You’re out of school now, you’ve gotten a start on your career, you have a place of your own and life seems good … except for one thing. You have those student loan debts hanging over your head. If you’re typical you owe around $26,000 because that’s what last year’s graduates averaged. Of course, if you borrowed money for graduate studies undoubtedly owe much more than that.
A brief history of student loans
Back in the 1960s the federal government started offering big subsidies to private banks. In turn these banks were to loan money to students. This continued until the 1990s when President Clinton instituted changes that made it possible for students to borrow directly from the US Department of Education. These are called Direct Federal Loans. If you received student loans anytime in the past 15 years the odds are that they are Direct Federal Loans – unless they were Perkins Loans and came from your school.
In 2007 the federal government initiated a new student loan repayment program called Income-based Repayment. This capped the monthly payments on certain types of federal loans at 15% of a person’s discretionary income. In 2010 Congress got even more generous and passed a bill creating a new repayment program called Pay As You Earn. This program caps monthly payments at 10% of a person’s discretionary income and forgives any remaining balances after 20 years. To be eligible for Pay As You Earn you must not have had an outstanding federal loan as of October 1, 2007, you must have had a Direct Subsidized or Unsubsidized Loan and the funds must have been dispersed on or after October 1, 2011. Plus, you must be able to prove a Partial Financial Hardship. Finally, Pres. Obama issued an executive order last year that made more people eligible for Pay As You Earn by extending it to people that acquired their student loans before October 2007.
Could you take charge of your student debts with one of these programs?
To qualify for either of these repayment programs or a third one called Income-contingent Repayment you need to prove that you have a Partial Financial Hardship. The way this is calculated without getting too technical is to take your gross income and then subtract 150% times the poverty line. Note: The easiest way to determine if you have a Partial Financial Hardship is with an online calculator such as the one provided by the U.S. Department of Education.
If you’re just out of school and unemployed
If you’ve been out of school for six months (or more) and are still jobless, the best thing you can do is contact your loan servicer to discuss repayment options. Conversely, the worst thing you can do is not make your payments. (More about this later.) As you have read there are several income-driven repayment programs available and you should sign up for one of them. Both Pay As You Earn and Income-based Repayment use your income to determine how much your monthly payments will be. Since you have no income, your payments could be zero dollars per month. That’s nada, zero or nothing. And it’s legal.
Would debt consolidation make sense?
There are instances where student loan debt consolidation would make sense. If you have multiple federal student loans that qualify, you could consolidate them into one new loan. You would then have better repayment terms, which should make it easier to repay them. For example, if you were to consolidate your Federal student loans into a Direct Consolidation loan you would extend the term of your loans from 10 to 30 years. Naturally you would then end up paying more interest over the term of the loan but your monthly payments will be much lower. In addition, you might still be eligible for some form of income-based repayment on the new loan. To see if you would be eligible for a Direct Consolidation loan, go to Student Loans.gov.
If it turns out that for some reason none of the repayment options makes sense for you, try for a deferment or forbearance. If you’re not familiar with these deferment is a period of time during which you don’t have to make payments on your principal or interest. You could be eligible for deferment if you’re still enrolled in school or are unemployed. To see if you would qualify, you will need to ask your lender or loan servicer. You could ask for forbearance if you find you don’t qualify for a deferment. This would allow you to stop making payments on your student loans for up to 12 months. However, the interest on your loans will continue to accrue. If you have an economic hardship, you could qualify for forbearance. However, forbearance be granted only by your lender.
Whatever you do don’t default
You’ll remember we said earlier in this article that the worst thing you could do is not make payments on a student loan. This is called defaulting on the loan or loans and it’s something you absolutely do not want to do. You’re considered to be in default the day after you miss a payment. However, this won’t be reported to the three credit bureaus for probably six months. This gives you time to work with your loan servicer to get caught up. In the event that you don’t fix things then after 270 to 360 days your loan could be turned over to a debt collection agency and things could really get ugly. Your wages could be garnished or a portion of your income tax refunds could be withheld. You will be unable to get any more federal aid and your debt will grow due to the expenses associated with collecting your debt such as court fees and lawyer’s fees. You may not be able to enlist in the Armed Forces and you’ll be ineligible for deferment. You will be ineligible for assistance under most federal benefit programs and your defaulted loans will stay in your credit reports for seven years and this will have a very negative effect on your credit score.
Last but maybe not least when you default on a loan, whether it’s a student loan debt or some other type of loan, you’ve basically stolen money from taxpayers or a private lender. When you signed up for those loans it was to finance a valuable commodity –your education. In return for that education you assumed an obligation, which was to repay the money. Whether you like to look at it this way or not if you default on your student loans you’re not much different from a person that engages in credit card fraud.
Choose a plan and get started
Regardless of whether you’re employed or not the best way to take charge of your student loan debts is by selecting a repayment program and getting started. For people just out of school one of the best options is Graduated Repayment. If you were to choose this program, your payments would start low but then increase gradually every two years. This can be an especially good solution if you know for sure that your earnings will also increase over the years. Beyond this, an income-driven repayment program such as Pay As You Earn should take the sting out of your monthly payments by making them very affordable.