3 Steps You Must Take for Student Loans

07/19/2011 6:30 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

Federal education loans are almost impossible to escape, even through bankruptcy, so it's imperative to gain control of them, writes MoneyShow.com personal finance expert Terry Savage.

Let me start with two startling facts about student loans.

  • First, there is more debt outstanding in the form of student loans than credit-card debt—more than $875 billion.
  • Second, the default rate for recent grads is now estimated at over 7%, about the same rate as defaults on credit-card debt.

But there is one huge difference: You cannot eliminate your federal student-loan debt through bankruptcy. The government will track that debt—and haunt you even when you are old enough to collect Social Security (if there is Social Security by then). They will deduct your debt from your monthly retirement check!

The message is that you must face up to your student loans immediately after graduation, within the six-month grace period (nine months for Perkins loans).

So here’s a step-by-step guide for recent grads. And some advice for those who have already started loan payments but find they simply don’t have enough income.

1. Know Your Loans
It sounds simple, but many students have both Federal student loans (subsidized and unsubsidized) along with private loans. And their parents may have PLUS loans.

You may have Federal student loans from multiple lenders (something that was common before 2010, when all new Federal student loans were issued directly by the government). If you didn’t keep a record of all of your Federal student loans, go to the National Student Loan Data System at www.nslds.ed.gov, or call the Federal Student Aid Information Center at 1-800-4-FED-AID.

You should also check with your school’s student assistance office. They would have a record of your private (non-federal) loans, since they were likely paid directly to the institution.

2. Consolidate Your Loans
This is where it gets a little tricky. All Federal student loans made after 2007 carry fixed interest rates: 6.8% for Federal unsubsidized Stafford loans, and 3.4% to 6.8% on "subsidized" Stafford loans, depending on the year in which they were taken out.

The interest rate for the federal consolidation loan is the weighted average interest rate of all the loans that are being consolidated, rounded up to the nearest .125%.

So, in most cases, the effective interest rate on the consolidated loan is slightly higher than if you don’t consolidate. But getting all your Federal student loans into one payment may make your life a lot easier, and you’ll still have the forbearance options described below.

There is an important exception to this consolidation rule. Loans taken out before 2007 have interest rates that are reset every year on July 1, based on Treasury bill rates. So use your once-in-a-lifetime opportunity to consolidate those old loans at very low rates if you haven’t previously consolidated.

Consolidate your Federal student loans through the Government at www.LoanConsolidation.ed.gov. Calculators there will help you understand the monthly payment and interest rates. Try to set up a plan that will pay off your loans in ten years, saving you a small fortune in interest.

Private student loans are difficult to consolidate. The lenders have you over a barrel, charging high rates that they don’t want to lose. You can search the Internet for some private loan consolidators, but beware of upfront fees, and make sure that you don’t include any lower rate loans in the consolidation.

By law you cannot be charged fees for consolidating Federal student loans, and the interest rate is capped. Never consolidate Federal loans into private loans, or you’ll lose some repayment options described below.

3. Get Help if You Can’t Pay
If you have Federal student loans and can’t keep up with your repayment schedule, there are several programs that offer help, including deferment and forbearance.

But the most interesting option is a new type of income-based repayment plan, which started in 2009. For an explanation, go to www.IBRinfo.org.

Whatever you do, face up to your situation and contact your lender or the Department of Education immediately. You don’t want to go into default and ruin your credit. And, remember, you cannot eliminate your student loan obligation through bankruptcy.

While there are many excellent Web sites offering advice on student loans, including SimpleTuition.com and Finaid.org, your search for advice on loan repayment should start at the Federal government’s Web site, www.StudentLoans.gov.

It’s always better to face up to the student-loan repayment issue sooner than later. And that’s The Savage Truth.

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