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Week of 6.19.09

Student Loan Survival: Advice You Can Bank On

Manisha Thakor
Learn more about Manisha and ask her your questions
Higher education has long been considered key to jumpstarting your career, not to mention sharpening your brain cells. But when the pomp and circumstance ends and the financial realities of student loans kick in, the result is often a less rosy picture.

So what can you do if your tassel has become a financial hassle?

If you're having problems making your monthly student loan payments, contact your lender and talk about your options. Here are some things to consider when having that conversation:

The New Income-Based Repayment Option

If you have federal student loans and you are currently in "good standing," mark July 1, 2009 on your calendar. That's when income-based repayment (IBR), a new payment option for federal student loans, comes into effect. On this date you can sign up for a new program that will enable you to cap your student loan payments at essentially 15% of your gross income. (Specifically, your student loan payments will be pegged to 15% of anything you earn in excess of whatever is the federal government's current definition of poverty—which right now is just under $16,500.) How is that different from what happens right now? Currently, student loan repayment plans are most commonly pegged to the total dollar value of what you owe. If you owe a lot—but have a small income—you could end up paying a quarter or more of your income in student loan payments. That's a classic recipe for a lifetime of Ramen noodles.

YouTube: Video explaining IBR
Under this new program, after 25 years of paying essentially 15% of your income in student loan payments, whatever is left is "forgiven." As an added incentive to encourage Americans to consider working in public service, those who take jobs in specified areas (e.g. teach at a public school, work as a police officer, etc.) only have to pay back those loans for 10 years and whatever is left over at that point gets wiped clean.

There are some serious things take into consideration with respect to the new IBR plans. First, you will likely end up paying more interest with this plan than you would under a standard plan (but this trade off may be worth it to lower your monthly payments). Second, unlike a standard plan, if your income goes up under the IBR plan, so too will your monthly payments. Third, if you are not working in public service, whatever portion is "forgiven" after 25 years is considered income to you, so while you won't have to pay this portion back you will have to pay taxes on it.

For more information see:

The Project on Student Debt: IBR program

Deferments, Forbearances, and Loan Forgiveness

A deferment is a legal way to temporarily postpone paying back your student loans. Not just anyone can get them, however. Some common reasons they are granted are:

  • You've lost your job.
  • You're facing economic hardship.
  • You've enrolled in graduate school.
  • You've joined the military.

If you meet the standards you must be granted a deferment. What happens to your interest payments on the loan during your deferment period, however, will depend upon whether your loan is subsidized or unsubsidized. If you fall into the former category, Uncle Sam will actually pay your interest during your deferment. If your loan is unsubsidized, you'll either have to pay the interest portion during the deferment period or it will get tacked back on to the amount you originally owe.

Note: The answers provided by Manisha Thakor represent solely her opinion and do not represent the opinion of NOW or its producers, who bear no responsibility for them. These answers do not necessarily reflect knowledge on Thakor's part of all factors relevant either to the circumstances of the questioner, or to circumstances experienced by others in their own situations. You therefore should consult with, and solely rely on, your own professional advisors before making any material financial or legal decision rather than on the answers provided here.
What happens if you don't qualify for a deferment? You can try for a forbearance. That will allow you to make reduced payments—or possibly even no payments—for a specific time period. But be warned the interest clock will continue to tick, however, even if you had subsidized loans. This means you will pay interest on the principal, as well as interest on the interest during this time. But your credit will remain in good standing during this period while you try to get back on your feet financially. Three common reasons for a granting of forbearance are:

  • Your student loan monthly payments are more than 20% of your pre-tax income.
  • You are having serious health issues.
  • You are a doctor doing an internship or are in residency.

Last but not least is loan forgiveness. If you have federal student loans and you choose to do certain types of volunteer work (Peace Corp, AmeriCorp, Vista) or join the military or National Guard, you may qualify for varying levels of annual stipends to be used to pay off or "forgive" your loan.

For more see:

Federal Student Aid: Deferment And Forbearance

Federal Student Aid: Public Service Loan Forgiveness

Student Loan Borrower Assistance: Loan Cancellation

Student Loan Borrower Assistance: Find A Solution

Should I Consolidate?

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Consolidation gives you one monthly payment at a lower rate than you might have on your individual loans. It is an option with government and private loans. Some people will find that consolidation enables them to stretch out the term of their loan—thus reducing monthly payments to a more manageable level (albeit increasing overall total interest paid). This online calculator can help you determine whether consolidation will work in your favor.

For more see:

Federal Direct Consolidation Information: Considerations for Consolidation

Student Loan Borrower Assistance: Consolidation Loans

A Note on Default

The key in thinking about all of these options is to do everything possible to avoid going into default. If you default on your student loans, your credit score will suffer. This can hurt you in many ways. Even bankruptcy won't wash that debt away—you can have your future wages garnished until those student loans are paid off. If you find yourself struggling (and millions of people are right now) it's important to contact your lender as soon as possible and start a discussion to find a solution that works for both of you.
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