The biggest concern for a student, or parent, about college financing should be keeping student debt under control. Full scholarships to play football would be ideal, but not everyone is able to get their education paid for.
As the price of education continues to grow, student loans have never been more common. Yet student loans have never been more dangerous. Nobody sets out to get into more student debt than they can afford, but it happens all the time.
The question then becomes, how do you balance the dangers of student loans with the need to go to college? The best choice is often to pick an a route that doesn’t involve student loans. This might mean going to school at night while working, or choosing a community college to start. It may also mean picking a less expensive state school to reduce the debt burden.
Ultimately, these decisions are often made by 18 year olds who are ill-equipped to fully understand the lasting financial implications. Many choose to take out student loans to help fund their eduction.
If I could offer one piece of advice to anyone taking out student loans, it would be this:
Make Interest Payments During School
With the exception of a few federal loans, every other student loan will generate interest while the student is in school. Instead of letting your balance grow with each month that passes, making an interest only payment will keep the balance at its original value.
Going this route helps avoid the debt growth that results from compounding interest. Because of compounding interest, a $10,000 loan from freshman year, assuming an interest rate of 6.8%, could swell to a balance of nearly $14,000 by the time the loan enters repayment. As the amount borrowed grows, or the interest rate grows, the damage of compounding interest also grows. For students who take longer than four years to graduate, the compounding interest can be especially devastating.
The Biggest Advantage
The best part about making interest only payments while you are in school is that it helps the borrower understand their future obligations. Once school is done, the interest only payments are the amount that it will take just to prevent their student loan balance from growing each month. For those with huge amounts of debt, it could be in the thousands of dollars! This point bears repeating – some student loan balances will grow by over a thousand dollars each month because of interest. Falling into this category should desperately be avoided.
By making interest only payments each month borrowers stay aware of their growing debt. With each year of college that passes, total debt goes up, and the total amount spent on interest will go up. This can be a great motivator for someone entering their senior year of college. First, it provides a great incentive to minimize borrowing AND to make sure to find the lowest interest rates available. Second, it helps provide insight as to the income necessary to manage the debt. The best time to realize that your degree might not pay what you need is during school.
What if you don’t have a job?
Some people make the decision not to work during school in order to focus on their studies. Though going this route makes paying for college much more difficult, many people elect to go this route.
Even if you have no income during school, making interest only payments is still a good idea. In fact, it may be even more important.
For a student who isn’t working, taking out a loan large enough to make interest only payments as the semester progresses can be a great option. Otherwise, the money that magically appears in their account each semester may seem like monopoly money. Only upon graduating and getting bills does the debt become real.
By sending lenders a check each month, the reality of one’s debt situation becomes apparent. Each dollar has value, and the importance of earning and saving becomes more clear. Best yet, sending in a payment each month helps build good financial habits.
The Bottom Line
College is a great time to make mistakes and learn from them. Unfortunately, student loan mistakes can take decades to clean up.
By making interest only payments during school, students are forced to responsibly manage their debt and less likely to regret their decisions for the next 30 years.