Student Loan Repayment Options for Federal and Private Loans
Staying current on college debt payments is serious business, especially since defaulting on a student loan can result in a host of problems, ranging from wage garnishments and blemishes on your credit report to difficulties landing a job.
But if recent data are any indication, an increasing number of cash-strapped students are being saddled with these issues – and the problem is only likely to get worse.For starters, the volume of student loan debt – including federal and private loans – is expected to top $1 trillion for the first time ever in 2011, according to Mark Kantrowitz, publisher of FastWeb.com and FinAid.org. Kantrowitz is perhaps the country's best-known expert on student loans and college financing.
Additionally, student loan delinquencies and defaults are on the rise. The latest figures from the Department of Education indicate that roughly 7% of all federal student loans are in default – meaning the borrower has missed at least nine months' worth of required payments.
Yet many observers believe the government's 7% figure is vastly under-stating the extent of the student loan burden on borrowers.
In March 2011, the Institute for Higher Education Policy issued a report called Delinquency: The Untold Story of Student Loan Borrowing, which put the student loan default rate at a substantially higher rate of 15%. Equally troubling, the report concluded that: "A total of 41% of borrowers faced the negative consequences of delinquency or default."
"It is important to recognize that for every borrower who defaults, there are at least two others who were also delinquent on their student loans, but successfully avoided default," the report states. (See my advice for how to fix defaulted student loans).
With so many people falling delinquent or going into default on their student loans, it's important for borrowers to know their options and how to avoid default.
Federal Loan Options
Here's an overview of the four major repayment options students have when it comes to paying off their federal loans – as well as advice about how to handle burdensome private student loans.
The Standard Loan Repayment Plan
Under this repayment option, you're required to pay a minimum of $50 a month, and your payments last for as long as 10 years. This plan represents the single fastest way to pay off student loans.The Extended Repayment Option
This plan also requires monthly payments of at least $50, but it lets you pay off your educational loans over the course of 12 to 30 years. Many borrowers choose this option to give themselves some financial breathing room.The Graduated Repayment Program
This repayment option lasts from 12 to 30 years and allows you to pay as little as $25 a month. Again, it's a choice for those who can afford to repay their loans but want lower monthly payments.The Income-Contingent Repayment Plan
This option generally permits you to make payments of as low as $5 a month, but it lasts for 25 years. The key to this program is that you'll always have what the Department of Education defines as an "affordable" repayment option since your student loan payment is tied to your income. Your student loans payments will be 15% of your income, to be exact.
If you're especially cash-strapped, have fluctuating income or expect your income to rise steadily, many experts suggest you sign up for the income-based repayment plan. "Income-based repayment provides a safety net for borrowers of federal student loans," says Kantrowitz, whose research shows that roughly half of all these borrowers are making a zero monthly payment.
For those with very high student loans ($50,000 or more) who make modest salaries, one attractive feature about the income-based repayment plan is that once you do pay that 15% of your income over 25 years, whatever remaining student loan debt you have is forgiven. That 25-year period gets cut to 10 years if you work in public service. This feature can be especially advantageous for those who went to professional school, like law school or medical school, since many people who borrowed for graduate school are saddled with six-figure debt loads and are taking extreme measures to pay off college loans.
For all other borrowers, as a rule of thumb, don't simply pick the repayment plan that will get you the smallest monthly payment, if you can afford to do otherwise. Selecting a longer repayment plan will help boost your cash flow in the near term, but in the long run, you'll pay thousands more in finance charges.
The best strategy: Pay as much as you can possibly afford on your student loans. If you can't swing the standard repayment plan (with a 10-year payoff) and you have to choose a longer repayment plan, then at least make extra payments (even an additional $25 to $50 a month will help a lot) on top of your normal monthly payment.
Private Loans Options
Although there's no official source that tracks national default rates on private student loans exclusively, Kantrowitz estimates that only 40% of all federal and private student loans are in repayment. The 40% figure includes debt for students who are still in school.
That means the other 60% of college loans are either in forbearance, deferment or default. And for students struggling with student loans they can't afford to repay, forbearance or deferment may be the best option. Such payment relief is generally available during economic hardship periods, such as times of unemployment or prolonged medical illness.
If you're having difficulties repaying your private student loans, the best starting point is to contact the lender directly, explain your circumstances, and inquire about your options. Be aware, however, that not only do private loans typically carry higher interest rates than federal loans, they also have fewer forbearance, deferment and loan forgiveness options.
That's why experts like Kantrowitz are troubled when they see members of Congress moving to cut real financial aid to students and their families. Kantrowitz says it's a "fiction that loans are a form of student financial aid." True aid, he contends, are things like scholarships and grants, including federally sponsored grants.
Unfortunately for college students, Republicans are trying to cut Pell Grant funding – which is free money from the government for financially needy students.
"Given a choice between cutting need-based grants and loans, loans should be cut first. But instead of cutting student aid, we should be expanding it," Kantrowitz says. "The combination of cuts to the Pell Grant and double-digit tuition inflation at public colleges will cause hundreds of thousands of low-income students to drop out of college."
Can Your Employer Help?
As I explained in my book, Zero Debt for College Grads, one, final, little-known way to get rid of college debts - including both private and federal loans - is to have your employer pay off the debt.
Many organizations will do so if you sign an employment incentive contract. This means that as a "bonus" or perk to you, your job pays off your student loans. In turn, you agree to be a loyal employee and remain with the company for a given period of time, say at least two to three years.
Think about it this way: Getting an employer to pay off your student loans is just another form of a benefit. Companies offer workers extra cash all the time – like hiring/signing bonuses, performance bonuses, year-end bonuses or holiday gift money. So money provided to knock out student loans is simply another form of cash compensation.
Why are companies willing to consider offering student loan assistance? It's simple: They want to hire and retain top talent – even in an economically challenging time like the one we're currently facing.