How to Finance your Student Loan (including Expert Advice)
Student loan might make you feel nauseous inside, but unfortunately, the majority of Americans can’t survive without it. If financing your student loan might seem intimidating, this guide will help you through the process.
This guide will teach you 1) what you need to consider before taking a loan, 2) how to choose the right loan, 3) give tips on repaying the loan including ways you could repay the loan quicker and 4) what to do in the case of an emergency.
STUDENT DEBT IN THE US – OVERVIEW OF THE CURRENT SITUATION
The importance of learning about managing and financing student debt is evident when you examine the current student debt situation in the US. MarketWatch reported on the current debt levels in January, quoting data by government agencies.
The data show almost 70% of bachelor’s degree graduates leave universities with debt. Furthermore, the overall student debt in the country has reached $1.2 trillion, which naturally has a big impact on not just the individual’s financials, but also the country’s economy.
A financial aid website Edvisors reported the class of 2015 left school with the highest debt level in history. The average student started their careers with $35,051 in student debt. The debt level is clearly on the rise, as the average student in 2012, left school with outstanding debt of $24,301. Furthermore, the worrying fact is that one in four borrowers end up either in delinquency or default on the student loan.
Some interesting trends that show that private lenders invest less while the state invests more into student loans (see slides).
WHAT TO CONSIDER BEFORE YOU TAKE A STUDENT LOAN
Before we start examining the ways to manage and to finance your student loan, it’s auspicious to understand the impact debt can have.
The harm of high debt
First, it must be mentioned that high student debt doesn’t just have an impact on the individual taking the loan, but it can have an effect on the wider society.
If studying becomes associated with high levels of debt and obtaining a large loan is the only way to finance education, the student will be more likely to study subjects with higher potential earning prospects to allow repayment quicker. This could result in the lower paying or more unsecure academic fields receiving fewer students.
It’s important for society to think critically about the impact of having fewer people studying areas such as social studies or creative fields has.
Above from having a wider impact, high debt is also harmful for the individual. High student debt can affect your lifestyle after graduation for a long time.
Your immediate focus will be on attracting the highest paying job in order to keep with student loan repayments. You’re not necessarily able to follow your dreams and accepting the jobs, you actually desire, as your mind is only set on managing the debt.
This could even put you off from taking a risk and becoming an entrepreneur, even if you dream about it and have a good business idea in mind.
Furthermore, if you have plenty of student debt, you are likely to delay some big decisions and events, as you don’t feel you can afford them.
This means you don’t want to get married and start a family, since the debt burden is hanging over your shoulder. Since you already have debt, you might feel less happy about taking on another big debt, such as a mortgage.
Certain student loans can also have an impact on your credit score, especially if you experience problems keeping up with the repayments. This can mean obtaining a credit card or a small loan becomes a huge obstacle.
All of the above can also strain your mental health. Countless studies have shown students with high debt are more likely to suffer from depression.
For those of you who love comedy while being educated, watch John Oliver’s episode on student debt.
The things to keep in mind before taking a student loan
If you haven’t yet taken a student loan, it’s important to prepare for the situation. Having a plan in place before you take a loan will help you schedule and prepare for the repayments later.
The most important things you should consider before taking student loan include:
Choose your school wisely
- Consider scholarships if they are possible in your situation
- Don’t just assume that ‘famous’ institutions are better worth for your money to less known schools. Going to a top school doesn’t necessarily guarantee a top career.
- In fact, public colleges can save money
- You can even start at a community college and transfer to a different college later
Consider different ways to lower other costs associated with student life
- Consider living at home, even if for the first year, if your university is near where you live.
- Weigh in the cost of living on-campus and off-campus. Sometimes renting a flat with friends can cost less than living in student accommodation.
- Consider studying abroad. University education can be cheaper, if not free, in certain countries.
- Start saving money before you go to college and create a saving plan even while at university.
Let’s look at the most common myths related to student loans.
CHOOSING YOUR STUDENT LOAN CAREFULLY
Once you’ve received a place in your chosen university, it is time to start thinking about student loans. Once you’ve selected the type of student loan, you can also figure out your repayment model and create a plan for repayment.
Choosing the type of your student loan
There are currently three main types of student loans available in the US:
- Federal student loans paid directly to students
- Federal student loans paid to the parents
- Private student loans paid either to the student or the parents
Below is a quick overview of the advantages and disadvantages of each option.
Federal student loans paid directly to students
The most common option is to take a federal student loan and have it paid directly to you, the student.
The advantage is the loans are provided, whether or not you have credit history, and you often don’t need to make any repayments during school if you are enrolled in at least half-time studies.
The repayment schedule has a six-month grace period after graduation or if you drop below a half-time status.
These types of federal loans also have more flexibility for repayment if you find it difficult to repay the loan – you can often put loans on deferment or in forbearance.
The big disadvantage of federal loans is the limit on the amount you can borrow. The amount is set by Congress, which means you might not be getting as much as you’d require.
Federal loans also give the federal government quite a bit of power in the event of defaulting on the loan. The federal government can, for example, garnish your wages and the tax returns. You also won’t be able to declare bankruptcy on federal student loan.
Federal student loans paid to the parents
The parents of the student can obtain federal student loans.
Under this model, credit history of the parents will be considered and loan approval is therefore not automatic or guaranteed. On the other hand, it has the advantage of coming with a higher loan amount.
The disadvantage, aside from the need to have a strong credit history, is that repayments start immediately.
Private student loans paid either to the student or the parents
Finally, students or the parents can also take private student loans. The banks or other financial institutions typically provide these and the loans are subject to credit score check.
They tend to have a higher limit to federal student loans, but unlike federal loans paid to parents, private student loans won’t require repayments until after graduation.
On the other hand, interest rates are higher than in the federal loans and therefore, you’ll most likely end up paying more for the loan. In fact, most financial experts will recommend exhausting federal loan options before considering a private student loan.
Defining the repayment options
As the above already suggested, different loans have different models for starting repayments. Furthermore, you can choose a suitable repayment model from different types, which are outlined shortly below.
You can find more information on each repayment model at Student Aid, the government owned website.
Types of repayments for federal loans
- Standard Repayment Plan – Payments are a fixed amount with timeframe ranging from 10 to 30 years. You’ll pay less over time under this model than the other plans.
- Graduated Repayment Plan – Payments increase in size typically every two years. Repayment schedule can range from 10 to 30 years.
- Extended Repayment Plan – Payments can be either fixed or graduated and the payment schedule can be arranged up to 25 years.
- Revised Pay As You Earn Repayment Plan (REPAYE) – The monthly payments amount to 10% of discretionary income and they are re-evaluated every year. Outstanding balance on the loan will be forgiven if you haven’t repaid the total amount after 20 to 25 years.
- Pay As You Earn Repayment Plan (PAYE) – The maximum monthly payment is 10% of discretionary income and the amount is calculated annually. Your outstanding balance will be forgiven after 20 years.
- Income-Based Repayment Plan (IBR) – The monthly payments will be 10% or 15% of discretionary income. The outstanding balance will be forgiven if you haven’t paid it back after 20or 25 years, but you may have to pay income tax on the amount forgiven.
- Income-Contingent Repayment Plan (ICR) – The monthly payment will be either: 20% of discretionary income or the amount you’d pay with a fixed repayment plan over 12 years, adjusted to your income. The balance will be forgiven if loan not repaid after 25 years.
- Income-Sensitive Repayment Plans–The monthly payment is based on annual income and the schedule of repayment is anything up to 15 years.
Read the Smart Grad’s Guide to student loan repayment.
Types of repayments for private loans
- Reducing Interest – You can have a period where you only need to make monthly interest payments on the loan. The deferment period is usually during while you’re in school and the separation period after graduation.
- Standard Plan – You’ll make a minimum monthly repayment, which is calculated with the repayment schedule of up to 20 years in mind.
- Graduate Plan – You’ll start with lower repayments, which increase by 10% every two years. Repayment term is up to 20 years.
- Economic Hardship Deferment – If you have problems repaying the loan due to personal finances, you can in some cases also obtain an Economic Hardship Deferment. During which you can reduce or abstain from loan and interest payments.
Tips for student loan repayment
Once the repayments start knocking on your door, you should have a plan in place to deal with them. Below we’ll discuss some of the tips that can make repaying your student loan slightly easier and definitely less stressful.
1. Create a repayment schedule
First, you should draft a repayment schedule for paying back the loan as soon as you get into debt, irrespective of whether you need to start the actual repayments yet. The plan will help you stay on top of the loan at all times and make you more aware of the things you need to do.
Remember most federal and private student loans don’t have restricting rules and regulations for making repayments even when you aren’t contractually obliged. Therefore, chopping off a piece of the student loan whenever you can is a good idea.
Create a repayment plan for:
- While in school – For example, if you have a private loan, you should start making interest repayments immediately.
- After school – What is the maximum debt you can repay without losing sleep?
2. Consider your repayment model carefully
As the above section highlighted, you have plenty of options when it comes to repaying the loan. Certain options above are better suited for different situations.
For instance, while the Standard Repayment Plan means you pay less over time, you can finish repayments quicker under the income-based plans. If you have a good income, repaying the loan shouldn’t be a problem and you have the protection of getting the loan forgiven if you can’t payback in time.
Keep in mind in most instances the repayment model can be changed from one type to another. This can be a useful option if your life situation changes drastically.
It’s a good idea to use the government provided Repayment Estimator to better understand the repayment amounts and schedule. You can also use these calculators to device appropriate budget for repayments. While these are mainly suitable for federal loans, you can discuss the repayment schedule in detail with your private student loan provider.
3. Create a budget for using the loan
You shouldn’t only focus on the loan repayments, but also ensure you use the loan wisely. First, you don’t want to borrow any more than you have to. While it might sound easier to take everything you can to guarantee a fun student life, you don’t want to ruin your future by creating a massive debt prison for yourself.
Be meticulous with your planning. Consider your housing needs, food spending, school fees and study equipment (books, stationary), and leave some room for entertainment spending.
When you are thinking of spending something, think carefully whether you actually need it or if you could find it cheaper elsewhere. Learning to budget properly while at university will prepare you for the future.
4. Update your plans regularly
Don’t just create the plan once and then forget about it. Try to check your budget monthly to see whether you can make adjustments.
With saving and repayment plan, you should go through your plan once a year and especially when your situation changes. For instance, if you find a part-time job (even during school), adjust the repayments to factor this in.
You’ll also want to set targets in terms of repayment. Try to be realistic but positive about the schedule. Repaying the loan, even for a bit, can mean you’ll have much more fun later.
5. Consolidate loans
If you have multiple loans, it will be useful to consolidate the loans. It can be more convenient to have your loans provided by a single servicer, instead of having to keep checking with different providers.
The benefit of consolidation is that it can extend the payback period. This means you can make lower payments in the short-term, although you’ll end up paying more interest in the long-term.
Nonetheless, don’t assume consolidation is always the best. Especially if you have both federal and private loans, you might miss certain benefits, such as being eligible for income-based repayment.
6. Consider changing to another lender
Finally, instead of consolidation, you can also consider changing the loan servicer. Different providers can offer better benefits to others, and for example, offer better interest rates. Check out the different options and don’t be afraid to shop around.
We did an interview with a founder of SoFi, a company that is helping students pay less interests for their student loans.
SPEED UP REPAYMENT
Repaying your loan as quickly as possible is definitely something you should aspire to. But how can you speed up the repayments?
Pay more than you have to (if you can)
First, it’s naturally helpful to make bigger payments than you are required to. If you can possibly afford it, don’t simply aim for the figures provided by the repayment plan. By paying more than you are required to you’ll end up getting rid of the debt quicker and you’ll pay less in the long-term.
Furthermore, Investopedia has calculated it’s better to make bi-weekly payments instead of paying off a specific sum every month.
Once you’ve obtained a steady income, you need to consider the trade-off between saving for retirement and repaying the student loan. It’s important to analyze the interest on both options.
For instance, if the return on your investments is much higher than your interest payments, you should allocate more of the income to the retirement portfolio. On the other hand, if interest payments on the student loan are higher, get rid of the loan first.
Two routes to paying more
Paying more than you have to might sound good to you, but it can also make you wonder how can you do so.
There are essentially two different routes to paying more:
- While studying, try to work part-time or freelance. This can provide you with two benefits:
- You earn more so you can start repayments even during school or possibly end up borrowing less altogether.
- You network with potential employers and earn valuable work experience, which can help find a better job after graduation
- Do extra work once graduated. You might not get into a high-paying job immediately, so consider continuing your freelancing career while working or take on some extra jobs for the first few years.
- Become part of the sharing economy. The sharing economy is a great way to earn a bit of money. If you have a house or even a room, consider renting it out, for example.
- Budget tightly. If you can’t find a way to earn some extra money, hasten your repayments by saving a bit more. Make a tight budget and find ways to enjoy life without spending a lot of money.
Sign up with ‘auto-debit’ or EFT
You should consider enrolling in auto-debit, especially if you have a steady income stream. This means the payment is automatically taken from your bank account.
The benefits of this model include:
- You won’t miss a payment, meaning you won’t be penalized for late payments. Just ensure your account always has the correct amount of money.
- You can be eligible for a discount. Certain lenders provide discounts for people who choose automatic debit. According to Finaid.org, the discount could be a 0.25% interest rate deduction. This can add up over time.
- You can still make extra payments. Automatic debit doesn’t restrict the amount of extra payments you make, so you can still pay more than you have to whenever you can.
HAVE AN EMERGENCY PLAN
Finally, you should create an emergency plan for the moments when things might not go according to plan.
The first thing to do is to not panic if you encounter repayment problems. Take a deep breath and follow the emergency plan.
Try changing the repayment plan and renegotiate the terms with the lender. If you notice the problems before you fall behind on your repayments, the lenders are more likely to help.
Consider refinancing your loan. For example, it is possible to refinance your federal loans and turn them into private loans. Refinancing could potentially provide you better loan terms, such as lower interest rate. But remember that refinancing federal loans to private loan will mean you forfeit access to loan forgiveness.
Finally, consider getting your student loan forgiven. If you work in public service, you can speed up loan forgiveness of your federal loan. Furthermore, deferment or forbearance are also options to consider, but you definitely want to avoid these if you can. These mean you can take time off from repayments, but remember that they will increase the total loan balance.
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