Student loan debts are now the second most common type of consumer debt. Due to the high cost of education, many of us carry debt held over from student days.
If you're struggling to make payments, learning how to lower them can be a lifesaver. You might even end up with a better credit score.
Student debt is up 20% from previous years, with the average amount of student loan debt now over $32,000. The median amount is closer to $17,000, but over 600,000 student loan borrowers carry more than $200,000 in loan balances.
If you’re still a student, or you’re financing your children’s education, let’s look at how student loans work today.
Most financing starts with filling out an application for Federal Student Aid (FAFSA). The form requires financial information from both students and their parents, and the application is shared with prospective schools, to help inform enrolment decisions.
The US Department of Education, as well as the financial aid office at every school, calculates the amount of aid a student qualifies for. The student receives an award letter from each prospective school detailing the aid offer.
For students who don’t qualify for aid or need additional aid, many often apply for a private student loan. Like other types of loans, lenders usually require a promissory note, which sets the monthly repayment terms and interest charges.
Now let’s look at the most common student loans.
Direct subsidized loans are available to undergraduate students who show financial need based on their FAFSA. The federal government pays the interest while the student is in school. Once a student leaves school or postpones loans through deferment, there's a six month grace period before the repayment and interests start accruing.
Direct unsubsidized loans are awarded with no regard for financial need, and they’re available for undergraduates, graduate students or working professionals. These loans are typically not covered by the federal government, and interest begins accruing as soon as the school gets the money. The annual limits for these loans vary, depending on the student’s creditworthiness, ranging between $5,500 to $20,500.
Plus loans are designed to cover costs not provided for under other forms of financial aid. They have higher interest rates and fees, and they require a separate FAFSA application as well as a credit check.
A variety of repayment options can lower the monthly burden. Here are some of the most common plans.
If you have a federal student loan, you’re automatically enrolled in the standard repayment plan. It's designed to pay off your debt over a ten-year period, and for some borrowers, ten years may be just right.
But for others, the standard federal repayment plan results in monthly payments they can’t afford.
As an alternative, federal loans also offer income-driven repayment plans, which set your monthly payments based on your income.
Monthly payments are fixed at 10% of a new borrower’s discretionary income and 15% for an existing borrower’s discretionary income. The maximum repayment period is 25 years.
Three types of income-driven repayment plans are currently available: Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE) and Income-Contingent Repayment (ICR) plans.
With the Pay As You Earn (PAYE) plan, your payments are set to 10% of your discretionary income. But if that calculation is more than the standard federal plan, you don’t qualify. The PAYE plan offers a repayment period of up to 20 years.
The Revised Pay As You Earn (REPAYE) plan is relatively new. It can be used with all types of federal student loans, including direct loans, Stafford loans and graduate Plus loans. Monthly payments are set at 10% of the borrower’s discretionary income, and the repayment period is 20 years for undergraduate loans and 25 years for graduate school loans.
If you don’t qualify for other plans, consider the Income-Contingent (ICR) plan. The ICR reduces your monthly payment without requiring any additional payments. Payments are set at less than 20% of your discretionary income or monthly payments when the loan is amortized over 12 years. The ICR plan offers loan forgiveness after 25 years.
Some employers now offer student assistance programs in order to attract talent. Employer programs offer up to $5,250 a year, which can be used to pay down student debt and is not taxable.
Before you apply for a job, check out the refinancing benefits offered by the company. Some also provide assistance with continuing education.
The two most popular types of student loan forgiveness programs are Public Service Loan Forgiveness (PSLF) and teacher loan forgiveness.
To qualify for PSLF, you must work for a federal, state or local government agency and make 120 payments yourself.
To qualify for a teacher loan forgiveness, you must work as a teacher in a low-income school or an educational services agency for five years. You may be eligible for up to $17,500 in forgiveness on federal direct loans or a Federal Family Education Loan.
If you have a federal student loan and you fail to make monthly payments, your federal tax refund might be garnished. However, this process won’t start until after nine months (270 days) of missed payments.
If you have a private loan and have defaulted, your lender can file suit to garnish your wages. A private student loan could go into a default with only one or two missed payments, depending on the loan agreement.
If your tax refund is going to be garnished, the lender managing your debt will send you a letter identifying the collector deducting payments. The letter should also include details on how to make arrangements to pay off your debts.
In 2020, due to the coronavirus, the federal government paused repayment plans by setting interest rates at 0%, halting collection activities and freezing loan payments.
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