Your school determines the amount you can borrow
• The U.S. Department of Education pays the interest while you’re in school at least half-time, for the first six months after you leave school (known as a “grace period”), and during any postponement of loan payments (known as a “deferment”).
Direct Unsubsidized Loans
• For undergraduate and graduate students
• There is no requirement to demonstrate financial need
• Your school determines the amount you can borrow and you are responsible for paying the interest for the duration of the debt.
• If you don’t pay the interest while you’re in school, during the grace period, or in any period of deferment, your interest will accrue and be capitalized (added to the principal amount of your loan) — a situation you should try to avoid.
Direct PLUS Loans
• Based on college costs and financial aid rather than financial need
• Interest is added to the principal amount of your loan at all times, with the exception of an optional six-month grace period after you leave school.
PRIVATE STUDENT LOANS
Private student loans are offered by lenders such as credit unions, banks, and online platforms. Two primary benefits of private loans are that (1) you may qualify for a higher borrowing limit and (2) with excellent credit, you may qualify for a lower interest rate. If you’re considering a private loan, take these factors into account.
Interest will accrue immediately, and rates vary. If you shop for a private loan, you may be able to choose a fixed or a variable interest rate. While a fixed rate remains the same throughout the life of a loan, a variable rate is just like it sounds. It may be lower than a fixed rate initially, but could increase or decrease over time depending on the federal interest rate.
You may need a cosigner. Because the majority of private student loan borrowers don’t have an established credit history, they need a cosigner (someone who will be responsible for paying back the loan if you don’t or can’t). Often a qualified cosigner will increase your chances of approval and may help lower your interest rate. If you have a cosigner, ask the lender about a release that will allow the cosigner’s credit to be cleared of the debt after you make a designated number of loan payments.
Online tools can help you compare rates and terms. Numerous online platforms offer free comparisons of loan options, including BankRate.com, StudentLoanHero.com, and Credible.com. In addition to looking at interest rates, check out the lenders’ options for temporary relief from payments if you experience financial difficulty due to job loss, medical leave, or other unexpected circumstances.
GET ON A REPAYMENT TRACK THAT WORKS FOR YOU.
So you’re out of school, the grace period has expired, and your monthly loan payments are due. Experts urge planning over panic. Take an inventory of what you owe and mark the due dates on your calendar. It’s also a good idea to set up regular, automated loan payments to help build your credit history. Here are a few more steps you can take, depending on your financial health.
Be strategic about the grace period. Making interest payments during this time will keep your loan balance from increasing. However, if you need the time to get your financial house in order, work to set aside a few monthly payments so you can remain in good standing with your lender, even if you have a rocky month or two down the road.
Speed up repayment when you can. Every time you make more than the minimum monthly payment, you reduce the principal, pay down the debt faster, and save money on interest. Before paying more, check if there are prepayment penalties in your lender’s fine print.
Unexpected setback? Look into your borrower protections. If you meet the eligibility requirements, deferment or forbearance allows you to temporarily stop making payments or reduce your monthly payment amount for a specified time frame. With deferment, you may not be responsible for paying interest that accrues on certain loans during that time.
Struggling to make payments? Consider refinancing or consolidation. Federal loans can be consolidated through a Direct Consolidation Loan. Refinancing with a private lender might save you more money, depending on the terms. “If you’re struggling to make payments, refinancing through a new lender can help you save down the road,” advises Finder.com’s Serio. “While it won’t lower your debt, it could potentially lower your interest rate or give you more affordable monthly repayments.”
Look into loan forgiveness. In some cases, borrowers can qualify for loan forgiveness. Under the Public Service Loan Forgiveness (PSLF) program, you could eliminate some of your federal student loan debt. The program releases the obligation to repay federal Direct Loans for borrowers who’ve made 120 qualifying monthly payments while working for a government or not-for-profit organization. For more details, visit studentloans.gov.
