PAYING STUDENT LOANS

Things to Consider

Two out of three college students have student loans and the average debt is $17,600. The College Board reports that the typical debt of graduates from four-year private schools is $19,400. College grads often owe significant credit card debts as well.

As you begin to pay off your student  loans and other debt, don’t forget how important your credit rating is:

  • A prospective employer may look at your credit history before extending a job offer.
  • A landlord will conduct a credit check before renting you an apartment.
  • You may be turned down for a car loan or mortgage or you’ll pay a higher interest rate.
  • Your application for insurance may be denied or you’ll pay higher premiums, because insurers believe you’re more likely to file a claim and may not pay your bills on time.

Having a bad credit rating exacerbates your money problems. You will be charged a higher interest rate on money you borrow or you may not qualify for a loan.

 

Your FICO Score

The Fair Isaac Corp. developed the widely-used FICO credit scoring system. You can learn more at www.myfico.com.

Typically, FICO scores are usually between 300 and 850. Below 620 may be viewed as a red flag. Above 650 is usually considered to be a good FICO score.

Your FICO score is affected by a number of factors including:

  • Timeliness in paying bills
  • Number of credit cards
  • Credit-use ratio

Your credit-use ratio compares your credit card balance to your credit limits.

If your credit cards have combined limits of $10,000 and you have $2,000 in outstanding charges, your credit-use ratio is 20 percent. Using less than 30 percent of your available credit is generally viewed as a positive factor.

Your credit score is available to you for free one time each year. Watch out for companies that promise a free credit report, but require you to enroll in a service that charges a fee.

 

Tips & Common Mistakes

Tip: Creating a budget

Paying off student loans requires the creation of a budget. Start by doing this:

  1. Write down all of your income and expenses.
  2. Look for cuts in your budget, such as finding a cheaper place to live. Watch out because the cost of moving may offset your savings. If possible, rely on public transportation instead of owning a car.
  3. Have your loan payments deducted automatically from your checking or savings account.
  4. Set up automatic payments from your checking account into a savings or brokerage account.

Don’t let creditors create your budget for you. For example, even if a credit card company says you can skip a payment or only requires you to pay a small amount, you need to take it upon yourself to pay as much as you can. This will help you pay off your debt in a timely manner and avoid exorbitant interest charges.

Common mistake: Bankruptcy

If you’re facing huge debts and limited job opportunities, bankruptcy is not the answer because:

  • With narrow exceptions, student loans will not be discharged by bankruptcy.
  • The bankruptcy laws changed recently and it’s far more difficult to wipe out your debts.
  • Bankruptcy will be reported on your credit record for ten years.

Tip: Living at home

Instead of filing for bankruptcy, look for ways to get on your feet. According to a survey by MonsterTRAK, four of ten 2005 graduates are still living with their parents. The survey found that 48 to 66 percent of the class of 2006 plan to live at home. Becoming a “boomerang kid” is one way to get a jump on your student loans.
 
Paying off student loans results in financial and psychological dividends. It will give you peace of mind and allow you to focus on investing for your future.

 

Getting Started

As a starting point, you need to know where you stand now and that information comes from your credit report. You can get it for free from www.annualcreditreport.com or by calling 877-322-8228.

Once you receive your credit report, you should correct any mistakes. Generally, credit bureaus have 45 days to correct mistakes you report to them.

The three largest reporting agencies are:

If your credit rating isn’t good, there are ways to improve your score including the following:

  • Start paying your bills on time. Make sure your payment arrives before the due date, even if there’s a grace period.
  • Pay your credit card bills in full.
  • If you can’t pay your credit card bill in full, at least pay more than the minimum amount.

 

FAQs

Should I consolidate my student loans?

During the past few years, millions of college students consolidated federal student loans to lock in the lower rates that were available. At the same time, many of them extended the terms of the loans to as long as 30 years. Although consolidating your loans and extending the term will lower your monthly payment, you’ll pay far more in total interest over the life of your loan. As an example, on a $20,000 loan with a 4.75 percent interest rate, you’ll pay:

  • $210 per month on a 10-year loan
  • $129 per month on a 20-year loan

Although your monthly payment is less with the 10-year loan, you’ll pay almost $5,800 more in interest. The good news is that the interest on student loans is usually tax-deductible. For more details, see http://www.irs.gov/faqs/faq-kw187html.

Generally, consolidating loans is a good idea if:

  • You can lock in a lower interest rate.
  • You’ll invest your savings, rather than frittering the money away.
  • You put that extra money toward paying off debts with a higher interest rate.

If you don’t honestly believe you’ll use your savings to improve other aspects of your financial situation, you should endeavor to pay off your existing loans as quickly as possible. Also, increases in interest rates make consolidation a less attractive option than it once was.

Should I delay repaying my student loans?

If the thought of paying student loans 30 years from now bothers you and you would like to move toward the goal of paying them off, it might be smart to get started now. For example, a medical school graduate need not begin paying off her loans until she finishes her residency. Nevertheless, she may decide that stretching out student debt might keep her from pursuing other goals like buying a house.

With student loans, you are also entitled to a deferment or forbearance if you encounter a financial hardship. Unless there are exigent circumstances, putting your student loans behind you may be the best way to move forward toward your goals.

If your goal is buying a house or car, you will probably need to borrow money. Your existing debt, including student loans, will affect your ability to qualify for a mortgage or car loan. Financial institutions are less likely to lend you money if you’re already deep in debt from college. Student loans and other debts that exceed 8 percent of your income will usually hurt your chances of getting a mortgage.