If you graduated college last spring, chances are over the winter holidays the government delivered a nice present to your door: your first student loan bill.
According to the Project on Student Debt, college seniors who graduated in 2010 with student loans owed an average of $25,250—the highest level ever recorded—and 2011 debt totals are predicted to be even higher. Additionally, those debt-carrying graduates also faced an impossibly tough job market, as unemployment for new college graduates hovered around 9% for most of the year. All of this means there are likely many more people this year feeling stressed out about student loans and overwhelmed by debt (or just plain broke) than at any other time in recent memory. If you’re one of them, here are five things you should know.
1. Yes, You Have to Pay
The first, and perhaps most important thing to know is, yes, you have to pay. This might seem like an obvious point, but according to FinAid.org as many as one-fourth to one-third of borrowers are late or delinquent on their very first payment. And further, the current estimated number of borrowers in default—those who haven’t paid on their loans for nine months—is about 4 million out of 36 million borrowers in repayment. Don’t be one of them. As Mark Kantrowitz, publisher of FinAid.org and Fastweb.com says, “The government has very strong powers to compel repayment.”
The federal muscle includes garnishing wages (up to 15%), intercepting your tax refunds and, if it gets that far, siphoning off some of your social security once you’ve retired. Additionally, student loan debt is almost never forgiven in bankruptcy proceedings. In the end, on average, people who default on their federal student loans end up paying 122% of the original loan because of interest and collection charges. “People often try ignoring their debt hoping it will go away, but things will always get worse,” Kantrowitz said.
2. Arm Yourself (And Your Lender) With Information
Now that we’ve all agreed that you have to pay your student loans, we can get to the meat: how you will pay them. First, you need to be well-informed. “Make sure you know what you owe and to whom you owe it,” says Lauren Asher, president of the Institute for College Access and Success. “It sounds simple, but it isn’t always obvious.” Additionally, make sure they can find you. Many people move after they finish college, so double check that the lender knows your updated address. Lenders don’t care that you missed a payment because the bill is sent to the wrong place—they just want the money you owe them.
3. Evaluate Your Options
Next, figure out the best method for repayment. Your loan most likely comes with a standard 10-year-term repayment plan. If you’re in an ideal situation and the amount you owe is less than your starting salary, you should be able to afford to make the standard monthly payments. If you fall into the other category, don’t panic: You have options. Communicate with your lender—this point cannot be overemphasized. They might seem like these big monsters that want to take your money, but they are very willing to work with borrowers who communicate with them.
The best, and often least known option, is income-based repayment. This option, instituted by the federal government in 2009, can provide meaningful relief for those whose income is insufficient to pay the debt. The way it’s calculated is complicated, but basically, lenders will look at how much you make, note how far above the poverty line it is, and adjust your payment accordingly. If the calculation is below the standard repayment, then you are given the option to pay less. If you stick with the plan for 25 years, any remaining debt (both the principal and interest) is automatically forgiven. For those who work full-time at a non-profit or public service job, remaining debt is forgiven after only 10 years. “This is the best option for those who are going to be struggling to pay their loans long-term,” Kantrowitz says.
Here’s how it would work in practice: A recent graduate starts their first job, making $50,000 a year. Under a standard 10-year-term plan, their payment on $50,000 in student loans would be somewhere around $575 a month. Using the standard calculation for the income-based repayment, the monthly payment is lowered to about $422.
The other option is to extend the period of repayment from 10 years to 20. But while this will lower the monthly payment, it more than doubles the amount of interest paid over time since the borrower will have to pay on the loan for twice as long.
Of course, all of this changes if you have private loans in addition to federal student loans. Basically, the only option with private loans is to repay them—and to repay them on the lender’s timetable. They do not allow deferment or income-based repayment. Extensions often don’t lower the monthly payments by much and, while they do allow forbearance, they often offer much shorter terms and sometimes charge fees. “You’re basically at the mercy of the lender,” Asher says. But, thankfully, 85% to 90% of student loans are federal, not private, so hopefully that doesn’t apply to most of you.
4. Even If You Can’t Pay, You Still Have Options
If you can’t pay, deferment and forbearance are always, always better than default. The fundamental difference between deferment and forbearance is who pays the interest, says Kantrowitz. If your loan is deferred, most often because you are still in school or experiencing economic hardship or unemployment, the government will pick up the tab for your interest on subsidized loans. Forbearance is basically the same thing, except the interest is on you. If you decide forbearance is the best option for you, try to pay your interest in the meantime so it doesn’t accrue.
5. But Don’t Delay the Inevitable
While forbearance is a good option for those who feel they can’t pay their loans, it is really best used in the short-term, in cases of short-term unemployment or medical or maternal leave. “It’s important to remember that all of these options will ultimately increase the cost of the loan by increasing the total interest paid over the life of the loan,” Kantrowitz says. So, if you think you will be struggling long-term with paying your student loans, forbearance really just delays the inevitable; it’s best to work with your lender to develop a repayment plan you can afford.
If all of this seems like a drag, let me leave you with this one shred of silver lining: Interest you pay on your student loans can be deducted on your federal income taxes.
For more information on how to repay your loans, check out FinAid.org and FastWeb.com, which are excellent resources for all things financial aid. You may want to check out this quick reference guide, as well. The Project on Student Debt also has a wealth of information, including a list of 10 tips for recent graduates. And if you want to learn more about income-based repayment, visit http://ibrinfo.org/.