Going back to school is always filled with anticipation, excitement AND stress. Now, more than ever, stressors about handling the costs of an education are on par with academic challenges. The average 2016 college graduate has $37,172 in student loan debt, creating a burden that lasts long past the college years and often sidetracks important life choices. Overall, student loan debt hit $1.26 trillion in the third quarter of 2016;more than double from 10 years ago.
With over 43 million Americans impacted by student loans, it is a chronic phenomenon which is fast becoming a crisis across all 50 states. The consumption of college debt not only envelopes students but their friends and relatives who co-signed the loans as well.
Print and broadcast media have spotlighted the problem and ways to initially avoid debt. Rightly so. For the majority of students, loans — at considerably large amounts — are an inevitable part of the college experience. However, there isn’t a significant amount of information available on what to do after the deep dive into debt, and more specifically, the identification of strategies to lessen the pay-back load once accrued. Based on The Financial Clinic’s financial coaching experience with 21% of customers burdened by an average of $27,776 in student loan debt, we have developed a few strategies to deal with just that. As a result, our customers have paid off a total of $392,000. It should be noted, however, that these strategies are not one-size-fits all but rather a look at a range of opportunities for ameliorating the student loan burden.
What are the different kinds of student loans?
Simply put, there are two kinds of loans: federal and private. Federal loans include Stafford (FFEL), Grad PLUS, Parent PLUS and Perkins Loans. The records of all existing federal loans are housed in the National Student Data System. They can be accessed by creating and logging in with a Federal Student ID.
It is also important to note that some federal loans are subsidized (the government pays the interest until repayment begins);others are not. Direct Subsidized Loans are available to undergraduate students with financial need, which is determined by taking the cost of attending a school minus one’s expected financial contribution. Perkins Loans are another type of need-based, subsidized loan, and these are available to graduate students as well as undergraduate students. Direct Unsubsidized Loans are available to both undergraduate and graduate students with no requirement to demonstrate financial need. Some agencies (like New Jersey Higher Education Student Assistance Authority or HESAA) present a misleading picture. Through various marketing tactics, such as a name that could easily be assumed to be associated with a government body, they lead students to believe they are offering federal loans, when in fact the loans HESSA offers are private loans. If you are considering taking out a student loan, a good rule of thumb to follow is this: If receiving the loan requires completing any paperwork outside of the FAFSA, forms on www.studentloans.gov, or authorizations through your school, it is most likely a private loan. If you’ve already borrowed loans, and are not sure whether it is federal or private, the best way to find out is to simply call the lender and ask.
Private loans are borrowed directly from a financial institution, rather than a government agency. Interest and loan amounts are market rate and based on credit, not financial need. They are typically offered at less favorable terms than federal loans and usually cover the gap between federal loans and other forms of financial aid, and total education expenses. Anybody who meets the credit and income requirements put forth by the lender is eligible for a private student loan.
Strategies for Holders of Federal (only) Student Loans
First and foremost, one must never miss a payment or default on a loan. Doing so will reduce the repayment options available to the borrower, cost the borrower more in the long run, and negatively affect the borrower’s credit history. If the borrower is unable to make a payment, they must call their lender to make arrangements as soon as possible, because as soon as a payment is missed, the loan becomes delinquent. In the case of short-term relief, the borrower may qualify for a loan deferment or loan forbearance. Deferment is a period of time when the borrower is not required to make payments on the principal or interest of the loan, and no additional interest will accrue on any Direct Subsidized, Subsidized Stafford, or Perkins Loans. Deferments are available for a variety of circumstances and can last up to three years. Forbearance is similar to deferment but with some marked differences, the first of which being the payments may only be reduced, not completely suspended. Additionally, interest will continue to accrue on all subsidized and unsubsidized loans. The factor of whether or not interest will accrue or not generally makes deferment a better option for most borrowers if they qualify for it.
Income-Driven Repayment Plans
Apart from winning the lottery, there are several ways to repay federal student loan debt. By far, the most popular are income-driven repayment (IDR) plans. These plans are available to borrowers who may be delinquent but are not in default. There are a variety of IDR plans: Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Based Repayment (IBR) and Income-Contingent Repayment (ICR). With IDR plans, monthly payments are capped, can start as low as $0/month, and may fluctuate based on a reasonable percentage of income and family size. Debt forgiveness may be available after just 10 years of full, on-time payment for borrowers in the public and nonprofit sectors. For other borrowers, the repayment period may extend to 25 years. Be sure to note, however, that extending one’s repayment plan beyond 10 years will lower monthly payments but drive up the amount of interest paid over the life of the loan. Anyone with an interest in pursuing “public service forgiveness” should enroll with an IDR plan to maximize the amount of student loan forgiven. (studentaid.ed.gov/sa/sites/default/files/income-driven-repayment.pdf)
Direct Consolidation Loan Program (DOE)
All borrowers with federal loans are eligible for consolidating these loans under the US Department of Education’s (DOE) Direct Consolidation Loan program. On the one hand, this can move borrowers with multiple student loans into a single, and more simple, payment plan;lower monthly payments by extending the life of the loan to 30 years;and set a fixed interest rate, determined by the weighted average of interest rates on all previous loans. This particular program also makes the borrower eligible for all federal repayment programs including the IDR plans above.
On the other hand, if the borrower stretches the life of the loan to 30 years, they may end up paying out more loan installments and greater interest over the long term. One may also lose borrower benefits (e.g., discounted interest rates and discharge or forgiveness accommodations) from an existing relationship. Furthermore, if a borrower is interested in consolidation as a way to get loans out of default, it’s important to note that consolidation does not remove negative remarks or accounts of old loans from one’s credit report.
Although defaulting on a federal student loan is by and far something a borrower wants to stay clear of for many reasons (e.g., it does significant harm to a credit score), there are a couple of options for addressing the issue if it occurs, besides the rare case that the borrower is able to repay the full amount outstanding. The most popular choice is to go through a loan rehabilitation program. The program enables the borrower to bring a loan current by making affordable payments over a specified period of time. This is a one shot deal. A borrower cannot rehabilitate a federal student loan more than once. Private loans cannot be rehabilitated.
Loan rehabilitation is for borrowers who need a more flexible, short-term monthly payment schedule and don’t have an immediate need for a “cleaner” credit report. The borrower must make 9 “reasonable and affordable” voluntary payments within 10 months. These payments can be as low as $5/month. As such, borrowers may find more flexibility in this option than with consolidation. The borrower will also become eligible for additional federal student aid after the 6th payment. Loans are not fully out of default, however, until after the 9th payment is made. At this point, all negative information regarding the loans is removed from the borrower’s credit report. In addition to an improvement in credit, after a loan is rehabilitated the borrower is now eligible for all federal repayment options, including the aforementioned income-driven repayment plans.
Additional Options for Federal and Private Loans
Along with the strategies mentioned above for federal student loans, both federal and private student loan borrowers may also refinance or consolidate loans through financial institutions or other lenders. Along with banks, many private companies have recently started refinancing federal and private student loans. However, a federal student loan borrower must be thoughtful about the advantages and disadvantages of doing so. By moving out of the federal loan system, these borrowers should be aware they will lose certain benefits like public service loan forgiveness and, most likely, will not have as many options to reduce payments in case of loss of income. With regards to income, and credit as well, a borrower must be in relatively good standing. Additionally, some lenders require that borrowers have already completed their degree.
For people who are contemplating this path and qualify accordingly, they can save themselves a significant amount of money by reducing existing interest rates. The bottom line is that going private with refinancing or loan consolidation can make good sense for borrowers with an anticipated secure income for the expected duration of student loan repayment and who are not interested in public service loan forgiveness.
In addition to legitimate companies offering refinancing of student loans, there are also many companies (such as Student Loan Assistance Center or Student Debt Relief) marketing “consolidation” services which do nothing more than enroll borrowers into an income-driven repayment plan — and charge the borrowers hundreds of dollars to do so. They advertise the best possible outcome ($0/monthly payments and debt forgiveness after 10 years) as though they are available to every borrower and are programs separate from what is already offered by the Department of Education. However, the reality is the most people will not qualify for $0/month payments or Public Service Loan Forgiveness. Borrowers should never pay to enroll in any type of repayment program and should know that if something sounds too good to be true, it is.
Some Final Thoughts
There are many different options for paying off student loan debt or moving a loan out of default. In evaluating these options, the borrower must keep in mind the following factors.
- Are the loans private or federal?
- What is the current status of loans: current, delinquent, or defaulted?
- What is the borrower’s current income and do they anticipate changes to income or career?
The US Department of Education’s “student loan repayment calculator” is also quite helpful in determining the best course to take.
Finally, it is important to remember that is the goal of ALL lenders to be paid back. Most will work out options to help the borrower get back on track.