3 Menacing Myths About Student Loans

By Markets Fool.com

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Source: flickr user Eugene Zemlyanskiy

Student loans can be a financial burden for many Americans, but there are right and wrong ways to handle your student loan debt. We asked our analysts to explain three commonly used student loan options that might not be as good of an idea as you may think.

Dan Caplinger: One myth is that it always makes sense to consolidate your student loans once you graduate. Many lenders try to convince you that the convenience of having a single monthly payment and the option to extend your loan payments over a longer time period make sense for everyone.

The problem with consolidation, though, is that you can lose the beneficial terms offered by some types of student loans. For instance, provisions of certain loans allow the principal you owe to be forgiven or reduced for certain reasons, but if you consolidate, you'll typically miss out on loan forgiveness even if you meet the terms at a later date. Similarly, some lenders reduce your interest rate once you build up a track record of timely payments, but you'll lose that benefit if you consolidate with a different lender.

Be sure to select the lender you consolidate with carefully, because some will offer better deals than others. By treating consolidation like a negotiation, you can get the terms you deserve, and you always have the option of simply paying down your current loans as leverage if a lender doesn't want to give you good consolidation options.

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Jordan Wathen: Many people make the mistake of thinking that an income-based repayment option is their best choice for paying off a student loan. Income-based repayments generally cap your monthly payment at 10% of your discretionary income, which can be much less than ordinary scheduled monthly payments. It sounds great in theory.

While it could be a good deal at the time, keep in mind that any balances will continue to accrue interest. Thus, this plan could result in you paying off your student loans for a longer period of time, and paying more in fees and interest over the life of the loan. In addition, any balances that are forgiven are ultimately treated as income, meaning you'll have to pay taxes on forgiven student loan balances as if you had received a fat check for the same amount in a single year.

Income-based repayments are just a way to kick the can down the road. They're an easy solution to a budgeting problem in the present, but the comfort they provide today often just comes at a higher cost in the future. Don't make the mistake of thinking the lower payments from income-based repayments are free money; they are anything but free.

Matt Frankel: Many people apply for a deferment or forbearance when they're having trouble paying back their loans but don't realize that interest continues to accumulate.

A deferment is usually the more favorable of the two options, if you qualify. You can generally defer your loans if you are in school (at least half time), unemployed, or are experiencing "economic hardship." While in deferment, the government might pay the interest on your Federal Perkins Loans and subsidized student loans. However, you'll be responsible for the interest that accumulates on any unsubsidized loans.

A forbearance may be granted for up to 12 months if you can't make your student loan payments but don't qualify for a deferment. Unlike a deferment, you'll be responsible for the interest that accrues on all loans, even subsidized ones.

Consider an example of a borrower who has $40,000 in student loans at 6% interest, half of which are subsidized loans. If the borrower receives a deferment for 12 months, $1,200 in additional interest would be tacked on to the principle. By contrast, during a 12-month forbearance the accumulated interest would come to $2,400.

If you legitimately can't pay your loans, a deferment or forbearance could be a useful tool to lower your monthly obligations and keep your credit good. However, these should be used as a last resort, since you'll end up owing even more than you started with. These are yet another way of kicking the can down the road, except the can gets bigger every time you kick it.

The article 3 Menacing Myths About Student Loans originally appeared on Fool.com.

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