Common Student Loan Pitfalls

As one of the largest sources of debt for Americans, student loans can seem daunting especially when you begin to calculate just how many years it will take to pay off. Plus, once you’ve taken the leap to take out a student loan, you’re responsible for the debt no matter how your financial status changes over the years to come. Yet for most, it’s unavoidable if you want to receive a higher education. Since borrowing money to pay for tuition is now part of the college experience, it’s important to understand how to set yourself up for success to stay afloat rather than feel like you’re drowning in payments. Curb the stress and feel prepared by learning more about some of the student loan mistakes you should try to avoid.

1. Choosing the Wrong Type of Loan

Many first time students are unaware that there different kinds of student loans available. After filling out the FAFSA (Free Application for Federal Student Aid) to find out if you qualify for federal aid, it’s important to explore all the loan options available to you.

Every student loan type comes with its own interest rates and requirements so you’ll want to research and understand each one to find the best fit. While every situation is unique, there are some loan types you should prioritize taking over others:

  • Federal Subsidized Loan – A Perkins or a subsidized federal loan defers interest payments for you until graduation. However, these are based on financial need, so not everyone qualifies.
  • Unsubsidized Federal Student Loans – These loans have a fixed interest rate that accumulates while you’re in school. They may be a good option if you don’t qualify for a subsidized loan and if you have the ability to make the interest payments while you’re in school.
  • Private loans with a fixed, low-interest rate -  Private loans offered by local financial institutions like credit unions and national banks offer loans that take credit scores into consideration.
  • Private loans with bad terms – Some private loans have prepayment penalties, charging you a fee for paying off the loan early or making an extra payment.  Look for the phrase “no prepayment penalty” before you sign.
  • Direct Plus or Parent Plus loans – These loans allow parents to borrow money to pay for their child’s education. Parent PLUS loans can be refinanced in order to qualify for a lower interest rate — ultimately saving you money on interest costs over the life of your new refinanced loan.

2. Refinancing Unnecessarily

If you’ve taken out a number of different student loans that each have their own monthly payment, you may be considering refinancing those loans to simplify your bills. In some cases this is a good idea, in others, it’s not. Consider these pros and cons before accidentally refinancing unnecessarily or at the wrong time:

Refinancing Benefits

  • You may be able to save money by consolidating your loans and receiving a new, lower interest rate.
  • You can choose your own lender.
  • Consolidating your loans means you can have a single payment, which will require less micromanaging.
  • If your credit is on the lower end, you may be able to refinance with a co-signer to get a better interest rate.

Refinancing Drawbacks

  • You’ll be stuck in one repayment plan. Federal loans offer you the option of switching your payment terms.
  • You’ll no longer qualify for deferment or service-based loan forgiveness that federal loans offer.
  • You need a good credit score (usually a score of 660 or above) to refinance.
  • The new interest rate may not save you enough money to make it worthwhile.

3. Forgetting Cosigner Responsibilities

Some private loans require a cosigner for loans that have lower interest rates. Many parents cosign student loans without fully understanding the weight of their responsibility. Similar to personal loans, student loan cosigners are equally responsible for paying back the loan. Therefore, if the student is unable to make payments, the cosigner must cover every month to avoid damaging their credit.

Luckily, federal loans do not require cosigners. If possible, you should focus on taking out subsidized and unsubsidized loans before turning to potentially pricy and restricting private loans.

4. Forgetting About Interest Payments

Many types of loans accumulate interest while you’re in school. Missing these interest payments have the same consequences as missing a regular payment – you may end up with late fees, a higher total amount, and a negatively impacted credit score. When estimating your college budget, it’s helpful to use a loan calculator to ensure you know what to expect up front and have the correct amount going towards your monthly loan payments. Given the hefty price of tuition and the amount owed to repay your student loan, if you don’t have a source of income while you’re in school, it might be worth your while to look into a part-time job.

5. Carelessly Choosing a Payment Plan

Students who take out federal student loans are automatically enrolled in the standard federal loan repayment plan. This plan is structured to have fixed, equal payments over a period of ten years.

However, you do have other payment options available so you can choose a plan that better fits your needs. If you qualify, you have the opportunity to switch to one of the following payments plans for free:

  • The Graduated Repayment Plan starts with low payments that gradually increase over time based on the assumption that you’ll be making more money as you advance in your career.
  • The Extended Repayment Plan allows you to spread payments out over a 25 year period. However, the amount you pay will be much higher than the amount paid within a small loan period.
  • The Pay as You Earn Plan uses 10% of your discretionary income for loan payments. The amount will be recalculated annually to account for changing life costs and will be adjusted into annual tax fees after 20 years.
  • The Income-Based Repayment Plan uses 10-15% of your discretionary income for loan payments.
  • The Income Contingent Repayment Plan takes either 20% of your discretionary income or the amount you’d pay on a 12 year fixed plan, whichever is less.
  • The Income Sensitive Repayment Plan is based on your income and a repayment period of 15 years.

6. Over Borrowing

Don’t borrow more money than you absolutely need — this cannot be stressed enough. While it can be tempting to take out an extra $3,000 to help pay for day-to-day costs like food and transportation, loans can come at a steep price that pushes you deep into debt before you even graduate.

Also, be specific and understand exactly what you’re taking the loans out for. Does the major you’ve picked have a competitive job market for postgrads? Does your school charge an exorbitant amount for an education that you could receive at a more affordable community college? Being mindful of exactly what that money is being used for will help you determine the right amount of money you’ll need to borrow.

7. Taking the Effect on Credit Too Lightly

For many students, the first loan they take out as they step into adulthood is a student loan. This experience is filled with many lessons to learn and one that is often learned the hard way is the effect a loan can have on your credit score. Given that these are likely to be two brand new topics to learn about, understanding how your credit score will change is often an overlooked element but is more important than you may realize. All student loans, including subsidized and federal loans, can increase and decrease your credit, here’s how:

Potential Benefits

  • If you are just starting to build credit or have a low score, each time you make a full, on-time payment, it is reported to the credit bureau, which will positively impact your score. This payment history accounts for 35% of your credit rating so staying in good standing is key.
  • Another 10% of your credit score is based on the variety of credit you have including, but not limited to, car loans, credit cards, student loans, etc. Adding student loans to your profile will improve your credit diversity.
  • Credit history takes on another 15% of the overall credit score. The money you have borrowed and paid off in the past will improve your rating so paying off your student loan will help in the long run.

Possible Negatives

  • If you have too many different student loans, your debt to income ratio may surpass the expected 36% threshold. This, along with simplifying your bills and saving money, is why it’s suggested to consolidate student loan borrowing.
  • Financial situations change and you may end up missing a loan payment or being unable to pay at all for some time. Since payment history accounts for 35% of your score, late payments will hurt your credit rating. Even more drastically, defaulting on a loan — not making a payment — will significantly drop your score in several categories making it difficult to recover.

8. Skipping or Making Late Payments

As you may recall, subsidized and private student loans require you to make interest payments while you’re in school. Missing your payments can drastically affect your credit score and increase the amount you pay towards the end of your loan period. The more you pay off while you’re in school, the better your position will be when your interest rate kicks in and begins to accrue on top of the principal amount borrowed.

What to do if you Can’t Make Payments

Federal loans allow a six month grace period after graduation before borrowers have to start paying, which means you’ll have six months to land a job that can not only pay for your living expenses but also your loan repayment. In the event that you are unable to make your payments,  there are ways to delay or push back payments with a small effect on your credit:

  • Deferring payments allows you to delay paying your federal student loans and interest until the end of the loan period.
  • Forbearance allows you to delay paying your federal student loan but does not stop your loan from accruing interest.
  • Public Service or Teacher Loan Forgiveness are work programs that allow you to discharge your student loans in exchange for work.

If you’re concerned that you may not be able to make upcoming payments, it’s best to be proactive before it’s too late. Reach out to our expert debt coaches to learn how you can get help managing your current financial responsibilities.

9. Confusing Variable and Fixed APRs

Regardless of the loan you plan to take out, be sure to read the fine print. A lender may offer you a loan that has a 3% interest rate today, but if it’s an adjustable or variable interest rate, it could increase dramatically. Now that low 3% rate suddenly jumped to an astronomical 11% without you even realizing it.

It’s always best to take your time, shop around for the different offers, and don’t choose anything that seems to be too good to be true without checking the details. If you can’t find a loan that meets the criteria you’ve set for yourself, it may be worth evaluating exactly what that loan is for, and whether or not you can change your educational standards.

10. Only Paying the Minimum

Similar to any other type of debt, paying off your student loans as fast as possible will save you hundreds of dollars in interest fees. Every chance you have to make larger payments will bring you closer to being debt-free and slow down the uphill battle of paying off more interest than the principal amount.

Evaluate your budget to determine how much extra cash you put aside each month. If you can, use some of that pocket money to make extra payments every month even if it’s tempting to spend it during a shopping trip. The more you put towards the debt, the quicker it will shrink, and the sooner you’ll be debt-free.

11. Not Doing Your Research

Student loans are a big decision and can affect your financial situation for years after your graduation. The more you know before choosing a loan, the better off you’ll be when you’re working towards paying it off. No matter which stage of school you’re in, it’s never too late to evaluate your student debt and turn your financial relationship with your loans into a positive one.

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