I’ve recently decided to talk openly about student loans and the impacts that student loan debt repayment can make on your lifestyle choices. When I first started taking out loans to fund my education at a private liberal arts college, I took out two types of loans: private lender loans and subsidized federal stafford loans. I ended up with a $7000 private loan with 11% interest for my second year in college. In retrospect, it sounds crazy that anyone would even offer that kind of credit to a 19-year old, but they do it all the time.
So when I took a break from school for a semester, my grace period dried up and suddenly I was notified that I owed $667 within two weeks on interest that had accumulated over the previous 7 months. I was shocked. I am not sure what I expected from student loans. I knew I’d have to repay them, and I knew that they’d accumulate interest, but until I got the bill, I just don’t think I understood it. Clicking “accept” to the loan agreements on a computer screen doesn’t quite prepare you for the reality of paying back student loans for the next 10 years of your life. I have since been able to pay off that loan, and I’ve paid about 30% of the cost to finish school out of pocket instead of taking out more loans. I am thankful that I was lucky enough to get that wake up call early in my undergrad years, because I can imagine my debt load would be unmanageable by now if I continued on that path.
The Occupy Wall Street group has put together a Debt Resistors’ Operations Manual that I’ve been looking through out of curiosity more than anything. There are some very interesting factoids and suggestions (that I have yet to check for accuracy), but I’m really uneasy with the idea of debt resistance– as in, intentionally defaulting and not paying your debts. On principle, I can’t accept that as an option, no matter how predatory the lenders seem (and the nonstop credit card offers that I get from my lender, advertised as helpful in paying off my debt, definitely makes them seem predatory). The best path to debt resistance is to avoid debt from the beginning. Absent that option, there are some other possibilities for student borrowers who honestly cannot afford their monthly payments. The student loan system has changed a lot in the past few years, much to the benefit of the borrower.
The new options for federal loans seem promising. If you switch from Regular payments of student loans to Income-Based Repayment (IBR), your monthly payments are decreased or even deferred depending on your income, and your interest on subsidized loans may also be waived for the first 3 years on the IBR program.
“If the borrower’s income is near or below 150% of the poverty line, the monthly payment under IBR will be $0. In effect, IBR will then function like the economic hardship deferment for the first three years and like a forbearance thereafter.”
This provides a rare opportunity for people who are willing to devote more of their discretionary income than the IBR repayment plan requires. There is no penalty for advanced payments on student loans. Of course, if you stick to the minimum monthly payment, which may be zero, then you will end up accumulating a lot of interest after the 3-year interest waiver period passes. If you can pay anything at all under the IBR, then you can pay down principal and help yourself out quite a bit by reducing the amount of your total loan.
If you have several loans with different interest rates, you can use IBR to prioritize payments on individual loans with higher interest. Potentially, if you are willing to pay the Regular payment level but you qualify for IBR, you can use IBR to reduce your interest for the time that you qualify, to put the entire payment amount toward high-priority loans (especially private loans, which aren’t covered under the IBR plan), and to have the option of paying a lower monthly payment (based on IBR) when you can’t make the full Regular payment. Considering IBR a tool to prioritize your repayment can actually save you quite a bit of interest, instead of costing more as you are often warned before you enroll in the new payment plan.
It is probably not wise to wait for the loan forgiveness that is promised 25 years from now. Unless you work in public service, you will pay income taxes on the amount of your forgiven loan in the year it is forgiven. That means if you have a $70,000 graduate loan that is forgiven 25 years from now, you are going to pay as if you made that $70,000 in income that year (plus the capitalized interest, which could be around $119,000 at 6.8% if your plan doesn’t cover interest payments, YIKES!). If it puts you in the 35-39% income tax bracket (or higher, we’ll see), then you’re basically paying back your loans in the form of taxes owed to the IRS. Doesn’t sound like a great plan to me. Some argue that the net present value, or value in today’s dollars, will be low so it won’t be as bad. It’s still cheaper than paying the full amount of the loans, I suppose, but if you don’t plan for this payment it can be a big hit down the road.
One of the best tools for prioritizing the repayment of all of your debt is this Debt-Elimination Schedule with Accelerator spreadsheet from BYU’s online personal finance course. You can use it to see how even a few extra dollars a month can make a difference in your payoff time and overall interest paid on your loans. I used it for a friend who has several types of debt and has been feeling hopeless and miserable about never being able to pay it off. We found out that if he prioritizes his loan repayments and dedicates most of his income after basic expenses to paying his debts off, then he can save an unbelievable $89,000+ in interest, and pay off his debt– including a mortgage– in under 4 years.
A commitment to repay your debts as quickly as you can and then a promise to take out no more unnecessary debt can save you much, much more time and frustration than spending your life trying to run from creditors or trying to get back at a system that you feel has wronged you.