Options for Students to Pay Down their College Loans

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Recent college grads are increasingly struggling to make their student loan payments because they either can’t find work, or, if they are able to gain employment, they aren’t making enough to pay down the debt in addition to their other expenses. So it comes as no surprise that student loan default rates are soaring.

“About a third of federal Stafford loan borrowers are late with their very first loan payment,” says Mark Kantrowitz, publisher of FinAid.org and FastWeb.com. “Defaulting on federal education loans can ruin your credit, making it more difficult to get a credit card, auto loan, or mortgage, and it may also make it more difficult to rent an apartment or get a job.”

President Obama’s new student loan plan announced last week a plan that  the existing plan to cap student loan payments at 10% of income scheduled to start in 2014 would start as early as 2012.

To avoid a bad lending situation, it’s important that students make a post-grad repayment plan that works with their financial circumstances.

Being a good borrower can pay off for students—if they make their payments every month for a year, some lenders will reduce the interest rate up to 0.50%, according to the experts.

“Not only is the lender giving you a discount – something that auto lenders and mortgage lenders almost never do; borrowers who repay their loans through auto-debit are much less likely to miss a payment,” says Kantrowitz.

Repayment plans and options

For students whose debt exceeds their income, or are not able to make monthly payments after the grace period, they can work with lenders to create an alternative, affordable repayment plan, says Kantrowitz.

There are four main types of federal student loan repayment plans: standard repayment (10-year term), extended repayment (up to 30 years), income-based repayment plan (depending on your discretionary income), and graduated repayment (payments start out low and are increased every two years).

The extended repayment plan allows borrows to pay a fixed monthly payment like the standard repayment plan (minimum monthly payment of $50), but over a 12 to 30 year period of time instead of 10. This gives borrowers the ability to reduce the size of monthly payments, but by stretching out payments over a longer term increases the amount you’ll repay.

Income-based repayment (IBR) plans are currently capped at 15% of discretionary income, but under Obama’s new it will be capped at 10%.

“The IBR is probably a good option for people starting out that have a lower income now than they will in the future; essentially they will defer some of the interest until the future but they will be able to handle that higher payment down the road,” says Mark VandeVelde, wealth partner at Hefty Wealth Partners.

Graduated repayment plans usually have a 12 to 30-year loan term, and the monthly payment can be no less than 50% and no more than 150% of the monthly payment under the standard repayment plan—borrowers can calculate what their monthly payment will be.

Students can change repayment plans at least once a year, and Kantrowitz suggests that borrowers start with a 10-year repayment plan, paying the highest loan payment they can afford and then changing it if it becomes hard to make ends meet.

Public service loan forgiveness

Graduates who are looking to get into the public service industry will reap some advantages when it comes to paying off their loans. Public service loan forgiveness, which works with IBR and cancels all or part of a student loan, applies to jobs such as public school teachers, police, fire, EMT, public defenders, prosecutors, government workers, members of the military and anybody who works for a 501(c)(3) organization, according to Kantrowitz.

Although IBR usually forgives any remaining debt after 25 years of repayment, public service positions forgives remaining debt after 10 years.

Volunteering for organizations such as the Peace Corps and AmeriCorps may also provide a stipend to put toward paying down loans, or can partially cancel certain loans.

Although these options can be great experiences, the experts warn against joining organizations solely for the benefit of the loan repayments.

“You’re better off finding a job that you really love and paying the loan back whereas if you get trapped in a bad job just to pay the loan off, it’s not a good thing either,” says Pete D’Arruda, author and host of the “Financial Safari” radio show.

Other repayment options

In addition to standard repayment plans and public loan forgiveness, consolidating loans can streamline  different loan payments and interest rates into a single monthly payment. The weighted average of the interest rate on the loans students are consolidating is rounded up to the nearest 1/8% and capped at 8.25%.

“Just because you have a lower payment now doesn’t mean it’s the best option--you may end up paying a lot longer and you may end up paying a lot more depending on what the structure of the loan is,” says VandeVelde.

Some people may choose to take a less conventional route to pay off debt, such as refinancing their house to repay the loan. Although it could make sense for some people with a lower interest rate on their home equity loan than on their student loans, experts warn borrowers should tread cautiously with this decision.

“If you can’t pay that bigger bill, you could lose everything--you could lose your home, so I advise people against that,” says D’Arruda.

Some companies help employees with their monthly loan payments, says D’Arruda, but that should be  negotiated at the start of a job.

“You say look, I’d love to come work for you, but the salary is a little lower than what I was expecting--can give me a little bit extra every month to pay my loans off?” he says. “Some employers will be open to that if you have a good skill set.”

Unfortunately, private loans do not have as many options for repayment as federal loans. Federal loans offer up to three years of economic hardship deferment and five years of forbearances, while private loans offer only one year of forbearance, and may charge a quarterly fee per loan in forbearance, says Kantrowitz.

Although it may be tempting to temporarily forget about loans after college, they shouldn’t be put on the backburner.

“You get eight to 10 years down the road and you’re still making those student loan payments and you’re going to say I wish I would have paid more upfront,” says VandeVelde.

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