Getting a college degree can be an excellent investment in your future, but if you aren’t careful, loans you take out to obtain that degree can act as a financial drag for years after graduation.
A recent U.S. Department of Education study found that 11.3% of students at postsecondary schools who were scheduled to begin paying their loans in fiscal year 2013 were in default by the third year of repayment. While that was a better rate than in previous years, overall levels of student debt are rising. As of June, students held $1.36 trillion in debt, up from $961 billion in 2011, according to the Federal Reserve Board.
We asked more than a dozen financial advisors around the country to offer some advice on how to deal with student loans every step of the way, including minimizing the amount of debt, picking the right school and finding the best repayment options. Here are 16 tips from the experts:
When you’re starting out
1. Get to know the FAFSA
Filling out the Free Application for Federal Student Aid will help determine the out-of-pocket cost of attending college and the necessary family contribution. The FAFSA is the primary form that the federal government, states and colleges use to award grants, scholarships, work study and student loans to help reduce the overall cost of college and student loan debt.
—Chris Burford of Clearpoint Credit Counseling Solutions in Jackson, Mississippi
2. don’t borrow more than you need
Understand all your options for paying for college and don’t just take out the maximum allowable student loans every year. Families can benefit by working with someone who specializes in developing college planning strategies that incorporate college selection, financial aid and tax aid.
3. Watch your loan-to-income ratio
A good rule of thumb is to borrow at a 1-to-1 ratio to your expected income after school. If you expect to make $35,000 your first or second year out of college, don’t take on more than $35,000 in debt. This rule doesn’t hold true for some professions, like doctors, who see a substantial jump in salary after residency.
4. Brainstorm alternatives to borrowing
Before taking out any student loans, think about how you could minimize or even eliminate the need to borrow money. Some options:
- Make applying for scholarships a full-time job.
- Attend community college for the first two years.
- Get a part-time job to help pay tuition as you go.
- Buy used textbooks.
- Compare on- and off-campus housing options.
5. Explore all loan options
Keep in mind all the available options, starting with federal subsidized and unsubsidized loans and then moving on to private loans and parent PLUS loans. Be mindful of the interest rates, especially whether they are variable or fixed, and the payoff options for each type of loan.
6. Remember the opportunity cost
If you’re spending a lot of money to pay off student loans after you graduate, you’ll miss out on having that money go into other important buckets, such as an emergency fund, down payment on a house or retirement savings. Let’s say you leave college with $50,000 of student loan debt with an interest rate of 6%, a loan term of 10 years and a monthly payment of $555. At the end of 10 years, you’ll have paid back $50,000 in principal and $16,612 in interest, for a total of $66,612. If, instead, you invested $555 at the beginning of each month for 10 years at an 8% interest rate, you’d have $102,165. That’s a huge swing, and a great start to building a retirement nest egg.
When choosing a school
7. Beware high tuitions and shady promises
Students and their families should beware of for-profit schools that charge high tuition and may make inflated promises about employment in the chosen field of study. They should also consider lower-cost options like community colleges and in-state universities, particularly when first starting out or if they’re not sure about selecting a major.
—Joy Gaddis of Clearpoint Credit Counseling Solutions in Marion, Illinois
8. Don’t overpay for your education
The biggest mistake is to go to an expensive college for a degree that will result in a low-paying job. For example, it doesn’t make sense to take loans of $100,000 to be a social worker. To save money, go to a state school or attend a community college or technical school for a few years, and then transfer to a four-year college.
If you want to go into public service, that’s a great and noble calling, but don’t pay $100,000 to a private college for the privilege of doing so.
9. Keep it in state
Students should also focus on colleges they can afford, which may mean attending a school in their state of residence. Each state runs its own public university system. Public, state-run universities are partly funded with taxes paid by the residents of that state. For that reason, tuition for state residents is typically much cheaper than for out-of-state students. California residents who decide to stay in state for college are lucky to have some of the world’s most prestigious public schools to choose from.
— Kyle Morgan
10. Check out programs for public servants
If you choose a career in government or at a nonprofit, you may qualify for the Public Service Loan Forgiveness Program. Under this program, your federal loans may be forgiven after you make 120 monthly payments. Before you take out loans with this strategy in mind, however, be aware that you must work full-time for 10 years at qualifying organizations — and that overall salaries for these jobs are often much lower than what they would be in the private sector.
— Laura Scharr-Bykowsky
When payments start
11. Beware default
Defaulting on your student loan debt could have serious consequences for your financial future. Delinquent payments or loan default will cause your credit to suffer, which could affect your ability to rent an apartment, sign up for utilities, get a cell phone, be approved for other loans — and even get hired for a job. Student loan default can lead to wage garnishment, in which the federal government takes a percentage of your paycheck every month.
— Kyle Morgan
12. Consider tapping a home equity loan
One option is to refinance the student loan through a home equity loan, if the student or family has enough equity in the home. The advantage of this kind of refinance is that you may deduct interest on as much as $100,000 in home equity debt from your federal income taxes. The student loan interest deduction is capped at $2,500 and phases out earlier.
13. Take advantage of tax deductions
Under current tax law, individuals and married couples can deduct only up to $2,500 in student loan interest per year, depending on income and filing status. While paying off any debt can be tough, paying interest with after-tax dollars only increases the burden. If possible, try to keep the student loan debt under the threshold where interest loses its deductibility. One rule of thumb is to divide $2,500 by the loan’s interest rate. For example, if your interest rate is 5%, dividing $2,500 by 0.05 equals $50,000. Keeping your debt below that amount can keep your interest deductible. This deductible interest limit presents an interesting opportunity for people whose home has appreciated in value to a level that would allow them to refinance. They may be able to pay off student loans with the refinance and essentially swap nondeductible student loan debt for deductible mortgage interest. Tax issues can be complex, so consult with a tax advisor before making a decision.
If payments become difficult
14. Learn about income-driven repayment
Income-driven repayment plans can be a good option for students and families when the monthly payment under the 10-year standard repayment plan is just too high. The goal of these plans is to better match your payment amount with your ability to pay. Rather than a fixed amount, the payment generally is 10% or 15% of your discretionary income. The pros of using one of these plans include lower monthly payments, forgiveness of the loan balance after the 20- or 25-year term and a payment amount that will change with your ability to pay rather than with interest rate fluctuations. However, you’ll pay more in interest over the life of the loan, because the repayment term is stretched out from 10 years to 20 or 25 years. And at the end of the term, you’ll have to pay income taxes on the amount forgiven, unless you’re in the Public Service Loan Forgiveness Program.
— Carrie Houchins-Witt
15. Look into student loan refinancing
Look into student loan refinancing options — but before you refinance, investigate any loan forgiveness programs available for your federal loans. If you refinance to a private loan, you’ll lose access to those.
— Steven Elwell
16. seek deferment or forbearance
If you can’t make your student loan payments because of a hardship such as a job loss or illness, ask the lender for deferment or forbearance. That would let you postpone payments to avoid defaulting on the loan. The goal is to allow you some time to get back on your feet and improve your financial standing so you can resume paying off the loan. Use this option judiciously, because interest on the student loan will continue to accrue and may be added to the principal, depending on the type of loan. Also, you must apply for deferment or forbearance and meet specific criteria — it’s not granted automatically.
— Carrie Houchins-Witt
State student loan default ratesThe 50 states ranked from highest student loan default rate to lowest.
|Ranking||State||Percent defaulting on student loans|