August 13, 2015
Falling behind on your student loans is one of the worst financial mistakes you can ever make. The penalties and fees if you fall behind, and into default, can add thousands of dollars to your bill. And there’s pretty much no way to escape this obligation. Student loans are nearly impossible to get discharged in bankruptcy court. Moreover, if you manage to make it to Social Security retirement age and still have a federal student loan balance, the government can take some of your monthly benefit as payment.
I can’t stress this enough: recent college grads are in a make or break moment. Get on top of your student loans right now and you will be in great shape. But if you don’t get a handle on things, you will be digging yourself a very big financial hole.
Here’s how to ace your federal student loan repayment test. (If you have private student loans, contact your loan servicer ASAP and make sure you are up to speed on exactly when and how much you need to start repaying.)
1. Start repaying your loans within six months of leaving school. Federal loans come with a six-month Grace Period after you leave school, when you aren’t yet required to start repayments. But please understand, interest will continue to be added to your balance if you have an unsubsidized Stafford loan. Advice: Start repayment ASAP to keep your balance as low as possible.
2. No job yet? You still need to start repayment, or ask for a delay. The federal government expects the payments to start no later than six months. No excuses. Now if you’ve yet to land a job, or have an illness, or are heading back to school you can apply for deferment or forbearance, where your payments may be suspended (though once again, the interest meter keeps running.) But you must apply! Learn more about student loan deferment and forbearance.
3. Aim to pay back your loan in 10 years. There are a few different repayment plans that if you meet certain income-eligibility requirements, allow you to stretch repayment out over 20 or 25 years. In general, I don’t recommend going with longer-term repayment schedules, as you will be stuck owing a lot more interest over the life of the loan. Moreover, while it’s true that any remaining balance after 20 or 25 years will be forgiven, the entire amount that is forgiven will be reported to the IRS as taxable income. So you could have one fat tax bill! One exception: if you plan on having a career in public service a longer repayment can make sense. (See #4 for details.)
4. Use a longer repayment schedule if you plan to work in Public Service for at least 10 years. Under the Public Service Loan Forgiveness Program, your loan balance will be forgiven after 10 years of payments (120 on-time payments) and you will not owe any tax on the amount that is forgiven. For this reason, it makes sense to apply for an income-based repayment plan with a longer payback period.
5. Automate your payments. I don’t want you ever--and I mean EVER--missing a payment. That’s a slippery slope that can be incredibly expensive to climb back up. Please set up an automated direct payment from a bank account to your loan servicer.