Borrowers are sometimes late with a loan payment or even default on a loan because they forget about one of their loans. This can happen because a typical Bachelor’s degree recipient graduates with 8-12 loans. Payments are due even if the lender does not send the borrower a statement or a coupon book. Keep track of vital loan information on a student loan checklist.
Borrowers must update their address and other contact information to receive loan statements and bills on time. Old contact information can cause delays, which may lead to late loan payments.
A single late payment is all it takes to damage an otherwise very good credit score. The credit score is intended to measure whether a borrower will repay his or her debts on time. Borrowers with lower credit scores are less likely to qualify for a loan and will be charged higher interest rates if the loan application is approved. Late payments can also mean that the borrower will not qualify for cosigner release.
Borrowers can deduct up to $2,500 in interest on federal and private student loans on their federal income tax return. The student loan interest deduction is taken as an above-the-line exclusion from income, so taxpayers do not need to itemize to claim the deduction. The deduction often yields several hundred dollars of tax savings.
Longer repayment terms lead to lower monthly payments. But, longer repayment terms also lead to more interest being paid over the life of the loan. Increasing the loan term on a 6.8% loan may cut the monthly payment by a third, but more than doubles the total interest paid over the life of the loan. Choose shorter repayment terms to save interest.
Every month, the borrower will be charged interest on the outstanding principal balance of the loan. Initially, most of each loan payment will be applied to interest charges, not the principal, so the loan balance will decrease slowly. There may also be interest that accrued during a deferment or forbearance. This interest must be paid off before the principal balance will decrease. Only after several years in repayment will a kind of domino effect cause the progress in paying down the loan balance become more noticeable. The only way to get quicker progress in paying down the loan debt is to pay more per month.
Deferring repayment can cause the loan balance to grow if interest is not paid as it accumulates. While the federal government pays the interest on subsidized loans during deferment periods, it does not pay the interest on unsubsidized loans during deferment periods or on any loans during forbearance periods. If the borrower does not pay the interest as it accrues, the interest will be capitalized by adding it to the loan balance. This can yield a bigger loan, digging the borrower into a deeper hole. Federal education loans are capitalized once, at the end of the deferment period, while private student loans may be capitalized more frequently, leading to interest being charged on interest, not just principal.
If a borrower has extra money, he or she can make extra payments on his or her loans. There are no prepayment penalties on federal and private student loans. Applying the extra payments to the loan with the highest interest rate will save the borrower the most money. Some borrowers, however, make extra payments on the loan with the lowest loan balance. This approach, called the snowball method, argues that the borrower will pay off that loan quicker, yielding a psychological boost. But, this does not necessarily save the most money. Accelerating repayment of the loan with the highest interest rate will also lead to quicker payoff of all the loans. Watching the loan balance decrease quicker gives more of a psychological boost than paying off a small loan first.
Borrowers can consolidate federal student loans for free at StudentLoans.gov. Borrowers can also choose alternate repayment plans that reduce the monthly loan payment without paying a fee. This is simple and can be done without professional or commercial help. Borrowers should never share their FSA ID with anybody and should beware of the risks of identity theft. Call the Federal Student Aid Information Center, a toll-free hotline sponsored by the U.S. Department of Education, at 1-800-4-FED-AID (1-800-433-3243) for free information and advice about federal education loans and other forms of federal student aid.
Borrowers sometimes think that a refinance will solve all of their problems. Most borrowers do not love their lenders, so switching lenders might not make the borrower happier. Even if a refinance leads to a lower interest rate, often, the real problem is the amount of debt, not the interest rate. A refinance may also be difficult to obtain, especially if the borrower has been experiencing financial difficulty. Ignoring problems will not make them go away and sometimes will cause them to get worse. Talk to the lender before defaulting on the loan.
The federal government has very strong powers to compel repayment, including administrative wage garnishment, offset of federal and state income tax refunds and Social Security retirement and disability benefit payments. There is no reason why a borrower should strategically choose to default, as the monthly payment under administrative wage garnishment is higher than the monthly loan payment under income-based repayment or pay-as-you-earn repayment, and the borrower will also have to pay collection charges of up to 20% of each payment. There is no getting away from the debt and no financial benefit to defaulting on the loans.
Federal and private student loans are almost impossible to discharge in bankruptcy. Very few borrowers each year succeed in getting a full or partial discharge of their student loans. To get student loans discharged in bankruptcy requires an adversarial proceeding and proof that repaying the loans represents an “undue hardship” on the borrower and the borrower’s dependents. Each judge has a different interpretation of what it means to have an undue hardship, but generally the borrower must demonstrate a present and future inability to repay the debt and maintain a minimal standard of living for most of the life of the loans. Borrowers must also have made a good faith effort to repay the loans.
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