Develop
a Plan to Get Out of Graduation Debt
If you’re one of the
millions of college graduates leaving college with a degree in one hand and a
stack of student loans in the other, you will want to read about the importance
of planning for the repayment of your student loan.
Step 1 – Understanding Your Loan
To fulfill your repayment
obligation and build a strong credit history, you need to understand the terms
of your student loan, develop a realistic budget, choose the right repayment
option, and make timely payments. Colleges generally conduct exit interviews
with seniors during which a financial aid counselor reviews the student’s
total indebtedness, the repayment options available, and when repayment begins.
Most loans give you six months of breathing room, but some require that you
begin repayment immediately.
Step 2 – Budget, Budget, Budget
Good financial planning starts
with sound budgeting. To determine how much you can afford to pay toward your
debt each month, you will need to compute your income and expenses. In terms of
estimating your income, be sure to take into account that the pay you are quoted
is not what you will be taking home. Taxes and a variety of other payroll
deductions, such as medical insurance, are going to result in a paycheck that
may be considerably less than you expected.
Once you have determined your
take-home income, you can realistically predict your monthly payments. Add up
your living expenses such as rent, utilities, food, car and transportation
expenses, and recreation. If you’re not sure where you spend your money, you
might want to keep a written record of your expenses over a few months. Student
loan borrowers are typically advised to keep their monthly student loan payments
within 8 to 10 percent of their monthly incomes. This guideline ensures that
borrowers have enough discretionary income to cover other living expenses, as
well as the occasional pizza or movie.
In addition to paying off your
debt, it is very important to save some portion of your pay each month. It
doesn’t have to be a lot, but it should be regular. Your first savings goal
should be to build up an emergency cash reserve equal to 3 to 6 months of
after-tax pay. Once you’ve done that, it’s not too early to start thinking
about saving for retirement.
Step 3 - Choose a Repayment Option
Your loan balance and interest
rate determine your monthly payment amount. As a general rule, you can plan on
paying about $125 per month for every $10,000 you borrow. The repayment options
available to you depend on the type of loan you have.
Most borrowers choose the
standard 10-year equal-installment plan that requires you to make payments of
equal amounts over a maximum of ten years. This plan carries the highest monthly
payment, but costs less over the long term because you pay less interest.
Students who cannot meet the monthly payment required by the standard repayment
plan may choose the graduated payment or income-sensitive plan. With a graduated
payment plan, your payments start out low and rise every few years, on a fixed
schedule. This option makes sense if you are just starting out in a career and
expect your income to increase steadily. Another option, the income-sensitive
plan, adjusts annually to reflect changes in your income. It is recommend that
you avoid stretching out the term of your loan unless it is absolutely necessary
that you do so. While flexible payment options reduce your monthly payment,
adding extra years to your loan means you will pay more interest over the life
of the loan.
Step 4 - Make Timely Payments
Once your repayment period
begins, it is important that you make regular payments. Failure to do so may
result in a ruined credit rating, substantial collection costs, and lost
opportunities in employment and in purchasing a car or a home. If you are having
trouble making your payments, it is important to contact your lender. Most
lenders are willing to work with you to make repayment easier. You may be
eligible for a deferment, which allows you to put off payment for a while if you
are unemployed, returning to school, or on parental leave. If you don’t
qualify for a deferment, you may be able to postpone payment through a
forbearance. Under a forbearance, the lender allows you to stop making payments
for a short period of time (though the interest on your loans will continue to
accrue). Another option, consolidation, affords you the opportunity to lower
your monthly payment by consolidating your loans and extending the term of your
loan up to 30 years.
As
a result of a recent change in the tax law, there’s one more step you’ll
need to take and this one will save you money. Student loan borrowers with
qualifying adjusted gross income may be able to deduct all or part of the
interest paid on qualified student loans. If you qualify, you may deduct $1,500
in student loan interest for 1999. That amount will rise in $500 increments
until it reaches $2,500 in 2001. This deduction is available whether or not you
itemize. Only interest paid during the first 60 months in which interest
payments are required is deductible.