Take Control of Your Student Loan Debt (Instead of Letting It Hold You Back)

Along with beach trips and blockbuster movies, summer also brings a nationwide crop of college grads. While this is an exciting time for both graduates and their parents, it also brings some anxiety. Graduates are hunting for their first jobs as the clock ticks toward their first student loan payment (most federal loans have at least a six-month grace period, though rules for private loans vary). And parents who co-signed their child’s loan must have their checkbooks ready if their child cannot afford the monthly repayments.

Seven out of 10 graduates now leave school with student loan debt, and for those who do, the average amount has soared to approximately $37,000. As a nation, our collective total student loan debt just surpassed $1.5 trillion. That student loan debt can come with some painful consequences:

• Home issues: Poor debt-to-income ratios can make it tough (or impossible) to qualify for a mortgage to buy a home.
• Love issues: Sadly, significant outstanding student loan balances make single individuals less attractive candidates for long-term romantic partnerships, according to research.

If you’re one of the many Kiplinger readers who has been making student loan repayments for a few years now, I’m sure you’d rather be watching your money grow in investment accounts like your 401(k) or IRA instead. But it’s important not to lose sight of the fact that to eventually achieve financial security, borrowers must pay down their debt in a reasonable time frame.

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Here are four important facts about student loan debt that you should be mindful of, whether your college or post-graduate years are behind you or your children are preparing to make their first repayment. While these facts may not come as a surprise, you may find some of them could pose unexpected problems for you down the road, while others may provide opportunities to pay down your debt faster.

1. Student debt often can be deferred.

While this is not necessarily a bad thing, it can get individuals into trouble over the long term. Borrowers can defer their debt for various reasons. For example, they can request an official deferment of a federal loan due to economic hardship, such as having income less than 150% of the poverty guideline for their family size, or joining the Peace Corps.

They can also defer their loans unofficially by paying them over a longer repayment period, such as moving from a standard, 10-year repayment plan to one that stretches up to 25 years or more.

Although income-driven repayment plans offer potential loan forgiveness at the end of 20 to 25 years for federal loans, borrowers should weigh the pluses and minuses of going this route. Monthly payments will initially be lower, but the life of the loan is extended for a very long period, driving up the total cost of the loan substantially.

For example, a graduate with $35,000 of loans at a 4.5% interest rate and a $35,000-per-year job would pay $10,729 more in interest under the Income-Based Repayment plan compared with the 10-year Standard Repayment plan.

2. Interest charges can start adding up right away.

With the exception of a six-month “grace period” for federally subsidized loans, interest almost always accrues the minute a graduate leaves college, even if your loan is deferred. While some types of deferments of federal subsidized loans do not let interest accrue, most situations result in interest accruing as long as the loan is outstanding. That means that the tab for a college loan is quietly rising in the background.

Unfortunately, many graduates do not fully understand or appreciate the impact of interest accrual. At some point, those who defer their loans eventually find themselves making large monthly payments yet barely moving the needle on the outstanding balance. Graduates and their parents who have borrowed need to keep in mind that just because you can defer repayment, doesn’t mean that you should.

A study released in February by the Brookings Institution found that most borrowers who left school with at least $50,000 in student loan debt in 2010 had failed to pay down any of that debt four years later. Rather, their balances had risen by 5% due to interest accruals, even as they made their payments month after month.

3. Early or extra payments can make good sense.

There’s no penalty for making payments before the grace period ends or for making an extra payment. Just because you have a grace period of six months doesn’t mean you have to wait until it ends to make your first payment. Start making your payments as soon as you can afford to, and consider making extra payments if an opportunity arises.

For example, if you get paid every other week, there are roughly two times per year where you will likely receive three paychecks instead of the typical two per month. You can use those extra two paychecks each year to knock off hundreds or even thousands of dollars of principal on your student loan debt. Just make sure you indicate that you want those extra payments to go to your principal and not interest.

Under a Standard Repayment Plan, a borrower with $35,000 in loans at a 4.5% interest rate would pay $362 per month to repay the loan over 10 years. The total cumulative payments would be $43,528, with $8,528 of that total paid in the form of interest. If, however, the graduate increased her payments by $100 monthly to $462, the total payments would be only $41,251, with $6,251 in interest paid over 7.5 years.

If the loan is repaid earlier, the graduate can reallocate the monthly payments to begin saving toward a home or other financial goal.

4. Consolidation takes some consideration.

Consolidation is an option, especially if you’ve been out of school for a few years now, but the climate has changed. All graduates should understand how loan consolidation works and consider if this makes sense.

Loans are typically consolidated for two reasons: First, to pay a lower rate of interest on a loan, much like a homeowner might refinance a mortgage loan. The second reason is to simplify the borrower’s financial life, as a graduate might have eight or more loans she has taken out over four years that all now need to be repaid.

Those looking to consolidate to a private loan will likely find it difficult to find a better interest rate than they currently have, because interest rates have risen in recent years.

Consolidation is much different — and more favorable — for federal loans, as the new consolidated loans create a new fixed rate that is the weighted average of the interest rates on the loans being consolidated.

In other words, the older, lower interest rates being charged are preserved when federal loans are consolidated.

The bottom line is that, due to the rising interest rate environment over the past couple of years, loan consolidation will be much more appealing to those consolidating under the federal program versus those borrowing from private lenders.

Getting yourself on the right track

Staring at tens of thousands of student debt may be daunting, but it’s a problem you have no choice but to face. Analyzing your monthly after-tax income, building a budget, and paying off as much student loan debt as possible each month is key. In other words, pay down extra principal by paying more than the amount due. Make paying off your student loans more tangible by tracking the outstanding balance on a monthly basis. This will help you maintain your discipline and achieve your goal of paying off your debt.

Not only will your personal balance sheet improve when your debt is reduced and eventually eliminated, you will build your credit history and improve your debt-to-income ratio, making it easier to get a mortgage down the road. And, while eliminating student debt may not guarantee you will suddenly be seen as a better romantic “catch,” it certainly can’t hurt.

So, just because you can kick the can (debt) down the road, think twice before doing so. Your older self (and future family) will thank you.