K is for Knocking Out Student Loans
Personal Finance from A to Z
Eileen St. Pierre, The Everyday Financial Planner
It can be expensive to go to college and the costs just keep going up. Taking out student loans had become the norm, but the recent recession and the accompanying high unemployment rate for college grads made the nation realize the consequences of too much student debt. Recently, there has been a lot of political debate over helping students refinance or increasing access to student loan forgiveness programs.
If you want to knock out your student loans, it’s important you understand your repayment options, strategies for paying off your debt faster, and the consequences of loan default.
Many students do not realize there are many different repayment options after they graduate. Some will forgive balances after you make payments for a specified period of time – just remember that the forgiven loan balance will be subject to income tax. The most popular plan is Standard Repayment with fixed monthly payments (minimum $50) for up to 10 years; you’ll pay the least amount of interest. Other repayment plans include:
- Graduated Repayment – monthly payments (minimum $25) start off low and then increase, usually every 2 years, for 10 to 30 years.
- Extended Repayment – payments may be fixed or graduated over 12 to 30 years; you will pay more in interest over the life of the loan but not all loans are eligible.
- Income-Based Repayment (IBR) – maximum monthly payment is 15% of discretionary income (Adjusted gross income – 150% of poverty guideline for your family size in your state); you must demonstrate financial hardship; loan balance forgiven after 25 years.
- Income-Contingent Repayment (ICR) – monthly payments (minimum $5) are calculated annually based on your adjusted gross income, family size, and amount of Direct Loans; loan balance forgiven after 25 years.
- Pay-As-You-Earn Repayment (PAYER) – maximum monthly payment is 10% of discretionary income and changes as your income changes; loan balance forgiven after 20 years.
- Income-Sensitive Repayment – monthly payments based on annual income so your payments change whenever your income changes, for up to 10 years; each lender has its own formula for calculating the payment.
Tips to Paying off Loans Faster
You cannot discharge student loans in bankruptcy so you have to pay these loans back. Here are some tips to help you out:
- Pick the shortest repayment period you can afford.
- Make extra payments on top of the required monthly payments.
- Pay off highest interest rate debt first.
- Set up automatic payments so you don’t forget to make a payment.
- Federal student loans will be forgiven after 10 years for those who are on the IBR, ICR, and PAYER plans and who are employed for 10 years in public service positions like police, fire, education, military and social work. The loan forgiveness is not retroactive, so prior employment does not count.
- For those who work for any federal agency, the Federal Student Loan Repayment program will pay off up to $10,000 annually to a maximum of $60,000 of federal loans.
- Employers may be willing to pay off both private and federal loans. In these cases, the student signs an employee incentive contract, in which the company pays the student loan and, in exchange, the student commits to staying with the organization for a specific period of time.
- Volunteers with AmeriCorps, VISTA or the Peace Corps, as well as those who help the impoverished or work in underserved communities can have their loans written off. Check with the volunteer organization.
- Students may be able to negotiate favorable terms. Ask lenders about lower interest rates based on making a set number of on-time payments, earning good grades or qualifying for other incentive programs available through the lender.
Consequences of Loan Default
Defaulting on a loan can impact a student’s life for decades. A loan default lowers a student’s credit rating, and by extension, job prospects, since many employers run credit checks on job candidates. But there are other consequences:
- Garnishment of wages and Social Security
- Seizure of federal and state tax refunds, as well as state lottery winnings
- Renewal of professional licenses blocked
- Loss of eligibility for future financial aid
Regardless of how a student chooses to structure repayment, part of paying the money back is actually mental. Make plans to repay the money before scheduled installments are scheduled to begin. Take advantage of the grace period to start out your professional life on the right foot.
Visit my College Planning page for more information.