At some point during my freshman year of college, I vaguely remember attending a mandatory 45-minute meeting in the financial aid office and signing some paperwork that had to do with my student loans. And I remember receiving notices about nine months after graduating that it was time to start repaying my loans, which I’ve been doing faithfully ever since.
But like most people I know, that’s about the extent of the time and energy I’ve invested in understanding my student loans and student loan debt.
The fact is, we’re borrowing more and more to go to school. The Wall Street Journal reports that the amount of money students borrow has long been on the rise:
New numbers from the U.S. Education Department show that federal student-loan disbursements—the total amount borrowed by students and received by schools—in the 2008-09 academic year grew about 25% over the previous year, to $75.1 billion…Today, two-thirds of college students borrow to pay for college, and their average debt load is $23,186 by the time they graduate…
With the cost of higher education soaring and the pressures our society places to become as educated as possible, this number will surely continue to grow. That’s a problem, but I’ll leave the debate about how much is too much student loan debt for another time.
The fact is many of us have student loan debt. And how we tackle that debt is one of the first big financial decisions we make once we’re on our own.
1. Understand the Difference Between Private, Subsidized, and Unsubsidized Loans
Student loans come in a variety of “flavors”. Federally-guaranteed student loans are backed by the U.S. Government and, as a result, have low interest rates and are available to most students regardless of credit history. The most common federal loan programs are Stafford loans, Perkins loans, and PLUS loans (for parents).
- Subsidized federal student loans are available to students meeting income requirements and do not charge interest while you are still in school or during grace periods.
- Unsubsidized federal loans are available to more borrowers but charge interest as soon as they are disbursed.
- Private student loans are not federally-guaranteed, require good credit, have higher interest rates, and charge interest as soon as they are disbursed.
2. Grace Periods and Deferment
Federal Stafford loans have a six month grace period; Perkins loans have a nine month grace period. That means you aren’t required to start paying them back until six or nine months after you graduate or cease being a full-time student. If your loans are subsidized, you won’t pay any interest on the balance during that time. If the loans are unsubsidized, however, interest will accrue, so it’s a good idea to make payments anyway.
If you are having trouble finding a job or are not working, you may be able to contact your student lender and defer your loan. Just remember that if you have an unsubsidized loan, interest will be accumulating.
3. Student Loans Must Be Paid!
The consequences for defaulting on a federal student loans are more severe than failing to repay other debts (e.g., a credit card). If you fail to repay a student loan, not only will you ruin your credit, the government can seize your federal tax refund, garnish your wages, sue you, and cut off federal benefits like social security. Finally, federal student loans cannot be discharged in bankruptcy; so even if you hit rock bottom, you will still have to pay up for your education!
4. Student Loan Interest is Tax Deductible
On a more positive not, if you earn less than $70,000 a year, you can deduct up to $2,500 of student loan interest on your federal tax return, even if you don’t itemize your deductions. Each year, you should receive form 1098-E from your student loan lenders, detailing how much interest you paid (and can deduct).
5. Student Loans May be Forgiven
If you enter a career that serves the public in high-need areas (such as teaching or delivering healthcare in rural, low-income regions), you may qualify for programs that will forgive a portion of your federal student loan debt. Consider, however, that you may have to work in the qualifying field for several years before qualifying and that the amount of the loan forgiven may be taxable as income. Check with your school or professional organization for information about loan forgiveness programs. Additionally, federal student loans are canceled if you die, meaning your spouse and children won’t be burdened by them.
6. Some Consider Student Loans “Good Debt”, If There Is Such a Thing
You may read about “good debt” and “bad debt”. Basically, some credit experts classify mortgages and student loans as “good debt” because they’re investments in your future, while consumer debt like credit cards is considered “bad debt” because there is little value attached to the debt. This distinction may come into play when you apply for new credit, for example. A lender will look more favorably on somebody with $200,000 in student loan debt from medical school than on somebody with $20,000 in credit card debt. The doctor has ten times the debt, but still looks better to future creditors than the guy with credit card debt.
- What about consolidation? Read more about student loan consolidation.
The other reasons student loans are sometimes called “good debt” is because they tend to have very reasonable interest rates and that interest may be tax deductible. At the end of the day, however, student debt is debt. When people ask whether you should pay down student loan debt early, I say: Only after you’ve paid down all your other non-mortgage debt, have an emergency fund, and are saving at least 15 percent of your income for retirement.