You’ve finished college — congratulations — and now it is time to repay your student loans. Here are ten tips to help you navigate the repayment process.
1. You owe more than you borrowed.
Your student loans started accruing interest (unless they were subsidized federal loans) while you were in college and the loans were not being repaid. When it comes time to begin repayment, this accrued interest is “capitalized” (i.e., added onto your principal) and you’ll find your loan balance is greater than the total amount you borrowed.
2. Filing for bankruptcy won’t save you.
Congress, exercising its infinite wisdom, changed the bankruptcy laws to make it nearly impossible to discharge student loan debts in bankruptcy. You would need to pass the “undue hardship test” which is unlikely for almost everyone. Declaring bankruptcy is not a safety valve if you get into financial trouble.
3. Don’t default on these loans.
Because bankruptcy is not an option, if you fall behind on your payments, loan collectors will chase you incessantly and fees and penalties will be added to your loan balance. In addition, wages, tax refunds, and even Social Security payments may be garnished. A default would be very costly.
4. Deferment and/or forebearance won’t help over the long term.
These are approvals to temporarily suspend your payments. However, they are only available for federal loans and not for private ones. In most cases (except for subsidized loans), your interest continues to accrue and your loan balance grows every month. Only take this option if you have no other choice.
5. Consolidation of your loans is usually sensible.
By consolidating your loans, you minimize the number of payments each month and the number of loan servicers with whom you interact. However, it will not save you money as the interest rate on your consolidated loan will be the weighted average of the underlying loans.
If you have extra funds to contribute to your loan payoffs, then I would notconsolidate your loans. Instead, devote all the extra payments to your highest interest rate loan and then work your way down as you pay them off sequentially.
If you consolidate, do not mix federal loans with private. Keep your federal loans separate in case you opt for an income-driven repayment plan.
6. Understand and evaluate income-driven repayment.
Income-driven repayment refers to a set of repayment options for federal student loans where your monthly payment is tied to your income, rather than your loan balance and interest rate. Note that private loans and federal PLUS loans (Parent Loans to Undergraduate Students) are not eligible for these repayment plans.
The different choices are complex in their implementations and nuances but generally, your monthly payment is anchored to ~10% of your adjusted gross income and any remaining loan balance is forgiven after 20 years of payments. You can see the differences and details of the three main plans — REPAYE, PAYE, and IBR — here.
There is one major drawback to all of these plans. After you complete the required payments, your remaining loan balance is cancelled. That’s the good news. The bad news is that this loan write-off will be treated as taxable income in that year and you will owe income tax on the amount of the write-off.
If Congress does not change the law, many people will face a large tax bill because their years of payments could leave a significant unpaid principal amount of their loans. In some cases, the remaining principal may be larger than the original borrowed amount because the monthly payments were less than just the interest. This tax liability could wipe out much of the savings of this repayment plan.
Proceed carefully and see my next point.
7. Understand the Public Service Loan Forgiveness option.
PSLF is a subset of these income-driven repayment plans. With PSLF, if you work for a qualifying employer — essentially any government agency or a 501(c)(3) non-profit — and make 10 years of payments, your loan is written off.
More importantly, the remaining loan balance that is written off is nottaxable. As I described in the prior point, this can make a big difference.
Especially if you attend graduate school and have amassed a large amount of qualifying debt, you should carefully weigh PSLF as you consider your career plans. It is much better than standard income-driven repayment and can significantly improve your lifetime financial health.
Congress and Trump are considering limitations to PSLF so be sure to monitor any changes that are coming if you are counting on this to finance your education.
8. Be organized and methodical.
Ensure your payments are on time and in full every month. Automate electronic payments directly from your bank. Create a simple spreadsheet that lists each loan, the servicer and the online access credentials, the interest rate, the monthly payment, the approximate loan balance, etc. When you move, be sure to communicate with your servicer so they know your new address.
9. Choose the repayment plan that is best for you.
The default repayment plan is a 10-year level payment for most loans. That may make the most sense, but not always. Be proactive about selecting the best repayment plan for your situation, including explicitly deciding if you’re going to enter into an income-driven payment plan.
10. Financing graduate school has different considerations.
As you’re working through your repayment options, factor in whether you will attend graduate school in the future. The financing options for graduate school are different; in particular, an income-driven repayment plan may make more sense when combining undergraduate and graduate school debt.
Have questions about student loan repayment? Get in touch.
PS: Previously I offered some guidance to parents and students about not borrowing too much for college. You can read it here.