Student Loan Repayment: 12 Rules

It’s easy to drown in the financial details of student loan repayment.  Here’s a life preserver.

The rules of thumb listed below were culled from interviews with two experts on student loans. Betsy Mayotte is director of consumer outreach for American Student Assistance, a non-profit that educates people about their loans. Craig Lemoine is program director for the American College of Financial Services, which trains financial planners.

1. If you earn enough to make your payments, start paying.

The reason: Student loans in most cases must be repaid in full.  The sooner you start making your full monthly payments, the sooner your loans will be paid off and the less in total you will have to shell out.  A decision about how much extra to pay on student loans should be weighed in the context of other financial goals, including paying off high interest credit cards and putting enough money in a 401(k) to ensure you receive your employer’s match.

2. Open your student loan mail.   

The reason: Owing tens of thousands of dollars is serious business. Ignoring a letter from the company that holds your loan won’t make the problem go away – in fact, it could worsen things.

3. Call your loan servicing company.  But do not call without doing some homework first.  

The reason: If you’re struggling to pay your loans, the companies that handle your student loans can be very helpful.  They are experts not only on your particular loan account but also on the federal government’s rules for loan repayment. Nevertheless, student loan servicers are not perfect.  Representatives might not know much more than is on the U.S. Department of Education’s website, Lemoine said.  And sometimes their advice can conflict with information from another representative in an earlier phone call. To make sure you’re getting the best advice, it’s important to read the information on the federal website, know your potential options, and compile a list of detailed questions pertinent to your unique situation. “Going in blind can cost you money,” he said.

4. The best option for lower-income former students with high debt levels is an income-based repayment plan.     

The reason: Federal repayment programs help students by recalculating and reducing their payments to a low fixed and affordable percentage of what they earn.  Believe it or not, payments can go to zero in some cases.  However, be aware that the interest rate on your loan is not reduced in a repayment plan.  The remaining balance on the loan can be waived only after 20 or 25 years under various repayment plans, and you will be required to pay income taxes on that balance.

5. Whether to enter an income-based repayment plan depends on how much you earn now and expect to earn in the future. 

The reason: Repayment programs are an excellent option for someone earning under, say, $30,000 per year who doesn’t expect his or her earnings to increase substantially over time, Lemoine said.  Understand that monthly payments are adjusted annually to reflect changes in your income – if your income goes up, your payments will go up.  How much they are allowed to increase, and whether you can revert to making your initial loan payments in the future, depend on the specifics of each repayment plan.

Repayment plans are less appealing for, say, a newly hired investment banker who expects to earn six-figure salaries in a few years. He or she would probably pay much more over time under an income-based repayment plan than by continuing to make the loan’s standard payments.

6. Don’t select a repayment plan based solely on the monthly payments.

The reason: Pay now or pay later – that’s always the tradeoff. But if there are ways to adjust your budget to pay more now, resulting in paying less in total over time, “that’s absolutely the strategy you should take,” Mayotte said. The U.S. Department of Education’s calculator will estimate your payments under every payment plan available and also the total amount that will be paid back under each plan over the life of the plan. For example, one option might have a $300 lower payment per month but would cost $5,000 more over the long haul. Also remember the calculation might be different for married borrowers.  In some repayment options, both spouses’ incomes – and student loans – will be factored into the household’s payments.

7. Don’t agree to a repayment plan blindly without developing a budget first.

The reason: When you enter a repayment plan, you are committing to make the payments every single month.  Take time to consider whether you truly can afford it by doing a budget of your income and expenses and how your budget might change over time. A budget is a way for graduates to avoid payments that they either can’t afford in the long run or that are smaller than what they could afford with some adjustments to their budgets. Some graduates are so aggressive in paying their student loans that they’re not able to save even $20 a month in an emergency fund.

8. Never pay for help with your student loans. 

The reason: Debt relief companies charge significant sums of money for information and repayment plans that student loan borrowers can access for free. Beware that some debt relief companies imply, falsely, that they have contracts with the Department of Education to resolve loan issues, Mayotte said. 

9. Be mindful of your credit score while paying off student loans.  

The reason: How you handle repaying all of your debts, from student loans and credit cards to auto loans, is a major factor in your credit report. Pay your monthly bills on time and you’ll build up a solid credit score. However, missing student loan payments – whether it’s falling just a few months behind or entering full default after 270 days of nonpayment – will hurt your credit score. A low credit score makes it difficult to do things like renting an apartment or obtaining some jobs.

There are ways to prevent a student loan from going into default, like forbearance and deferment, which do not affect your credit rating. However, if you’re delinquent but haven’t yet hit the 270-day mark, you can get retroactive forbearance and deferment. While this is an important option to prevent default and all its consequences, your credit report will still reflect that at one point you missed some of your loan payments.

10. Avoid deferment or forbearance, if you can.

The reason:  Deferment and forbearance, by putting payments on hold temporarily, are ways to take a breather from student loan payments in extreme emergencies or when repayment plans aren’t workable – but use them wisely. That’s because the interest and missed payments that could pile up during this breather could add hundreds to the typical monthly payment.  [In just one case, the interest accrual is frozen: the deferment of subsidized federal loans.  But most people have unsubsidized federal loans, which always accrue interest.]

11. Find out whether your profession qualifies you for loan forgiveness. 

In some situations, loans may be forgiven by the federal government after the borrower in a qualifying profession makes payments on time for 10 years – or a total of 120 on-time monthly payments.  Some states offer to forgive loans in specific situations – to veterinarians in several states and to certain medical professionals in California, for example.  Consult this e-book for more information about forgiveness programs.

12. Avoid defaulting on your loans at all cost.

Default on federal student loans is a very messy, confusing, expensive, and unpleasant process that probably will not end well. The Consumer Financial Protection Bureau estimates one in three people who emerge from default status will wind up back in default. In default, the balance of what you owe will increase by 25 percent or more, due to the addition of collection costs and interest charged by the federal government. The government can also garnish your wages and federal tax refunds. Default can also jeopardize job prospects and the ability to get loans in the future.

Finally, remember every situation is unique. Don’t commit to a plan of action until you feel certain it is your best option.

Squared Away writer Kim Blanton invites you to follow us on Twitter @SquaredAwayBC. To stay current on our Squared Away blog, please join our free email list. You’ll receive just one email each week – with links to the two new posts for that week – when you sign up here.