There’s plenty of advice available for managing student loans, some of it good and some not so good. But you should be wary of a one-size-fits-all approach. Depending on your circumstances, some common tips for handling student debt could backfire.
Before following these four tips, take a closer look to see if they’re really right for you.
1. Consolidate your federal student loans
Federal debt consolidation is often confused with student loan refinancing, but it’s important to know the difference between the two; consolidation can end up costing you more money, but you may lose some benefits if you refinance federal loans.
Consolidation allows you to bundle your federal loans into a single direct consolidation loan. Your interest rate would be the weighted average of your rates, rounded up to the nearest one-eighth of a percent. Depending on how much you owe, you could end up with a loan term that’s up to 20 years longer than your current term. That means you’d pay extra in interest. Plus, you’d lose the option to save money by paying down your higher-interest loans first.
Refinancing your loans, on the other hand, could help you get better loan terms. Essentially, a private lender would buy out your existing loans and issue you a new one with different terms. If you have great credit and a low debt-to-income ratio, you could qualify for a lower interest rate. It’s available for both federal and private loans, but be aware that refinancing federal loans means giving up borrower protections like Public Service Loan Forgiveness.
“If a client has a really good income and they’re not taking a public sector job, then it generally makes sense to refinance [federal loans] and get a lower rate,” says Brett Tushingham, a registered investment advisor in Wilmington, North Carolina. “It’s definitely not one-size-fits-all, but a lot of the time it at least makes sense to consider refinancing.”
2. Switch to income-driven repayment
If you’re struggling with your federal loan payments, income-driven repayment can help. It caps payments at a percentage of your income and extends your loan term to 20 or 25 years. If you have any balance left over after that, it’s forgiven.
An IDR plan adds years of interest payments to your loans, so it won’t save you money long term, especially if you won’t have a balance left over. The main reason to choose one of these plans is to keep your payments manageable so you don’t end up in default.
Two other drawbacks to income-driven plans: You’ll need to reapply each year, and any debt that’s forgiven will be taxed as income.
3. Take your full loan award
It’s best to minimize your student loan debt. Some might argue that taking out more loans can help your credit after graduation, but that isn’t exactly true. Student loans can help you establish a credit history, but the amount you borrow doesn’t factor into your credit profile; overborrowing only increases your payments.
To reduce your student debt, fill out the Free Application for Federal Student Aid, or FAFSA, and take advantage of all free aid. Consider getting a part-time job to pay for extra costs, or ask your family to chip in.
When you get your financial aid award letter, carefully consider the terms of your loan offers and reject any that you don’t need. Unsubsidized loans should be the first to go; they accrue interest while you’re in school, so the cost of borrowing those is higher than it is for subsidized loans.
4. Make student loans your top priority
It’s the classic postgraduate dilemma: You want to pay down your student debt quickly, save for retirement and start an emergency fund, but your entry-level salary can only stretch so far.
“My wife and I had to choose between saving for a home, accelerating the payment of our student debt, or saving for retirement. We ended up saving for a home because we had a child,” says Douglas A. Boneparth, a certified financial planner in New York City. “You’ve got to know what your honest goals are and allocate your savings toward them.”
Once you know what you want to focus on, the key is setting smaller, more realistic goals. So instead of contributing $600 a month to your 401(k) while making your minimum loan payment, for example, you might decide to reduce your retirement savings to $100 a month, put $400 a month into your emergency fund and add $100 a month toward debt with the highest interest rates.
After you have a plan for your finances nailed down, revisit it every few months to make sure it still makes sense for your circumstances.