Student loans are a godsend for many students but they can be a curse for other students. The world of student loans is murky waters for the average person. Careful considerations must be given for the type of student loan, interest rates and method of repayment.
Types of Student Loans
For students who qualify, government-subsidized student loans are relatively easy to obtain because the risk to the lender is low. They are also advantageous to the borrower because the interest rates are low compared to commercial loans; in some cases, interest rates are as low as 3 percent.
Many government-subsidized student loans are tied closely to your eligibility for financial aid. Most students today have some kind of eligibility. Check with the financial aid office at your college about determining your eligibilities.
There are four basic kinds of low-interest, government backed student loans for education. They are:
- Perkins Loans
- Stafford Subsidized Loans
- Stafford Unsubsidized Loans
- Parent Loans for Undergraduate Students (PLUS).
Stafford Loans are available to all students and are administered by regular lenders such as banks, savings and loan institutions, credit unions and others.
SLS and PLUS are also administered by regular lenders. SLS loans are for independent, self-supporting students. PLUS loans are for the parents of dependent students. Both SLS and PLUS loans have higher interest rates and tighter repayment rules.
There are also some more specialized types of loans for those entering the health care field.
For all student loans, there are regulations about how much you may borrow and when you must begin repayment. Your school or lender will provide you with the details.
Loan Consolidation-what they don’t tell you
It's common for students to borrow from several lenders and loan programs to fund their college education. After graduation, when the former student is just entering the workforce, the loans typically come due. With several different loans to pay, financial commitments that seemed reasonable on paper can quickly become overwhelming.
Many people carrying student loans have a unique opportunity to reduce their overall borrowing costs. Former students or parents with at least $7,500 in PLUS loans can consolidate debts with a SMART Loan from Sallie Mae, Nellie Mae or a similar deal from other lenders.
You shouldn't consolidate loans just because you can. Stretching out repayment terms is almost always a bad idea unless it's done strategically. When the payback period is lengthened, it increases the total finance charges and encourages you to remain in debt.
But student loan consolidation is smart in three specific situations:
1) When making ends meet is a constant struggle.
2) When you're already paying a much higher interest rate on credit cards or another type of debt.
3) When you're anticipating borrowing money at a higher interest rate.
Consolidating student loans can reduce monthly payments by as much as 40 percent. You're eligible if you want to consolidate more than $7,500 in Stafford Loans, SLS Loans, Perkins Loans, Health Professions Student Loans (HPSL), Nursing Student Loans (NSL) and/or PLUS loans.
To apply, you must be in your grace period or already in repayment
Stafford, Perkins and HPSL loans can be consolidated at a 9-percent rate. If you add SLS to the mix, the rate will be the weighted average of all your loans (with a minimum of 9 percent and a maximum, under the SMART Loan program, of 12 percent).
Try to avoid refinancing a Perkins Loan, which carries a 3-, 4- or 5-percent interest rate. Trading it for a 9-percent loan is not a good idea.
The other deals may be more advantageous, particularly with regard to Stafford Loans. Stafford Loans are variable interest rate loans. Since most Stafford Loans start at 8 percent and jump to 10 percent after four years of repayment, switching to a 9-percent rate can actually save you a little bit of interest if you can't extend the repayment period.
Always check to see what the new variable rate and current cap is.
Of course, most people do stretch out repayment. Instead of paying what you owe in five to 10 years, you can extend payments over 10 to 30 years. Sallie Mae's "Max-2" option requires interest-only payments for the first two years of the loan, followed by fixed payments for the rest of the term. With "Max-4," it's interest-only for the first four years, then gradually increasing payments for the remainder. (Nellie Mae offers interest-only plans for one to four years.)
Consolidating a student loan can be expensive
What's the potential cost of consolidating? A 10-year, $15,000 Stafford Loan (the 8 percent/10 percent variety) would cost an average of $187.67 a month. The total repayment cost of the loan, including interest, would be $22,520.64. By consolidating the loan to a 15-year repayment schedule with two years of interest-only payments, the monthly bill drops to $112 for the first two years and $163 thereafter. The additional interest cost-$5,677.36.
Debt-reduction strategies
Lower payments come at the expense of longer and deeper debt. The decision to apply a debt-reduction strategy like extra principal payments lies in the interest rate. Using 9 percent as the dividing line between high and low interest, it's a good strategy to pre-pay principal on student loans with interest rates above 9 percent but continue to make regular payments on any low-interest loan over the full term of the loan.
When you have extra money, don't apply it to your low-interest loans. Instead, apply the money to any higher-interest loan you may have, or put it toward your savings and investment plan.
If you have school loans with interest rates in the 12-percent range, target them for early payoffs. If at the same time you have even higher-interest debt, such as credit card debt at 18 percent, pay off the credit cards even before you begin paying down your high-interest student loans.
If you find yourself in a position where you are unable to make the payments on your student loan, contact the lender as soon as possible. Most student loans will allow you to defer payments if you are still in school, unemployed or experiencing a personal hardship.
Defaulted Loans
What do you do if your student loan is already in default?
If the Student Loan Commission reported the delinquent account, the only way you can remove it is to pay off the loan in full and then dispute it with the credit bureau. You can inform the bureau that the loan has now been paid in full (only if it has, of course). The credit bureau will then have to verify the information with the Student Loan Commission.
If the bank or the collection agency reported the delinquent student loan account, then you can negotiate a settlement with the agency that you owe the money to. You can either work out a new payment plan or pay off the debt completely
In some cases, you might want to consult the services of an attorney or professional debt-negotiator. It may even be possible to settle the account for pennies on the dollar or create a new payment plan that is within your means.
Bankruptcy and Student Loans
Student loans are generally backed by a government agency, and consequently, are governed by special rules under the bankruptcy code. In most cases, government backed student loans cannot be discharged through bankruptcy. There are, however exceptions.
Student loans that are not backed by a government agency generally fall under the same bankruptcy rules as other loans. Additional questions regarding student loans, or the dischargeability of other debts, should be discussed with an attorney.
Closing Thoughts for student loans
Don't take student loans for granted. If at all possible, plan ahead and save for your (or your children's) college expenses. Before taking on the responsibility of a student loan, seek out all scholarships, grants or other sources. Also, there's nothing wrong with the old-fashioned concept of working your way through college. In the next chapter you'll learn how putting a little bit away each month can pay off big in the future.
