October 24, 2017

9 Things You Need To Know About Repaying College Debt

College loans are coming due so know your repayment options. Here's the info you need to make the best decision.
Megan Kelly, CFP®

Americans have a lot of student debt. In fact, they owe 1.45 trillion dollars. The 2016 college graduate has an average of $37,172 in student debt, and only 41 percent of them know when they will have it paid off.

Most graduates have so much debt that they believe they will never be able to pay it off. One quarter of those with student loan debt are in default, and the sad part is that 70 percent of them would have qualified for an income-driven repayment plan. If they had evaluated their options, they could have avoided going into default and destroying their credit score.

There are several college debt repayment options that are less onerous and fit better into entry level salaries and budgets than the standard 10-year payback plan. Let’s put our education to work by evaluating the available repayment options and how to qualify for them.

1. Know how much college debt you have

The first step to paying back student debt is to figure out how much you borrowed and the balance including any interest. If you’re not sure what debt you have, go to the National Student Loan Data System. Once on the site, determine if your loans are federal or private, the interest rate, and terms of each loan.

2. Use a repayment estimator

Next, go to studentloans.gov. They have a repayment estimator that will help determine what plans you qualify for and the amount of your monthly payment under each plan.

3. Know your repayment options

If you have federal loans, there are several repayment plans to choose from depending on your income and type of loan. These include income-driven repayment programs such as income-based repayment (IBR), pay-as-you-earn (PAYE), and revised-pay-as-you-earn (REPAYE). Other options include Public Service Loan Forgiveness (PSLF), deferment, and forbearance.

There are stringent qualifications to be accepted into any of these plans and important things to consider with each option. The chart below outlines the main qualifications for each repayment plan.

Note that no new loans are being made under the Federal Family Education Loan Program (FFEL). All new loans are made under the Direct Loan program.

4. Choosing the right plan for you

There are benefits and drawbacks to each repayment plan option. Some of the benefits to the income-driven repayment plans are lower monthly payments and any balance of the loans at the end of the repayment term is forgiven. It may be tempting to opt for one of these plans with the lower payments; however, you will end up paying more in interest—possibly thousands of dollars—over the life of the loan. You are also responsible for paying taxes on any loan amount that is forgiven.

Income-driven repayment plans are best for those who are having trouble paying for essentials such as rent and groceries. If you can afford the standard plan payment each month by adjusting your discretionary spending, it usually makes sense to stay on the standard plan. You will pay less in interest and won’t have the possibility of a hefty tax bill if the loan balance is forgiven. You will also pay off your loan in 10 years versus the 20-25 years with an income-driven repayment plan. Also, remember that you are not stuck with the plan you choose and can change from one plan to another at any time if you meet the qualifications for that repayment plan.

5. Private loan repayment plans

With private loans, you are limited to the repayment options allowed by the lender. Don’t be afraid to ask if they have different options as some may offer graduated or extended repayment plans. In a graduated repayment plan, your payments start out lower and increase over time. In an extended repayment plan, you have lower payments for the life of the loan, but the loan period is longer, so you end up paying more in interest.

Read: Smart Saving Strategies for Millennials

6. Set up automatic payments

Once you’ve decided which plan is right for you and you’ve been approved, set up automatic payments. With any of these plans, if you miss even one payment, then you are no longer eligible for the loan forgiveness which could cost you tens-of-thousands of dollars. 

7. Re-certify every year

If you choose one of the income-driven repayment plans, you must re-certify every year around the same time you entered the plan the previous year. Your monthly payments are based on your income and family information which may change throughout the year, so you are required to resubmit every year even when nothing has changed.

When it’s time to re-certify, you can do that online at StudentLoans.gov. You’ll need to have your most recent tax return and family information handy. Even though loan servicers should remind you to do this, it’s best to set a reminder yourself to avoid any increase in payments should you forget.

8. Watch out for taxes on forgiven loans

It is rarely talked about, but if you do have student loan debt forgiven under any of the above plans (except for Public Service Loan Forgiveness and Student Loan Forgiveness for Teachers), then the amount that is forgiven is considered taxable income! Depending on what tax bracket you’re in when the loans are forgiven, you could be liable for thousands of dollars in taxes.

9. Marriage and monthly payments

If you’re planning to get married, find out how your new status will affect your loan repayment and eligibility. You may have qualified as a single individual, but getting married and filing taxes jointly can increase your income, and therefore your payments, or even make you ineligible for the programs because your combined income is too high. Check with your accountant or financial advisor to see how this may impact you and your future spouse.

Choosing the best repayment plan can help you save money (not to mention your credit rating) in the long run. By choosing a plan with a monthly repayment amount that you can live with, you won’t have to sacrifice other goals like saving for a house, putting aside some money for retirement, or taking a well-deserved vacation.

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Shawn: Now you hear all kinds of deals about leasing cars, how can you negotiate a better deal if you want to lease?

Nina: Okay, well many people don't realize that they can actually negotiate the sticker price on a leased car in the same way that you would do that if you're buying a car. And since when you lease -- when you're, you know, your lease payments basically cover the depreciation, the difference between the sales price and the residual value. So it's definitely in your best interest to try to reduce that sales price as much as possible because then you'll pay you know, smaller dollars over the life of the lease. Make sure you pay attention to the down payment at the lease signing. And so here's an example, you might see an ad that says you know, lease payment is only 1.99 a month and that sounds like a great deal for thirty six months. The catch is, is that it might require a $3,600 down payment. So, if you amortize the down payment, then actually that 1.99 special, becomes 2.99. So, you really have to kind of look at total costs. 

And then lastly, dealerships use the term, money or lease factor, when they're calculating your financing costs and a lease factor is not the same as an interest rate. So, you have to make sure the dealer converts that lease factor into a comparable interest rate so you know what your financing charges are. 

Shawn: At the end of the day, does one method wind up being more expensive more often than the other, or can we tell that?

Nina: You know what, it really depends on how long, if you're going to hold the car for a long time, you're better off buying. But if you know, and if you're not, if you just really enjoy driving and you want to have a new car, then go ahead and lease. I mean, there's pros and cons to both, to be honest with you, it's not one size fits all.

Shawn: Alright Nina, great. Happy Thanksgiving to you. Alright, Nina Mitchell is with The Colony Group, for more go to wtop.com and search Her Wealth.

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Megan Kelly, CFP®

Megan is a natural puzzle solver with a sharp, investigative mind. Combined with her easy fondness for her clients, you can see why financial planning is her passion.  Her mission is to help other young adults be smart about their money.