3 Ways to Handle Student Loan Debt
Seven in 10 seniors who graduated from public and nonprofit colleges in 2015 had student loan debt, with an average of $30,100 per borrower. The transition from college to the real world involves significant changes. Not only will you be embarking on your new career, you’ll need to begin paying back your student loans. It is important to have a plan so that your repayment strategy does not interfere with your goals.
There are three common ways graduates can handle student debt, and each has its advantages and disadvantages. Also, which method you use may depend largely on your personal circumstances and where you are in your career.
Income Driven Repayment Plans
The first method is income-driven repayment plans. This is a loan repayment plan based on your income rather than the standard payment you would have paid under the original repayment agreement.
Meeting Income Requirements
Not everyone will be eligible for income repayment plans. Payments are based on a percentage of discretionary income, which is the amount you earn annually over 150 percent of the Federal Poverty level.
When the income repayment plans first went into action in 2009, repayments were capped at 15 percent of discretionary income, but that amount dropped to 10 percent in 2010.
REPAYE or PAYE
If you borrowed before July 1, 2014, you can check into the revised pay as you earn (REPAYE) or the pay as you earn program (PAYE). Both will cap your loan payments at 10 percent of your income, making them potentially lower than they might be under the original repayment plan.
The downside is if you have grad school loans, they extend repayment time to 25 years and require you to include your spouse’s income in your calculations even if you file taxes separately.
Another advantage of borrowing before July 1, 2014, is that the remainder of your loans will be forgiven after you have made 20 years of payments. If you borrowed after that, your loans will be forgiven after you have made 25 years of payments.
If your loans are forgiven, you will have to count that amount as income on your taxes the year forgiveness is granted. You will then have to pay taxes on that amount. So if you anticipate that a large amount of your loans will be forgiven, you may want to set aside savings for your tax bill.
You must reapply annually for income-based repayment. If you fail to do so, your payments will jump to the standard amount. The amount you pay will increase or decrease with your income and family size, but will probably never be higher than the standard amount unless your earnings increase dramatically.
Refinancing and Consolidation
Refinancing your loans or consolidating them might be a good idea for you. To determine if now is the right time to refinance your student loans, there are a few things you must consider first.
Private vs. Federal Loans
If you have Federal loans, you cannot refinance them and keep them Federal. You can move them into private loans, but by doing so you lose your eligibility for Federal programs. These include loan forgiveness, income-based repayment options, and other deferment options. If you plan to use those benefits, refinancing is not a good idea.
To take advantage of lower interest rates on private loans, you need to have excellent credit. If so, you can take advantage of lower interest rates, a single payment, and lower costs in the long run. This is why it is important for you to monitor and understand your credit score and how it impacts your ability to get lower rates.
For refinancing to be a viable idea, you must have a stable income. While Federal income based repayment plans will adjust your payments based on your income should you suffer a setback, private loans do not work that way.
Once your payments are set, you must make them or risk going into default and facing legal action. It is important that your income be stable and significant enough to easily cover your loan payments before you refinance.
Simplify Your Finances and Save Money
If you are ready to simplify your finances and save money, and you do not plan to use any of the Federal loan forgiveness, income-based repayment, or other deferment options, refinancing may be right for you. Lenkey can help you find out more about student loan refinancing and help you determine what options are best for you.
Aggressive, Rapid Repayment Strategy
The final option is to adopt an aggressive, rapid repayment strategy. Primarily this involves some strict financial planning.
Make Payments Before You Graduate
If you start making payments before you graduate, you will obviously pay off your loans faster. At the very least, begin to make payments before the grace period after your graduation is over.
For most loans, you are accruing interest while you are in school, so any payments you make early will save you on interest as well.
Set a budget to determine what you can afford. When setting up your budget, don’t forget to allocate money into an emergency fund so you are covered in case of injury or unexpected unemployment.
Be realistic in setting your financial goals and determine what you can reasonably spend on your loan payments.
Some employers offer education credits or loan repayment as a benefit. Even if your employer does not currently do so, ask. Getting someone else to pay for part or all of your student loans is the quickest way to eliminate them.
If you enroll in auto-debit programs, not only will you never miss a payment, avoiding late fees and charges, but it will also prevent more interest from accruing.
Many lenders also offer discounts for enrolling in auto-debit, sometimes as much as 0.25 percent reduction of the interest rate, which adds up over time.
Paying more than you owe each month is the fastest way to pay off your student loans. However, you need to be careful how you apply the extra money you are paying. When you pay above your monthly payment, you will probably be given choices. You can either apply the extra funds to the next month’s payment or opt for it to go towards paying down the principal which is the amount you still owe excluding interest.
When you make a normal monthly payment, you are paying two parts of your loan: a portion of the interest that has accrued on the loan, and the rest to the principal.
If you choose to put the money toward the next month’s payment, your payment is split the same way, between interest and principal. Instead, choose to pay down the principal, which reduces the overall balance, the amount interest is calculated from. Then interest will be calculated on this lower balance, reducing your costs in the long run, and enabling you to pay off your loans faster.
Most borrowers have many loans unless they’ve been consolidated, and the interest rate on those loans often varies. Paying more toward the principal of the loans with higher interest rates is best.
Finally, consider switching to bi-weekly payments, as it will do two things immediately for you. First, you will pay less interest, because there is less time between payments for it to accrue.
Second, even if you don’t pay extra every time, you will automatically make an extra month’s worth of payments every year due to the way weeks and months correspond.
Make More Money, Spend Less
If you are going to prioritize debt reduction in your budget, you are going to have to make more money and spend less in areas where you can cut expenses.
You can make more money by picking up a side job, or even a freelance gig in your area of expertise. You can even pick up a part time job, and put that money toward debt.
You can cut areas in your budget that are extra, such as entertainment, eating out, and groceries. You can even lower your utility bills by being conscientious about how you manage your heating and cooling needs, not leaving lights on when they are not needed, and using less water.
There are many ways to handle student loan debt, but these are the three most common. Whether you choose income-driven repayment plans, refinancing or consolidation, or to take an aggressive approach to pay off loans faster is a personal choice, and it’s a good idea to examine all of the options available to you.