Paying for college is a huge challenge for most students and families in the United States as tuition and education expenses continue to rise each year. What’s worse is that many people end up paying more back in student loans by not utilizing resources that are available to them.
The high school class of 2017, for example, left up to $3 billion in federal grant funding on the table due to not completing the Free Application for Federal Student Aid (FAFSA). Sallie Mae’s study on How America Pays for College reveals that the top reasons that families did not complete the FAFSA in 2020 were that they didn’t believe they would qualify for aid, missed deadlines, or trouble with the application. Overall, 14% of families didn’t know about FAFSA while 11% didn’t have the information required to complete the application.
Today, the $1.5 trillion that 43 million Americans carry in student debt has become a major problem as it has become unmanageable for so many. Having a plan to strategically manage your loans and understanding your options is a great place to start if you’re feeling overwhelmed by your student loan debt.
Despite its significance, student loan debt only makes up a fraction of your total financial position. “When it comes to student loan debt, it’s totally individualized. It really depends on many items: What are your goals and priorities? What other debts do you have? What are your financial goals?” says Renee Earwood, MS, AFC®, Founder and CEO of Student Loan Coach LLC, and knowing where your student loan debt fits into your financial situation requires careful evaluation of each element.
“I know that a lot of young professionals have many different financial goals that are really important to them too, like getting married, starting a family and buying their first home,” says Justin Chidester, CFP®, AFC®, owner of Wealth Mode Financial Planning in Logan, Utah. “So you need to save dollars towards those things too and find balance as you’re trying to pay off student loans.”
The way that federal student loan debt differs from other kinds of debt is based on your approach, according to Chidester. “With student loans, the very first thing you have to look at is, should I even be going for full payoff in the first place?” he says.
Paying off your debt as quickly as possible is a great attitude to have for credit card debt, car loans, and even mortgages. When it comes to student loan debt, taking a step back and looking at what forgiveness options are available to you may reveal alternatives to paying that debt in full.
If you have federal student loans, there are more relief options available to you than there are for private student loans.
“If you have a high enough debt compared to how much your income is, you should first consider if it’s better for you to pursue some kind of forgiveness program where you don’t actually pay your student loans off in full,” Chidester explains. If this is the case, then your goal will not be to pay your debt back as fast a possible. “If you’re going for forgiveness, then your mentality is going to be, ‘How do I pay less on my debts slower?’”
If you do decide to go for full payoff, the ways to pay your debt off faster are the same ways you can try to pay off any kind of debt faster. You can make extra payments, you can refinance to a lower interest rate, you can try to challenge yourself to spend less and save more or throw more towards your debt payments.
“That’s where it becomes highly individualized and you have to find what’s the best balance for you,” says Chidester.
For recent graduates, either all or most of their debt is federal student loan debt. You should be very careful before you decide to refinance your federal student loan debt into private student loans, because the second you do that you lose a lot of the flexibility features that federal student loan payments have.
Chidester warns, “You first need to absolutely make sure that your best strategy is to fully pay them off because the second you take them out of the federal side and privately refinance them, you don’t have any forgiveness clauses available to you.” With federal loans, if you ever lose your job or go through a setback where you’re unable to make your payments, you can ask for forbearance. The government grants three years of cumulative forbearance you can use of federal student loans.
Earwood recommends knowing all the federal programs that exist that you may be forfeiting, as well as the terms of the new private lender. Private lenders sometimes will include certain types of features that might be available to bring them more in line with federal options, like deference or forbearance. “You really just have to educate yourself on what you’re giving up and what you may be obtaining,” she states.
Once you go from a federal loan to a private loan, the decision is irreversible. This is important because perhaps you may have the opportunity to qualify for public service student loan forgiveness, which is based upon your years of service in a public industry. Once you refinance, that will no longer be an option. Default rehabilitation will no longer be an option once you refinance either.
Refinancing your loan to get a better interest rate is probably the biggest benefit of doing so. “If you’re taking a very aggressive approach, you don’t think you’re going to use any of the [federal forgiveness or rehabilitation] options, and your main objective is to refinance to save money on interest and get the loan paid off as soon as possible, that’s usually when it makes sense to do so,” Earwood concludes.
If you’re still fresh out of school or are not financially stable, Chidester says it might be wiser to wait longer before refinancing, maybe when you have a better emergency fund or are further into your career.
If you’re starting out with private loans, however, you can refinance them as many times as you want, but of course, each private loan has different terms. If you’re shopping rates, still remain cognizant of the opportunity costs of each loan.
You have a six-month grace period after you graduate before you have to start paying on your loans. Once that sixth month is up, there’s a good chance you may still feel like you aren’t in a good place to start paying on your loans.
“I think the biggest mistake people make is they forget to request forbearance, or — what might even be better — to apply for an income-driven repayment plan (IDR plan),” explains Chidester.
When you apply for one of the IDR plans, the government bases your monthly payment towards your federal student loan on your income from last year’s tax return, which is likely to be very low, even zero if you didn’t have any income, if you’ve recently graduated. So it’s possible that you can get into an IDR plan, and when they calculate your income from the previous year, your payments may still end up being zero.
“That’s the better route to go if you’re trying to suspend before you have to start making big payments because you’re not using up some of that forbearance time,” he furthers. “That forbearance is really useful for later in your life if you have a serious emergency where you aren’t able to make payments for a while.”
Forbearance and deferment make it easier to forget about your student loan payments, but remember that the interest is still going to accrue.
The other side of IDR plans is that some of them have built-in 20-25 year forgiveness. “But when they do reach that point, there could be a tax consequence on the amount of debt that’s forgiven, which a lot of people don’t realize,” warns Earwood. “If that is the case, people should prepare ahead in their financial plan a tax strategy to deal with that.”
Why it’s important to have a solid plan that you’ll be able to stick to in repaying your student loan debt is that you want to avoid defaulting on your payments, which typically occurs after failing to pay for nine consecutive months. Being in default can have major negative implications for your credit, amongst other things, and this can stop you from being eligible for future loans.
“When it comes to student loan default, the most important thing is to start paying attention to it and to take action,” Earwood confirms. This may involve giving your collector a phone call and starting a rehabilitation program if you’re eligible.
Everyone gets one chance for federal student loan rehabilitation. To successfully complete the rehabilitation program, you must make nine on-time payments over a ten-month period. “If you complete the rehabilitation program, they will actually remove the default status from your credit report, so that’s a really great incentive to make the phone call to get a rehabilitation plan,” notes Earwood. Further, she says, is that you’ll be able to confirm that the payments are an amount you can afford based on your income and expenses.
Because you only get one shot at rehabilitation, the risk you take when entering the program is that you don’t complete it successfully. “If you’re in that rehab process and you don’t make a payment on time or you don’t pay the full amount you’re supposed to pay for that month, then there’s no going back. It will then just take some time to go into more distant history on your credit report,” Chidester furthers.
Loan consolidation may be another option for you to get your federal student loans out of default. While consolidation restarts your loan over and you get out of default, it does not remove that default from your credit report. Earwood reiterates that this is another reason to talk through your goals with a financial coach or advisor to determine if this is a good option for you based on where your credit lies in your financial priority list.
In addition to all of the resources available online in articles, blogs, and podcasts, studentaid.gov has all the general information you’ll need to understand the basics of your federal student loan. The information on how to apply that information to an individualized plan for you is where a coach or advisor can come in and assist you with the process.
rebel Financial is a registered investment adviser and the opinions expressed by Wealth Mode Financial Planning and Student Loan Coach, LLC in this article are their own and do not reflect the opinions of rebel Financial. All statements and opinions expressed are based upon information considered reliable although it should not be relied upon as such. Any statements or opinions are subject to change without notice.
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