Grads Should Do Homework Before Picking Loan-Payback Plan
There may be an ominous strain running through the pomp and circumstance of this college graduation season.
That’s because graduation day sets the clock ticking on student loan repayments, which generally start six months after students leave school. And never in history have students been quite so indebted.
Indeed, the number and size of student loans have exploded in the last four years, says David Merkowitz, spokesman for the American Council on Education in Washington.
The number of student borrowers has soared 53% since 1990, and the amount borrowed has more than doubled to $27.1 billion. A student who borrowed the average amount over the last four years is now graduating more than $13,000 in debt. And the debt burden is rising. In 1995, the average student borrower secured a $3,948 loan--just for the 1995-96 academic year. And many students take more than four years to graduate.
However, thanks to increased competition for the government-backed student loan business, graduates have a wide array of choices to ease their repayment burden. Moreover, a handful of lenders have instituted cut-rate programs that can save you thousands of dollars over the life of the average student loan.
Savvy graduates can use their six-month grace period to investigate the options and figure out which one will prove most advantageous.
The tricky part is that your options, to some degree, depend on who owns your loans. However, if you’re not wild about your lender, you can sometimes switch by asking the lender to sell your loans to a secondary marketer, such as the Washington-based Student Loan Marketing Assn., also known as Sallie Mae, or by securing a consolidation loan with another company.
The vast majority of student loans are held by just four organizations: the government, through its direct-loan program; Sallie Mae; New York-based Citicorp; and New England Education Loan Market Co., or Nellie Mae, a nonprofit student lender based in Washington. (Chase Manhattan previously ranked as the nation’s third-biggest student lender, rounding out the top five. But Chase recently merged with Chemical Bank and sold its student loan portfolio to Sallie Mae.)
They all offer four basic repayment options: a level-repayment plan, in which your payments stay the same for 10 years; a graduated plan, where the payments start low and rise gradually; an income-contingent plan, where the payment is based on the amount of money you’re currently earning; and a loan-consolidation program, which allows you to refinance all your federal student loans and stretch the payments out more.
All federal student loans also offer payment deferrals for people who can’t find work or who go on to graduate school or have an economic hardship that makes it impossible to start paying right away. Deferrals give you more time until payments are due; however, interest continues to accrue on unsubsidized loans.
By and large, the government offers the best deals for cash-strapped borrowers who have a lot of debt but are going into a low-paying profession. Specifically, the government’s income-contingent loan program will stretch payments over periods as long as 25 years. If you can’t pay off the balance in that period, the remaining balance is forgiven. But you have to pay tax on the amount you didn’t pay--debt forgiveness is considered a taxable gift. (Also note that student loans cannot be discharged in bankruptcy.)
Although the other lenders also offer income-contingent programs, they all expect the loans to be paid in full, usually in 15 years or less. As a result, monthly payments are likely to be higher.
Many students are drawn to the income-contingent program because with the possibility of low monthly payments, it appears the most advantageous, experts say. But over the long haul, it can cost thousands of dollars more.
For example, Nellie Mae examined the total amount due from a borrower with $15,000 in loans who chose a standard level-payment plan lasting 10 years and compared that with someone who chose an income-sensitive plan that lasted 15 years. The level-pay borrower paid $183 per month, for a total of $21,839. The income-sensitive borrower’s initial payments were $100 per month, but gradually rose to $236. In the end, the income-sensitive borrower paid $29,740--$7,901 more than the level-pay borrower.
Why so much more? Your interest charges are based on the unpaid balance each month, and when you choose the income-contingent program, your unpaid balance remains high for a longer period. Indeed, in some cases, initial payments may be set so low that your monthly payment won’t cover the interest portion of the loan.
“Students might look at this and think, ‘I want lower payments now,’ but by spreading it out, they will pay much more over the life of the loan,” says Sandy Baum, professor of economics at Skidmore College in Saratoga Springs, N.Y.
Of course, you can always pay off your loans early--generally without any penalty.
For current graduates who expect to be able to pay their loans on time, Sallie Mae offers the best deal because of the interest rate breaks it gives for prompt payers.
If you make your first 48 payments on time on loans taken out after Jan. 1, 1993, you earn a 2-percentage-point cut in the loan rate, says Sallie Mae spokesman Josh Dare. If you have your payments automatically deducted from your checking account, you can score an additional quarter-point rate cut. On a $15,000 loan, that saves you between $1,200 and $1,500, depending on the interest rates on your loans, according to Sallie Mae’s toll-free answer line. (Sallie Mae also offers somewhat less generous prompt-payment discounts for consolidation loans.)
Both Citibank and Nellie Mae have recently instituted similar programs, but these are available only for recently written loans.
Notably, a student who is unhappy with his or her lender’s repayment options is not necessarily stuck. If you have at least $7,500 in student debt, you are allowed the option of “consolidating,” or refinancing, your debt with one lender.
In any event, recent graduates have six months to consider what type of employment they’re likely to secure and then consider their loan-repayment options. Those who need help can call their own lenders or the government’s direct loan program at (800) 433-3243.
The other numbers: Sallie Mae, (800) 891-1407; it also operates a Web site at https://www.salliemae.com where browsers can get loan information and calculate the costs of loans and college. Nellie Mae can be reached at (800) EDU-LOAN (338-5626). Citibank can be reached at (800) 967-2400.
Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Business Editorial, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or message kathy.kristof@latimes.com on the Internet.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Student Loans
The federal government has been sponsoring a student loan program since the late 1960s. But in the last few years, both the number and average size of loans have increased dramatically. The average size of the first 89 loans, written in 1966, was $828, compared with $3,948 in 1995. Statistics for the last 10 years:
THE GROWTH OF LENDING
*--*
No. of loans Total dollars Average loan Year (in thousands) (in millions) amount 1985 3,833 $8,913 $2,326 1986 3,610 8,570 2,374 1987 3,876 9,736 2,512 1988 4,513 11,816 2,618 1989 4,713 12,466 2,645 1990 4,493 12,291 2,734 1991 4,818 13,500 2,804 1992 5,130 14,749 2,875 1993 5,647 17,863 3,163 1994 6,566 24,138 3,676 1995 6,870 27,126 3,948
*--*
Source: American Council on Education
PAYMENT PLANS
How is the cost of paying off student loans affected by the repayment plan you choose? New England Education Loan Marketing Co., better known as Nellie Mae, estimated the cost based on $15,000 in loans made at an 8% annual rate. Figures are rounded.
Plan Type: Standard
Payment: $182
Total cost: $21,839
Terms: Level monthly payments throughout 10-year term of loan
Plan Type: Graduated
Initial payment: $126
Total cost: $22,906
Terms: Payments start low but gradually increase, to $177 at beginning of third year and to $230 in year six. Loan is paid off after 10 years.
Plan Type: Income-sensitive
Initial payment: $100
Total cost: $29,740
Terms: Monthly payments are based on percentage of borrower’s after-college income. Assumes initial payment is set at 4% for borrower who earns $30,000 after graduation. In this example, payment rises to $143 in year seven, then to $236 for final three years of loan. Loan is paid off in 15 years.
Plan Type: Consolidation
Initial payment: $144
Total cost: $25,802
Terms: Allows one--or numerous--student loans to be folded into one package and repayment to be spread out over periods ranging from 15 to 30 years, depending on balance outstanding. In this example, payments are level in last 15 years.
Source: Nellie Mae
