Digging Out of Student Debt

Don't despair. You have options with private lenders and the feds to cut your payments.

When Angela Moore looks into her future, she sees checks for $500, $147, $280 and $250 piling up like leaves in a forest. Those are the amounts she could be paying every single month on her four student loans, which total $92,000, for the next several decades. If she postpones payments, the amounts she owes will go up. If she skips them, she could ruin her credit and end up in court.

Moore, 26, graduated with a bachelor's degree from the University of Hartford in 2009 with $25,000 in federal student loans and $67,000 in private loans. She devotes about half of her paycheck to those bills and resorts to credit cards to cover other expenses. Says Moore, the first in her family to graduate from college, "It's heartbreaking to have a college degree and not be able to pay for normal things because I have to pay student loans."

Moore works at an orthopedic surgeon's office, the same job she had in college. She would like to move on someday but can't afford to make less than her current wage of about $18 an hour. Nor does she see an obvious way out of her predicament. "If you're in that much debt and have a house or car, you at least have something you can give back. I have a piece of paper. I have nothing to give back."

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Meet the young and burdened. Of borrowers who graduated from four-year colleges in 2008, 10% walked away with $40,000 or more in student debt, almost three times the number of students who borrowed at that level in 2000, according to the Project on Student Debt, an advocacy group. The default rate for students who entered repayment between fiscal year 2006 and fiscal year 2007 was 6.7%, the highest since 1998.

You'd think bankruptcy would be a solution to massive student debt, but for most people, it is not an option. You must demonstrate to a judge that repayment would cause "undue hardship," a term interpreted by some courts to mean the "certainty of hopelessness," according to Deanne Loonin, of the National Consumer Law Center. This strict standard applies to both federal and private student loans. Proposed legislation in Congress would change that standard for private student loans, making them eligible for discharge under the more lenient rules that apply to credit-card and other consumer debt.

Meanwhile, federal loans offer programs that let you reduce payments or even qualify for loan forgiveness. As for private loans, some lenders are offering deals to borrowers rather than see loans go south.

Cut a deal with a lender. A few years ago, lenders were rushing to offer private loans to students, including those who were less than creditworthy. Now, borrowers who couldn't afford the loans in the first place are defaulting in droves, says Joshua Cohen, a Hartford-based lawyer who specializes in debt. "The industry is either going to take a bath or start coming after people."

Some lenders hope to avoid both scenarios by offering interest-only repayments or other arrangements that lower payments for a time. "It does us no good to have a customer with a loan he or she is unable to repay," says Patricia Christel, of Sallie Mae, the giant student-loan company. Check your promissory note to see whether it includes such provisions. "It's very case-by-case," says Loonin. If it does not, try to negotiate a plan with your lender.

If you don't reach an agreement, ask the lender for forbearance, in which you make no payments at all for three-month increments, usually for no more than a year (interest continues to accrue). Lenders are less willing than they once were to sign off on these deals, but they may do so if they believe the break will get you back on track. "The important message is, contact your lender sooner rather than later," says Tim Ranzetta, of Student Lending Analytics.

With federal loans, you can be past due for months before going into default. With private loans, you generally fall into that category as soon as you miss one payment. A collector will start calling, and eventually a third-party collection agency will take over the loan. (The Fair Debt Collection Practices Act protects you from abusive collection practices. See 6 Ways to Fend Off Debt Collectors.)

Unlike the feds, who have the authority to tap your resources, private creditors must go to court to collect debts. "Until then, there's nothing they can do," says Cohen. Defaults are subject to your state's statute of limitations, typically six years. If you do get sued and lose, the creditor can garnish your wages, put a lien on your house and wipe out your bank account.

Pick a plan from Uncle Sam. Federal loans, which include Perkins loans, Stafford loans and Grad Plus loans, provide more options. (The Perkins loan repayment provisions differ somewhat from the other two; call your school for details.) For Staffords and Grad Plus loans, the standard plan gets you out from under after 120 equal monthly payments over ten years. If you can't afford those payments but expect to have a higher income in a few years, you can choose the graduated plan, through which you make lower payments in the first few years and higher payments later over the ten-year span. Because you pay less at the beginning, you pay more interest overall.

If you owe at least $30,000 in federal loans, consider the extended repayment plan, which lets you stretch monthly payments as far out as 25 years, for lower monthly amounts but at a higher cost. Or you can consolidate your federal loans through the federal Direct Loan program and extend your payments to 12 to 30 years, depending on the amount you owe. (For details, see www.loanconsolidation.ed.gov.)

Borrowers whose federal debt outstrips their annual income should look into the income-based repayment plan, which is "like gold" for those who qualify, says Edie Irons, of the Project on Student Debt. This program, which improves on two other income-based programs, can reduce your payments to as low as zero.

You probably qualify if your total debt exceeds your annual income (see the calculator at IBRinfo.org). After 25 years, any remaining debt is forgiven; you owe tax on the forgiven amount. If you enter the income-based repayment plan and then get a big bump in salary, your payments from that point on are calculated according to the standard plan.

Cops, public defenders, public-school teachers and others working full-time in the public sector qualify for cancellation of any remaining debt after 120 payments, made on or after October 1, 2007. To get this deal, your loans must be with the federal Direct Loan program, as opposed to the now-defunct program (known as FFEL) offered by private lenders. You can consolidate FFEL loans into the Direct Loan program. The forgiven amount is tax-free.

You have the right to defer federal-loan repayments for up to three years if you are unemployed, experiencing economic hardship, attending school at least half-time or serving on active duty in the military. The feds pick up the interest during the deferment on subsidized loans but not on unsubsidized loans. Call your lender for details.

If deferment isn't an option, ask your lender for forbearance. With a federal loan, you can suspend payments for up to three 12-month periods. Depending on the amount you earn and owe, you may be legally entitled to this deal. If not, ask anyway: It's in the lender's best interest to give you time to get on your feet. Interest accrues during forbearance.

Jane Bennett Clark
Senior Editor, Kiplinger's Personal Finance
The late Jane Bennett Clark, who passed away in March 2017, covered all facets of retirement and wrote a bimonthly column that took a fresh, sometimes provocative look at ways to approach life after a career. She also oversaw the annual Kiplinger rankings for best values in public and private colleges and universities and spearheaded the annual "Best Cities" feature. Clark graduated from Northwestern University.