As the class of 2019 collects their diplomas, not all of these graduates will be jumping right into the job of their dreams. Some may have an entry-level job that barely pays the bills. Others may not have found a job in their desired field. Worst of all, some may not even have a job at all.
While these employment circumstances may just be short-term setbacks, unforced student loan errors can cost thousands and are completely avoidable — even for those without a job.
Error #1: Ignoring Student Loans
The notion that not having an income means there is nothing that can be done about student loans seems logical. Unfortunately, this logic is deeply flawed.
The reality is that there are a number of steps that can be taken to keep student loans current, even if you don’t have a job.
For those with federal loans, enrolling in an income-driven repayment plan is an excellent first step. Borrowers who don’t have any income are able to make $0 payments to stay current. While doing nothing and making $0 payments may seem identical, it makes a huge difference on a student loan balance. For starters, enrolling in an income-driven repayment plan with $0 payments means there will not be any late fees or penalties. Better yet, borrowers who enroll in the Revised Pay As You Earn plan will have their balance grow at half the rate of other plans.
Those with private loans will find their lenders far less forgiving than the federal loans. However, a phone call to your lender and an explanation of the situation can lead to reduced monthly bills, or best of all, a temporary interest rate reduction.
Error #2: Paying the bills as they come
One of the universal recommendations of finance experts is that consumers should always have a rainy day or emergency fund. For some people this means saving away months or years worth of expenses in a savings account. For a college student this can mean making sure that the checking account always has a few hundred extra dollars just in case.
Far too many borrowers make the mistake of dipping into their reserves to pay their student loan bills. This error is most notable when it comes to federal loans.
As we previously discussed, income-driven repayment plans can mean $0 payments. Those with jobs are only expected to pay a small portion of their discretionary income. However, when the federal loan servicers mail out the first student loan bills, they do it according to payments on the standard repayment plan. Under the standard repayment plan, loans are usually paid off in full after 10 years. This can mean a huge monthly bill. This can also lead to borrower mistakes.
Suppose a recent graduate has $2,000 saved away for a rainy day. Unfortunately, that rainy day is here, because this graduate is still looking for work. When the student loan bills start coming, this graduate pays them. Paying bills is normally a responsible decision, but in this case, student loan bills could be eating away at the essential cash reserves. Had our graduate signed up for an income-driven repayment plan, that money could have been used towards rent or food. Unfortunately, there is no way to undue this mistake. Once enrolled in an income-driven repayment plan, loan servicers will not refund prior payments because they could have been much less.
Sadly, borrowers who do not enroll in an income-driven repayment plan in a timely manner risk making this avoidable mistake. It may seem odd that paying a bill is a mistake, but in this case, it can be an expensive error.
Fixing things on a big scale
Loan servicers and the federal government are in a position to help borrowers avoid both these errors with federal student loans. The standard repayment plan is the plan that has the highest minimum monthly payments of all the federal repayment plans. Seeing this large bill can induce borrowers to give up and ignore the student loan debt completely, or it can cause them to make large payments they cannot afford long-term.
Rather than starting borrowers on the standard repayment plan, the default plan could be an income-driven repayment plan. After all, the government already has borrower tax returns, so it could be done without any borrower involvement.
Alternatively, the first few student loan bills could explicitly remind borrowers that plans based upon their income are available. At present, many servicers just have language saying to contact them if payments are too large. They could make things much clearer and help out many new graduates.
Lessons for New Graduates to Learn
Unfortunately, loan servicers should be viewed by borrowers as bill collectors rather than advisors on managing student loan debt.
This means that borrowers should take some time to research their options at graduation. Put together a plan and know how to make it work. These are steps that can be taken by any borrower in any income situation. Ignoring the student loan debt will only serve to make the problem grow into a larger more difficult problem.
Finally, it is critical to think long-term. Being able to afford a single payment is a good thing, but borrowers should always be looking forward. Can I continue making payments on the current repayment plan? If the monthly bill is not sustainable long-term, it is time to come up with a fix immediately — don’t make payments and wait for the money to run out before asking for help.