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With seven out of 10 college graduates leaving school with student loans, many people’s first major financial experience is repaying this debt once they get started in their career. Unfortunately, student loans are a very complex and poorly understood financial product. This leads many student loan holders to make some big mistakes which can result in a lot of grief, frustration, and unnecessary expenses.
Thankfully, there are simple steps you can take to ensure you don’t make these mistakes, which are shared after the details of the problem at hand.
1. Not paying student loans on time
Student loans do not go away if you pretend they are not there. Not only are student loans not dischargeable in bankruptcy, but the federal government now issues 94% of student loans and is the most effective and persistent debt collector in the business.
If you have federal student loans, you have lots of options to structure your payment in order to make the monthly payments more affordable — or even suspended for a period of time — if your current life circumstances are making it difficult to make payments.
Simply avoiding the bills and not talking to the company that processes your student loan payments (your student loan servicer) will just lead to more fees and accrued interest on your loans, so reach out and don’t pay more than you need to.
2. Not modifying them if you’re struggling
The second major mistake to avoid is thinking there is nothing you can do if you are struggling to make student loan payments. Most federal student loans begin all borrowers on a standard 10-year repayment plan, regardless of the loan balance or the income of the borrower. But these loans also have very generous payment modification plans that can lower your student loan payment to as low as $0. If you reach out to your student loan servicer, explain your situation and provide proof of income.
These payment plans are collectively called “Income-Driven Repayment plans.” Under these plans, you pay a new monthly amount that is based on your income level and when you received your loans (which, in turn, determines how much you can afford to pay each month on your student loans).
These plans, called Income-Contingent Repayment, Income-Based Repayment, and Pay As You Earn, limit your monthly student loan payment to 20%, 15%, and 10% of your monthly income over the federal poverty threshold, respectively. To apply for these plans, you need to either contact your student loan servicer to request moving on to one of these plans or apply directly on the FSA site.
Even though you will end up paying more in total on an Income-Driven Repayment plan than on the standard plan, this method is far preferable to using high-interest credit cards or other forms of financing to meet a gap in income and payments.
3. Paying more than you need to
Finally, many people could be limiting the total amount they pay on their student loans but haven’t realized the options they have to do so. Similar to people who are struggling but don’t know how to modify their monthly payment down, people who have a well-paying job and few other expenses have options to lower the total amount they pay over the lifetime of their loans.
First, people in this situation should examine if they could qualify for a lower student loan interest rate by refinancing their loan in the private market. Many companies are now offering student loan refinances at competitive interest rates, and they can consolidate both federal and private loans, which will yield lower total interest payments and decrease the total cost of the loans.
Second, there are no pre-payment fees for student loans, so increasing the amount you pay every month if you have the means to do so can accelerate your repayment and reduce the interest expense incurred over the life of the loan.
There is always an option. You just have to act! Not taking action is the common theme with the three biggest mistakes we’ve seen people make with their student loans. If you reach out to your servicer, whether you are in great financial health or on the brink, you will have options to change your situation for the better.