Miss These 4 Student Loan Slip-Ups

Miss These 4 Student Loan Slip-Ups

We live in a college town, but it’s more than just that. It’s the sort of town where a lot of people come for the school but stay for the awesome — yours truly included.

But to come to Fort Collins and do the school thing, you’ve got to pay the tuition bill and fees as well as buy the books. In today’s world of hyper-increasing college expenses, many turn to student loans to cover some or most of the costs. If savings, scholarships, grants, and other financial aid can’t pay all the bills, student loans are the next step in the process.

It seems fairly straightforward. Borrow the money, pay the bills, then pay back the loan — but several ways exist to trip borrowers up and could lead them to make costly mistakes. Whether you’re a parent who’s sending a child to school soon or in the middle of navigating your own student loan journey, here are four key items to consider and look out for as you make your way.

Slip-up 1: Taking the wrong type of loan without careful consideration

Federal student loans are very, very often much more borrower-friendly and flexible than private student loans. In spite of this, according to the Consumer Financial Protection Bureau in late 2012, 54% of private student loan borrowers hadn’t exhausted all of their federal loan options or taken a federal loan at all.

Check out some of the pros and cons of federal and private loans to better inform your decision:

Federal

Pros

  • Fixed interest rates and tend to be low.
  • Payments usually aren’t due until you “graduate, leave school, or change your enrollment status to less than half-time.”
  • FAFSA determines eligibility.
  • Repayment plans, as well as forgiveness, discharge, and cancellation opportunities, are available.

Cons

  • Needs-based, so loan limits may be low and those with substantial assets may not qualify.
  • Must file the FAFSA before the deadline to be eligible.
  • Borrowers may only use federal funds to pay for certain expenses.

Private

Pros

  • Rates tend to be competitive compared to federal loan rates and may even be lower in some cases.
  • Not needs-based, so the application process may be easier and you could be eligible to borrow a larger amount.

Cons

  • Terms may not allow you to do things like make income-adjusted payments when you graduate. Private loans aren’t eligible for loan repayment plans or loan forgiveness.
  • You may have to begin paying on private loans while you’re still in school. You might also have the option to defer payments until after graduation — but interest could be adding up during the deferment period.
  • May charge variable or fixed interest on your loan, and the interest rate could be higher than a federal loan.
  • May be subject to a credit check or need a cosigner.

In some situations, however, a private loan is the last option available to pay for school. In that case …

Slip-up 2: Borrowing too much

Like any good financial decision, the amount of student loan funds you take should be reasonable. You can base the amount on your or your child’s current financial resources and your or your child’s expectation of financial resources upon graduation. If savings, scholarships, grants, and federal student loans can’t cover the cost of attendance, perhaps it’s a good idea to re-evaluate your or your child’s ability to afford the chosen school.

Another easy trap to fall into is to accept more money than necessary to cover essential attendance costs. Your child, when faced with the idea of receiving an extra few thousand dollars in cash, may be easily tempted to take it. It’s important to stress to him or her that borrowing money to pay for pizza and beer is just not a good idea.

Slip-up 3: Relying on forbearance and not exploring repayment options

With federal student loans, forbearance allows a borrower to not make payments on student loans for up to 12 months at a time. While it seems like a nice option to create some financial breathing room, it can be costly. During the forbearance period, interest continues to accrue. It adds to the balance of the loan — making the eventual amount to repay plus interest higher.

Eight repayment options exist for federal student loans. Some allow the borrower to repay based on income, to varying extents. Others allow borrowers to gradually increase payments over a set period of time. With some of the options, the Department of Education forgives the remaining loan balance after sticking to the plan for a certain number of years. Here’s a simple breakdown of federal loan repayment options:

1. Standard Repayment Plan — A 10-year repayment window with fixed payments that ensures the borrower pays off loans by the end of that time frame.

2. Graduated Repayment Plan — Similar to the Standard Repayment Plan, with the Graduated option, loans are on a 10-year repayment time frame. However, the Graduated plan begins with lower payments, and the payments due increase about every two years.

3. Extended Repayment Plan — Borrowers can choose fixed or graduated payments, but this option extends the time frame to 25 years. Borrowers who choose this option will pay less each month than with the Standard or Graduated Repayment Plans. However, they’ll pay more over the life of the loan.

4. Revised Pay as You Earn (REPAYE) — With this plan, payments due are equal to 10% of discretionary income. For a borrower with a spouse, discretionary income includes both spouses’ discretionary income, even if only one spouse is repaying student loans. Forgiveness applies to any amount remaining due after 20 years of payments for undergraduate loans or 25 years for graduate or professional loans.

5. Pay as You Earn Repayment Plan (PAYE) — Like the Revised PAYE plan, payments are equal to 10% of discretionary income. However, the Standard Repayment Plan level is the cap on those payments. For spouses, discretionary income is only combined if filing taxes jointly. Lastly, forgiveness includes any amount remaining after 20 years of payments.

6. Income-Based Repayment Plan (IBR) — Payments for this plan type are 10-15% of discretionary income but, like PAYE, can never be more than payments the borrower would have paid under the Standard Repayment Plan. Also similar to PAYE, discretionary income is only combined for spouses if filing jointly. The percentage of discretionary income as well as the repayment time frame — 20 or 25 years — depends on when the borrower received his or her first loans.

7. Income-Contingent Repayment Plan (ICR) — For those who choose this repayment plan, payments are the lesser of 20% of discretionary income or the amount the borrower would pay on a fixed 12-year plan, with payments adjusted annually according to income. For spouses filing jointly, discretionary income includes both spouses together. And spouses filing separately can elect to repay the loans jointly, in which case discretionary income is also combined. With ICR, foregiveness applies to any amount due after 25 years of payments.

8. Income-Sensitive Repayment PlanFor those who want to spread their payments out over a longer period of time than the Standard Repayment plan — and don’t mind paying more over time to do so — the Income-Sensitive plan is an option. Annual income determines payments, but a borrower will repay the loan in 15 years.

For more information, check out the U.S. Department of Education’s summary page, covering the options. And, of course, if you’re wondering how student loans would fit into your or your child’s financial life, get in touch with your financial professional.

Don’t Forget! The Free Application for Federal Student Aid (FAFSA) Deadline Is June 30!

Filling out the FAFSA form is necessary for students to see if they qualify for federal student aid, and “most people are eligible” for:

— Grants, or “free money for school”
— Federal work study, aka part-time jobs for students
— Federal loans with fixed rates

Without filing a FAFSA, students may only be eligible for private scholarships, grants, and loans. Learn more and apply.

Slip-up 4: Not looking into loan forgiveness, cancellation, or discharge

In addition to repayment plans, loan forgiveness is an option available to some — but often more difficult to receive. The Department of Education may also cancel or discharge loans under certain circumstances. Here’s what you should know about the seven main types of federal student loan forgiveness and discharge:

1. Public Service Loan Forgiveness (PSLF) — Eligibility for public service employees who have paid 120 student loan payments to have the remainder of their loans forgiven.

2. Teacher Loan Forgiveness — Available to elementary and high school teachers who have served low-income students for five years in a row.

3. Total and Permanent Disability Discharge or Death Discharge — In the event the borrower becomes totally and permanently disabled or passes away, the Department of Education discharges the loans.

4. Bankruptcy Discharge — This type of discharge is rare and only occurs if the bankrupt individual would face undue hardship if required to repay the loans.

5. Closed School Discharge — Available to borrowers whose schools closed, leaving them unable to complete their programs, this discharge is also available to borrowers who withdrew from their programs within 120 days of their schools closing.

6. False Certification of Student Eligibility or Unauthorized Signature/Unauthorized Payment Discharge — Forgiveness for borrowers whose “school falsely certified a borrower’s eligibility to receive a loan.” This also includes victims of identity theft: If a thief takes a loan in the name of an individual, the loan may be eligible for discharge.

7. Unpaid Refund Discharge — If a school fails to return funds to a borrower’s lender, the Department of Education may discharge the amount the school was supposed to return to the lender.

In addition, the Department of Education may cancel Perkins loans under a variety of situations. To learn more about the forgiveness and discharge opportunities listed above or Perkins loan cancellation conditions, see these charts from the Department of Education.

Before making a major financial decision, such as taking out student loans, it can be helpful to take a fresh look at your financial plan. Begin by making sure the choice would fit with your or your child’s other long-term goals. And, of course, it’s always a good idea to meet and discuss the situation with your financial professional.

If you have student loan or financial planning questions, just ask!

Interested in meeting to plan the path to your financial future? You can start by taking a look at the How It Works page to learn more. Then, simply schedule a time for a no-cost web or in-person financial planning consultation.

Jason Speciner
jason@fpfoco.com

Jason Speciner is a CERTIFIED FINANCIAL PLANNER™ professional, an Enrolled Agent, and the founder of Financial Planning Fort Collins, a 100% employee-owned and fee-only firm. He is also a member of the National Association of Personal Financial Advisors (NAPFA) and XY Planning Network (XYPN). Since 2004, he has served clients of all ages and backgrounds with unique experience working with members of generations X and Y. To learn more, check out Jason's blogs and see the media he's been featured in.



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