Paying off student loans requires smart decisions

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Personal Finance

Last June’s college graduates face a tough choice this month. That’s when the automatic six-month deferment on their student loans expires, forcing them to start repaying the money or beg for additional time.

Never have students been so deep in debt and so unprepared to pay.

The average student is carrying a record debt load of more than $23,000, according to a just-released report by the Project on Student Debt. Meanwhile, unemployment among college graduates ages 20 to 24 is the highest in recorded history, at 10.6%.

“With debt and unemployment at record levels, college graduates may feel stuck between a rock and a hard place,” said Lauren Asher, president of the Institute for College Access and Success in Berkeley, a nonprofit advocacy group that is affiliated with the Project on Student Debt.


Graduates do have options that could make the debt more manageable, she added. But figuring out the best option with student loans, particularly loans with special bells and whistles, can be mind-boggling, said Lynn O’Shaughnessy, who writes the College Solution blog.

“College graduates have to be really smart about their loans because it is so easy to get in trouble with student debt,” she said.

How do you make smart choices?

Separate your debt

If you have been borrowing all the way through school, you probably have a variety of loans with different interest rates and terms. Before considering repayment options, you need to examine the type of loans you have and separate your loans into piles. Gather your documents and sort them by loan type:

* Perkins loans

* Subsidized Stafford loans (the federal loans that you were granted because you had financial need)

* Unsubsidized Stafford loans (federal student loans that anyone can apply for)

* Stafford loans that you got before 2006.

Why should each of these loans be in different categories? Because Perkins loans are issued at extremely low interest rates and offer deferment and loan forgiveness programs that are not available for other types of loans.


If you consolidate a Perkins loan with other types of student debt, some of these special features are lost, said Edie Irons, a spokeswoman for the Project on Student Debt.

Subsidized Stafford loans should be separated because the government pays the interest on them when you are in school and when your loans are in deferment, which means that deferring these loans when you don’t have a job costs you nothing.

Unsubsidized Stafford loans, on the other hand, accrue interest while you are in school and while the payments are being deferred. As a result, the longer you wait to pay on them, the more you owe. If you can’t pay back all your loans right away, these are the loans you should pay back first.

Finally, Stafford loans that were secured before 2006 are issued at variable interest rates that are at rock-bottom levels, now less than 2.5%. It can be smart to consolidate these loans because that allows you to lock in that rate for the life of the loan.

Repayment options

There are five repayment options available for federal student loans. However, the newest of them, income-based repayment, makes two of the others (income-contingent repayment and graduated repayment) largely obsolete. For most borrowers, the best options boil down to:


* Standard repayment, which repays your loan over a 10-year period.

* Extended repayment, which allows you to repay a significant balance over as much as 30 years.

* Income-based repayment, which allows you to pay what you can afford, based on your discretionary income.

If you have sufficient income to repay your loans, standard repayment is the best bet, said Mark Kantrowitz, president of, a website that explains financial aid options. It gets the job done fastest with the lowest overall cost.

However, standard repayment is also the option that produces the highest monthly payment.

If you owed $40,000 at 6.8%, for example, you’d need to pay $460.32 each month under the standard repayment formula. Over 10 years, that would cost you $55,238, which is your $40,000 loan balance plus $15,238 in interest charges.

If you need a lower monthly payment, you could choose the extended repayment option and spread your repayment over 25 years. (The maximum term for extended repayment depends on your balance; the higher the loan balance, the longer you can take to pay.) That would cut your monthly payment to $277.63 a month. It would cost you far more over the life of the loan because you’d end up paying far more in interest charges. This option would cost you a total of $83,289.

With income-based repayment, your monthly payment will vary each year based on how much total student debt you have and how much discretionary income you have. With this option, all of your loans would be repaid according to this formula. (With other repayment choices, you can repay one or more loans on a standard repayment and others on extended repayment; it’s up to you.)


If your earnings are low, income-based repayment could allow you to pay nothing at all, Kantrowitz said. The catch? There’s far more continuing paperwork with this loan because you have to verify your income each year. When your income rises, your payments will too.

But if your income remains low, and you pay religiously for 25 years, any remaining balance after that point is wiped out, Kantrowitz said.

Public service

If you believe you’ll earn a small salary for a long time, primarily because you are in a public service profession, you should consolidate your loans into the Direct Loan program, which is offered through the Department of Education, and choose the income-based repayment option. This gives you low payments now, and your direct loans can be forgiven after 10 years of full-time work in qualifying professions.

Permanent vs. temporary

If you haven’t yet found a job or simply don’t earn enough to repay your loans as scheduled, you have the option of deferring repayment because of unemployment or economic hardship.


However, if you have even a part-time job, you might want to try to pay at least the interest that accrues on the unsubsidized Stafford loans, Irons said.

That would at least keep your loan balance from rising, she said, which could save you a fortune in the long run.

Rescue options

If you choose a repayment plan and decide later that it’s not working, you can shift to a different plan, Kantrowitz said.

So if your standard repayment is killing you, switch to an extended repayment or an income-based repayment, he suggested.

But whatever you do, don’t default on your loans, said O’Shaughnessy, the College Solution blogger.


If you find yourself struggling to make payments, call your lender immediately to see whether you can put your loan in deferment or forbearance, or whether you can switch to a lower monthly payment by switching your repayment option.

If you default, the penalties can drastically boost your loan balance, and student loans are almost impossible to discharge, even in bankruptcy.

“If you default, the penalties and fees are astronomical,” O’Shaughnessy said. “It is shocking how quickly they can turn a small loan into an unmanageable debt.”