Anyone considering borrowing a student loan should understand the student loan life cycle.
A second-year undergrad’s financial concerns are much different from those of a borrower in their tenth year of repayment. However, student loan choices made early on in the student loan life cycle have both immediate and lasting impacts.
Students who borrow with an eye on the future will benefit from their decision-making for many years.
Picking a College and Comparing Financial Aid Offers
Before even choosing a school, student debt should already be an important consideration.
If a school is too expensive, you may run out of funding before graduation, or you may get stuck with a lifetime of student debt. Families should carefully consider funding options and school alternatives.
Part of this review should include a careful examination of the financial aid offers provided by the schools. If the financial aid offer from a school is too dependant upon student loans, it might be best to consider a different school. A good rule of thumb is that your expected starting salary should be larger than your expected student debt at graduation.
Student Loan Selection
When choosing student loans, there are two main options. Federal student loans have the best repayment plans and forgiveness options, but they also have strict borrowing limits for undergrad students. Private loans are far less flexible, but the borrowing limits are much higher.
As a student, the biggest concern might be finding the easiest application or getting quick approval. These concerns are temporary.
Once repayment begins, the importance of loan terms and interest rates becomes apparent. The borrowers who focus on these items during loan selection will have the best outcomes long-term. For this reason, shopping around is an essential step for borrowers who need private student loans.
Student Loans During School
Most student loan funds are disbursed directly to the college. After tuition and fees get paid, the remaining funds are given directly to the student. These funds can cover housing, food, and a variety of other expenses.
Term to Understand: Loan Origination Fees
A loan origination fee is an upfront cost associated with borrowing some student loans. For example, if a $1,000 loan has a 5% origination fee, the borrower will only receive $950 after deducting the fee. Origination fees are unavoidable with federal student loans. Students that need private loans should look for loans that do not charge origination fees.
During school students usually are not required to make payments on their loans. However, the loans still generate interest during this time. As a result, the amount you borrow will be smaller than the amount you have to repay. If you have a high interest rate, the amount you repay could be considerably larger.
Minimizing expenses and keeping student loan borrowing at a minimum should be a goal of all students.
Student Loans at Graduation
For most students, student loan repayment does not begin immediately after graduation. Most student loans come with a six-month “grace period.”
During the grace period, recent graduates should be generating a play to repay their student loans. This is also the time many borrowers start to panic about their debt levels and repayment options.
Here are a couple of tips for a productive start to repayment:
- The first federal bill may be quite large – It is based upon the 10-year repayment plan, but many more affordable repayment options exist.
- A Notice of Unpaid Interest is not a bill – Many graduates cannot afford to pay all of the unpaid interest right away. As long as they have a strategy to eliminate debt, the unpaid interest notice shouldn’t be a concern.
A common mistake during this portion of the student loan cycle is ignoring student debt. Many former students ignore their loans entirely in hopes that they will just disappear. Others assume that they can’t afford payments, so they don’t bother with the loans. These are huge mistakes. There are many options for lower monthly payments, and ignoring student loan bills will only make problems worse.
Repayment Phase One: Survival
When you first enter the workforce, your salary may be small compared to your student debt. Simply making payments is often a struggle.
This phase of repayment is a struggle for two reasons. First, from a purely accounting perspective, high monthly bills and a smaller income present a considerable struggle. Second, from a psychological perspective, it might seem like the debt will never be paid. This double-whammy makes it hard to stick to a student loan plan.
If there is good news, it comes from the fact that just $10 a month extra can make a difference in student loan repayment.
The survival phase typically lasts until that first student loan is paid off. Even if the first loan eliminated is small, it is a huge milestone. For many borrowers, knocking out the first loan is the hardest part.
Repayment Phase Two: Debt-Elimination
As borrowers find a groove with repayment, debt elimination becomes the focus.
Those with smaller balances or higher incomes often adopt an aggressive repayment strategy. Other borrowers have to learn to balance their debt elimination goals with other financial goals, such as buying a house or saving for retirement.
A couple of resources also enter the equation. Borrowers with high credit scores often refinance their loans at a lower interest rate. Other borrowers may pursue student loan forgiveness. These resources can be helpful in repayment, but it is critical that students do not borrow and assume that they will be able to refinance at a lower interest rate or get their loans forgiven.
The Cycle Repeats
Perhaps the most depressing part of the student loan cycle is how it repeats from one generation to the next. Many parents struggle to help their children pay for college because they are still paying off student loans of their own.
The best way to avoid a student loan nightmare is to make intelligent decisions when picking a college and when borrowing.
