Guest Post: from Dollar Diligence
For most college graduates, student loans are a fact of life.
Because the cost of a college degree has skyrocketed in recent years, student loans are necessary for a large number of students who would not otherwise be able to afford to obtain a degree.
Recent college graduates are nearing the end of what is known as the “grace period.” This is the six-month period of time after graduating or leaving school where a borrower does not have to make a payment on his or her student loans. After the grace period ends, a borrower will have to start making payments on his or her student loans.
That means that Class of 2017 graduates who received a diploma in April, May, or June, will soon receive their first student loan bills. It is critically important for these grads to understand the fundamentals of student loan repayment so they can be successful.
Learning more about student loans, including strategies for how to best pay off your loans, is vital to making informed decisions about your student loans moving forward.
Read on to learn the basics about what student loans are, your repayment options, and how you can take charge of your repayment schedule to pay them off more quickly.
Types of Student Loans
There are two types of student loans: federal student loans and private student loans. Federal student loans are offered by the government through the Department of Education. Private student loans are offered by private banks and lenders.
Federal student loans include both Direct Loans and Perkins Loans. With Direct Loans, the Department of Education is the lender. With Perkins Loans, the school is the lender.
There are three types of Direct federal student loans.
Direct Subsidized Loans
These are available to undergraduate students with a demonstrated financial need to help them pay for the cost of a degree at a college or career school. With subsidized loans, the government covers the cost of interest while the student is enrolled at least half-time in school, in a grace period, or during a period of deferment or forbearance.
Direct Unsubsidized Loans
Direct Unsubsidized Loans are available to undergraduate, graduate or professional students. They are similar to subsidized loans, except that students do not have to demonstrate financial need to be eligible, and students are responsible for interest on the loan.
Direct PLUS Loans
Direct PLUS Loans are available to graduate and professional students and to parents of dependent undergraduate students. Though the interest rates do not vary on these loans, the government will check to ensure that you do not have any serious adverse credit history before giving out the loan (such as bankruptcy).
All federal student loans have fixed interest rates, which means that the interest rate is the same for the life of the loan. The interest rate is the percentage that a bank or other lender charges you to loan you money. The higher the interest rate, the more money you will pay over time.
Private Student Loans
There are two primary options with private student loans: those with fixed interest rates and those with variable interest rates. Variable interest rate loans tend to start out lower but can go up over time. Fixed interest rates are usually higher, but are more predictable.
Private student loans typically have higher interest rates and eligibility is based on creditworthiness. If a student does not have good credit or has no credit history at all, they can elect to add a cosigner to the loan who shares the responsibility of repayment.
It is always smart to max out federal student loans before taking out any private loans as they typically have fewer benefits and few options in the case of financial hardship.
There are a number of options for repaying your student loans based on the type of student loan that you have (federal or private) and your current financial situation.
As mentioned, federal student loans are generally considered to be more favorable because they offer more generous repayment options, particularly for those struggling to meet their minimum monthly payments.
Income-Driven Repayment Plans
For borrowers with federal student loans, income-driven repayment plans are a good repayment option for anyone who does not currently have a high salary. This plan will cap your monthly student loan payment at a percentage of your monthly discretionary income, from 10 to 20 percent.
However, the standard federal student loan repayment term of 10 years will usually be extended around 20 to 25 years. At the end of that period, the remaining balance will be forgiven.
The benefit of an income-driven repayment plan is that it will immediately decrease the amount of money that you pay each month. However, because it extends the loan term, you will pay more in interest. You will also owe taxes on the amount that is forgiven.
Forbearance and Deferment
If your financial problems are temporary — for example, if you have been laid off or are suffering an illness — then you may be eligible for a forbearance or deferment of your federal or private student loans. Each of these options will put your student loans on “pause” while you cannot make payments.
For federal student loans, a deferment allows you to not make payments for up to three years. Forbearance for private student loans is available for up to 12 months. However, for both private student loans and unsubsidized federal loans, interest will continue to grow on your loan balance, which means that making this choice can result in owing more money on your student loans.
Student Loan Refinancing
For borrowers with multiple student loans, refinancing might be an option to help save money and reduce your interest rate. Refinancing your student loans is essentially applying for a new loan to pay off your private student loans, and if you choose, your federal student loans.
Borrowers can often obtain a lower, fixed interest rate by refinancing, which can help them save thousands of dollars in interest and pay off their loans more quickly. However, you should be aware that if you refinance your federal student loans along with your private student loans, you will lose the protections of the federal student loans, such as income-driven repayment plan options.
Refinancing requires that the borrower have a history of making on-time payments, a solid income and a credit score of at least 660.
Strategies for Repaying Student Loans
Paying off your student loans should be a top priority for recent college graduates, but it can be difficult to accomplish, particularly if you have a low starting salary. But by taking certain steps and working towards paying down your loans, you can achieve this goal.
Whenever possible, borrowers should pay extra money towards their student loans. This could be as little as $25 each month, or as much as $1,000. Each little bit can help to pay down the total amount owed on your student loans.
Next, borrowers should take steps to reduce their interest rate. This can be accomplished through refinancing (described above), or often by signing up for automatic payments, or by making a certain number of on-time payments. Check with your lender to determine if they offer any incentives to reduce your interest rate.
Finally, borrowers should try to make extra payments whenever they can. A single extra payment each year can significantly reduce the total amount owed, and help you pay off your loan more quickly.
About The Author
Aside from his full-time job as a high school teacher, you can find Jacob blogging about personal finance, reading books about history, and figuring out which kind of puppy to get next. Follow him on Twitter to keep up with him! Or visit http://www.dollardiligence.com