Dealing with Student Loans can be a minefield. If you are not doing your research, odds are you are paying more than necessary. Here are five of the most common ways people make mistakes on their student loans.
1. Signing up for the wrong repayment plan. Federal loans have a variety of repayment plans. Some are old relics, while others such as Pay As You Earn are new and improved and can benefit most borrowers.
The standard federal government repayment plan is the ten-year plan. If you have a tiny federal loan balance, this plan may work, but for most, it ends up being a very expensive option. A recent federal government study showed that most people had selected the wrong repayment plan.
Regardless of where your finances stand, any responsible borrower should be aware of all of the plans available.
2. Only making minimum payments. This is especially true for high interest loans. If you are only making the minimum payment, the vast majority of what you pay each month is interest. Paying down principal is the only way to make a loan disappear. If you are only making minimum payments you are maximizing profits for your lenders.
The smartest way to pay off your student loans is to pick one loan, and attack it, paying down as much as possible whenever you have extra money. Most people elect to try and pay off their smallest loan, or their highest interest loan. These approaches, known as the avalanche and snowball methods can make debt disappear dramatically quicker.
3. Ignoring student loans. Pretending student loans don’t exist is a huge mistake. Ignoring student loans might temporarily receive a little stress, but while you are ignoring your loans, late fees and interest continue to pile up.
As noted earlier, for federal loans there are a number of repayment plan options. These include repayment plans based upon your income. No matter how low your income, ignoring the debt is never a good idea.
4. Spending too much on interest. When you are trying to pay off debt, interest is your enemy. Some people pay too much in interest by only making minimum payments, others pay too much in interest because they fail to take advantage of opportunities to lower their interest rate.
If you are barely able to make payments on your student loans, some private loan lenders are actually offering programs to lower your interest rate. In the news, we have also seen indications from other lenders that they plan to offer lower interest rates to borrowers who are struggling.
On the other side of the coin, some people have a solid income and are doing fine with their student debt. Those in stronger financial positions can refinance their debt to below 3% interest. Over the life of the loan, this could result in a savings of tens of thousands of dollars.
5. Getting a deferment or a forbearance. Like those who ignore their loans, people who rely upon a deferment or a forbearance, are likely making a mistake. Bills may not come each month, but that doesn’t mean that you are not be charged interest each day. Except for very limited circumstances, a deferment or forbearance is a bad idea. If you are struggling with your student debt, going this route just makes your student loan problems grow.
Readers: What student loan mistakes have you made or seen others make?