In your twenties, there is a high likelihood you will spend time filling out applications for student loans. Most of us realize the value in a college degree, but we also recognize the enormous financial commitment required to obtain a collegiate diploma. And it can get even worse if you decide to enter into a graduate degree program. You want to become a doctor or a lawyer, you say? The financial commitment could be simply remarkable. Borrowing money in any capacity can truly feel extremely stressful and scary-especially if you are not familiar with the rules of the game.
I can remember the conversation like it occurred yesterday. Years ago, my father kindly informed me he would pay for 100% of the costs associated with an education at a state school or I could attend a private school of my own choosing and take out loans for the difference. Like most college-bound students, I was 18, and had no clue what I should do. After a long conversation with my father, I quickly determined taking out debt could be a horrendous and unnecessary decision. So off to the State University of New York I went. I was one of the lucky ones.
But now, more than ever, a large amount of young adults recognize the value in a higher education, and face the harsh realization it will be on their own dime. They don’t have the money now, so they have no choice but to borrow it and pay it back later. The difficult learning experience I avoided with student loans was quickly evident by watching everyone else. Many of my friends and loved ones have fought a difficult battle with paying back their loans.
The day those checks arrived to my lending friends and loved ones seemed to be better than Christmas. The bars and restaurants were packed. I even remember guys going out and buying new wardrobes. I was secretly jealous. Where was my windfall of free money? Why didn’t I apply for these pennies from heaven? Well the truth is that all good things usually come to an end and their debts eventually had to be satisfied. If they only knew then what they know now. Irresponsible spending and creating large debt early in life can be a financial death sentence. To help avoid this happening in your future, I will discuss the different options available and how to minimize the risk of borrowing thousands and thousands of dollars.
Choosing the Right Loan for You
There are numerous types of loans available to college-bound students. But, the first step is applying to schools you are willing to pay for. Consider the amount of money you are willing to borrow and research the tuition of each school to which you are applying. Ensure they are within your financial budget and you are comfortable with the overall price tag.
Additionally, consider other potential expenses like the cost of living, food, books, and other incidentals like travel and the need for a vehicle. Depending on the location of the school, there may be astronomical requirements you should consider. Take the time to sit down and create a spreadsheet outlining all of your potential costs for each semester. That will allow you an opportunity to truly understand how much this may cost in the long run.
Next, familiarize yourself with the different loan options available. To offer a global perspective of the most popular choices, consider the following:
Stafford Loans. Stafford Loans are the most common type of loans. They are federal education loans. Based on income, they can be either subsidized or unsubsidized. A subsidized loan is one where the government pays the interest while the student is in college. Once the student graduates, the balance of their loan is only principle and carries no required interest to be satisfied. Unsubsidized loans accrue interest while the student is in college and the student must repay interest and principal.
Perkins Loans. Perkins Loans are very low interest (currently at 5%*) federal loans and are based on income. Only those students who show exceptional financial need can qualify and apply for these types of loans.
PLUS Loans. PLUS Loans are loans that can cover the “other expenses” that aren’t covered by Stafford or Perkins loans such as books and supplies. The benefit to these loans is that it offers you the opportunity to subsidize other fixed costs you will experience during your educational journey.
Institutional Loans. Institutional loans are loans that are given to students by the institutions they attend. They are not affiliated with the government and are much less common than federal loans.
Private Loans Private loans are loans that are not funded by the government, but generally made by a bank or other lending institution. They have a variety of different terms, interest rates, etc. They are not fixed and can often be negotiated with the lending institution. Students who do not meet the financial need criteria for federal loans, but still need to borrow money for their educational journey, typically obtain these loans.
There are both advantages and disadvantages to each of these loan options. Some call for specific qualification requirements while others carry specific terms that may or may not fit you and your financial lifestyle. It is a top priority to ensure you are fully informed and research each option before you make a decision on which loan is right for you.
What’s the Debt?
When applying for college, students should first try to obtain any “free” money that they can get. Since most loan programs are capped at a certain amount per year and in total, additional options like scholarships, work study programs, and federal grants should always be at the top of the list before applying for any type of loan. For example, students obtaining subsidized Stafford Loans are capped at $3,500 in year 1, $4,500 in year 2 and $5,500 in years 3+ with a maximum of $23,000 borrowed over the course of the loan. Thus, there may be a gap between what you borrow and what you need. There are numerous programs and websites that offer very detailed and thorough information regarding the available loan options and many even allow you to enter your information and your needs and will suggest the right loan option for you.
For any federal loans, students apply via their college application. Students can apply for the maximum amount, compare the loan terms and then accept only what they need. Many students choose to accept the maximum amount they can get and live off of the funds that they don’t need for tuition. However, in many cases, interest is accruing on these funds so it may be a very nearsighted approach to managing your money.
The point is that you have to understand the overall exposure to you and your finances. Everything may seem up and up in the beginning, but understand that these loans will eventually mature and you will be on the hook for every dollar you borrowed. Before applying for any loan, the most important step to take is to research and understand your exposure, including principal and interest so you can budget accordingly.
Too Late…What Now?
Many students reading this have already applied for and received student loans. But rest assured there are steps you can take under your current loan structure to help minimize the financial strain they may cause later in life. As previously noted, students don’t have to accept all of the funds. Meeting with the financial aid department of your respective college will enable you to decline a portion of the financial aid if you choose to do so. Unfortunately, the amount of financial aid offered by the federal government is allocated among students pretty quickly and if students wait too long, the only option for obtaining additional financial assistance is through private loans (which will likely require a co-signer as many college students don’t have credit at such a young age).
Furthermore, remember that there is always a continuing opportunity to apply for scholarships and grants. Hundreds of thousands of dollars in scholarships are lost each year because students simply don’t apply. There are many different types of scholarships available. The first place to start is your respective college’s student handbook publication. These handbooks will generally list all scholarships available at the university. In fact, many alumni create scholarships in honor or memory of someone. Some scholarships are available to all students while others are focused on a particular degree of study. Also, community organizations and companies offer scholarships and while these aren’t as common, a little research could go a long way.
The point is that your loans are a living and breathing organism. There is always an opportunity to restructure or lessen the blow by subsidizing your costs through grants and scholarships. A little paperwork could be a difference of thousands of dollars in forgiven debt.
Always consider the occasion to repay your loans. If you are currently in the middle of your college career and are already receiving loans for your education, start paying them back now. A summer or weekend job could create enough financial opportunity to pay down your loans or even borrow a lower amount. Remember, the less you borrow, the less you will owe. The less you owe the less interest you’ll have to pay once you conclude your education. A hundred dollars here and a hundred dollars there over the course of your lengthy education could make a substantial difference in the pinch your loans may create once they mature.
We all think about graduation day as one of the happiest times of our lives. But it is also the first day of the rest of your life. Soon, you will be on your own, ineligible for further loans, and positioned to get a job and begin the process of paying back your loan. Loans backed by the federal government generally carry a six-month deferment period after a student graduates. This gives students a little time to find a job and get on their feet before requiring them to begin repayment. During this time, students should work to consolidate their loans. Not only will it make life simpler, but student loan repayments are often based on the new graduate’s income.
For example, if a student graduates and owes $20,000 at a 6.8% interest rate (the current Stafford Loan rate*) and the standard 10-year amortization, the payment would be about $230 per month. If the student is only earning $30,000 annually, then the student loan payment as a percentage of income is almost 10%. Most of the time, programs will work with the graduates to reduce the payment in the short term and increase it when earning increase. Additionally, you can defer payment if you continue for an advanced degree.
Thus, the first step for any new graduate is consolidation. Once the loans are consolidated and the graduate has worked with the lender to get a reasonable payment relative to their income, then we use the same repayment principles that we always use (high interest debt is knocked out first and then lower interest debt is paid, in most cases). The good news is that most interest on your student loans is tax deductible and can be written off. But you still have to budget. Hypothetically, someone could be locked in at extremely high rates while the current loan rate is half of what they are paying. It is difficult for them to watch loan rates decrease and their high interest rate remains the same. Someone could have major trouble paying back their loans at a high rate and it might follow them for years to come. So much so that they could be denied a major investment such as a mortgage because of missed payments and their debt to income ratio.
The point is that a bad decision in your twenties (or even earlier) can follow you for the better part of your adult years. It is easy to fall into the attitude that you can deal with this later in life, but eventually later will become now. And then you are stuck. Making informed and financially intelligent decisions early in the process can ensure you are positioned to handle the debt once it comes due.
The Three Do’s…
With an overview of the student loan process in mind, consider the three big do’s of managing your student loans…
DO… APPLY FOR FREE MONEY. Too much scholarship money goes untouched every year. Fill out the applications, write the essays and then submit them. The benefit financially over the longer term is tremendous.
DO…GET A PART-TIME JOB. This will not only help you reduce the amount of financial assistance you will need, but it will also show potential future employers that you’ve been in the work force and you can juggle many financial responsibilities. It may be the difference between getting a job or even a different loan for a car or a house.
DO…CONSIDER JOB OFFERS THAT FORGIVE OR REPAY STUDENT LOANS. There are numerous government positions that offer loan forgiveness or are willing to help repay a portion of your outstanding loans. The same is true in the medical industry. Salary should be just one consideration when accepting a job. Consider the total amount of money saved and earned with any potential job offer.
The Three Don’ts…
Sometimes what you don’t do is just as important as what you do. Consider these important landmines you should work to avoid during and after college relating to your student loans…
DO NOT…FAIL YOUR CLASSES. If you do, you’ll be stuck with no degree, student loan balances and no way to go back to college as you will not be eligible to receive financial assistance if your grades don’t reflect serious effort. This can be one of the worst positions you find yourself in. You will have nothing to show for your efforts but a debt to repay.
DO NOT…ACCEPT ALL FINANCIAL ASSISTANCE IF YOU DON’T NEED IT. Doing so will cause your repayment amounts to be higher and cause you to pay back more interest than necessary. If you do not need the money, don’t apply for it. Only apply and accept what you know you have to have. Ever heard the statement, “starving college student?” Don’t starve yourself, but don’t feast either.
DO NOT…APPLY TO ANY SCHOOL WITHOUT UNDERSTANDING THE REAL COST. Not all colleges are created equal. Some are more expensive, cost more to live in, and require more of you financially. It can be beneficial to understand the whole package. Then, consider if it is worth it to you. You should never go into the process blind and feel caught off guard when that first bill comes in the mail. Remember to educate yourself and make the best decision for you and your life.
Student Loan debt never goes away–not even in Bankruptcy. If you borrow the money, you will have to eventually repay it in one fashion or another. Don’t want to repay it? Well, that could cost you good credit and the ability to ever take a loan out again. So, take the time to consider all of your options as well as the potential earning capacity you may have after college. Then, you can truly assess the right type of loan for you. Next, assess how much you truly will need and try not to apply for a loan over that amount. The temptation of having the money may help justify the spending of it. Making intelligent and calculated decisions before you apply for your loan can minimize the impact these loans can have on you as you enter the real world.
Cary Carbonaro, MBA, CFP®, Managing Director, United Capital of New York and New Jersey
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