Tackling Your Student Loans: A How-to-Guide
If you’re a young professional who graduated within the last decade or two there’s a high likelihood that you’ve got student loans to show for it. In today’s world of higher education, there is likely only one thing more common for students and graduates than shoe box sized dorm rooms, below average cafeteria food, and Saturday football games—student loans.
In fact, nearly 70% of recent college graduates are now leaving school with student loans. On top of that, more than 80% of graduate students end up funding their graduate degrees with loans. Cumulatively graduates have now amassed $1.2 trillion in loans or what is more accurately reflected as $1,200,000,000,000.
See: ‘Not Having a Plan For Your Student Loans’ won the Lifewise 2016 March Madness of Top Personal Finance Mistakes tournament.
In today’s blog post we aim to outline a framework for tackling your student loans in the most efficient and appropriate manner that helps you take advantage of the various repayment options available.
Step 1: Taking Inventory of Your Student Loans
When it comes to paying back your loans, the first critical step is to establish a really clear picture of what type of loans you have and their current status. It’s not uncommon for students to have 10 or 12 different loans, all of which might have different interest rates, loan amounts and ultimately repayment options.
In order to create a clear understanding of your loans it’s best to get a detailed breakdown of every detail for both your federal and private loans. This can be achieved fairly simply with two online resources:
- To inventory your Federal loans, visit NSLDS.ed.gov. Then click on the “Financial Aid Review” button, which will prompt you to login or create a Federal Student Aid ID. Once logged in, you can view the summary page, details of each loan or simply click the “My Student Data Download” to download a text file that will include any and all details surrounding your loans.
- To inventory your private loans, visit annualcreditreport.com. You can request information on your private loans straight through your loan servicer, but that can sometimes be tedious especially when multiple private loans with multiple servicers exist. Your best bet is to simply pull your free credit report. Any loans that show up on your credit report that don’t show up on the federal list, are private loans.
Step 2: Identifying Your Needs
Once you’ve inventoried your student loans, it’s time to take a step back and assess the bigger picture. Decisions surrounding paying off student loans—like any personal finance decision—should never be made in a vacuum. There’s just too many moving parts when it comes to the financial lives of young professionals to do so.
First, start by assessing your cash flow situation both now and over the next 12 months, three years, and five years—anything past that is really just a guess. This can be as simple as writing down all of your monthly expenses, allowing you to get clear about what your basic living expenses will cost month in and month out. Also, give thought to how your income may or may not fluctuate and/or grow in the future.
On top of determining what your monthly living expenses are it’s important to understand how much your company will match on 401(k) contributions to ensure that you are receiving the full match by contributing a portion of your salary. Even with student loans it’s critical to find a way to at the very least to take full advantage of the company match even if you can’t save anything above and beyond that in the short-term. A company match is essentially free money!
Step 3.1: Assessing Your Federal Loan Options
There’s really two routes you can take when it comes to repaying federal loans: (1) traditional repayment and (2) income-based repayment plans.
Traditional repayment plans are similar in a lot of ways to a traditional mortgage or car loan, where the amount owed is amortized over a certain period of time and you then make fixed payments over the course of the loan. The three primary options include:
- Standard Repayment: This repayment plan is eligible to all borrowers and requires borrowers to pay back the loan with fixed payments over the course of a 10-year time period.
- Graduated Repayment: This payment plan starts with smaller monthly payments that increase every two years, while still requiring payments to be made over 10 years.
- Extended Repayment: Payments are fixed over a 25-year time period. This means a significantly smaller monthly payment which can be good, but you will pay more interest over time.
When it comes to income-based repayment options complexity unfortunately is the norm. On a high level these plans are designed to limit the amount a borrower is required to pay to roughly 10-25% of their income. Here are some additional details on each plan:
- Revised Pay as You Earn (REPAYE): REPAYE was introduced in the fall of 2015 and made many of the benefits of PAYE available to five million more borrowers who did not qualify for PAYE by eliminating two key hurdles. First, borrowers are no longer required to meet certain debt-to-income ratios. It also opens the door to borrowers regardless of when their loan was taken out. This plan caps loan payments at 10% of discretionary income (Income – 150% of poverty line).
- Pay as You Earn (PAYE): The PAYE repayment plan was the gold standard of student loan repayment options in a lot of ways, until its successor, REPAYE. In short, PAYE caps monthly payments at 10% of your discretionary income and ensures that your monthly payments will never rise above the standard 10-year repayment plan. Additionally, any amounts owed after 20-years will be forgiven (NOTE: This amount is considered taxable so plan ahead).
- Income-Based Repayment (IBR): IBR is similar to PAYE in a lot of ways, however, it tends to be slightly easier to qualify for. The cap on monthly payments is set at 10% for new borrowers and 15% for older borrowers. Similar to PAYE, to initially qualify any payments will need to be less than a standard 10-year payment plan.
- Income-Contingent Repayment: This plan has been made obsolete in a lot of ways by the newer incarnations listed above, as this plan only limits monthly payments the lesser of 20% of discretionary income or approximately the equivalent of a 12-year standard repayment plan.
Step 3.2: Assessing Your Private Options
When it comes to private loans there is significantly less complexity, but with that comes far fewer options. In fact, borrowers should be extremely careful when considering refinancing federal loans with private loans as virtually any and all borrower protections and flexibility goes away by refinancing federal loans into private loans.
When it comes to consolidating (combing multiple loans into one) private loans borrowers will need to apply and be approved, but if you are approved, you’ll stand to potentially lower your interest rate, as well as the monthly payment on your loans.
Lastly, a few other things to be aware of when looking to consolidate private loans or refinance them. First, private lenders are not required to offer any type of forbearance options that can help if you run into a situation where you are unable to make your loan payments.
Second, be aware that the rates many private lenders advertise might not be something you can qualify for. Oftentimes the advertised rate is something only a person with a large income, a perfect credit score and an ability to increase their income will qualify for. This is why it’s always important to do your homework before settling on a private lender.
Step 4: Establishing your Strategy
With a clear picture of your current loan landscape, a good understanding of your broad financial situation both today and into the future you should be poised to work through and establish a strategy around what’s best for your personal financial situation.
In general, keeping your monthly payment as low as possible is the best course of action to take simply because it will provide considerably more flexibility if—and in all likelihood when—your financial situation changes. You are always free to pay back your loans quicker but keeping the payment low provides additional month to month flexibility as needed.
Ultimately only you can assess your situation and what is right for you but following the above framework should help in assessing your current situation and ultimately selecting the most appropriate repayment plans given your situation.
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