The Student Loan Grace Period Is Ending, Now What?

New college graduates often face many initial financial burdens, such as moving expenses, security and utility deposits, furnishing an apartment, buying a new car, and getting a wardrobe for work. It is easy to lose track of student loans, especially during the six- or nine-month grace period after graduation. Now that the grace period is ending, it is time to get organized and plan for repaying student loans.

Get Organized

Borrowers should start by making a list of all their loans, including the name, website, telephone number, payment address, and other contact information for the lender and servicer. Also, record the loan id numbers, the amounts owed, the interest rates, the monthly payment amount, the name of the loan program, and the payment due dates. Use a student loan checklist, such as the one available from Edvisors.com. Keep the paperwork and correspondence concerning each loan in its own file folder, labeled with the name of the lender and the loan id number.

Borrowers who don’t get organized will get into trouble. Among borrowers who are late with a payment on their student loans, about a quarter to a third of them are late with the very first payment. The typical college student graduates with 8-12 federal and private student loans after four years in college. It is easy for one of those loans to get lost and, inadvertently, go into default. The consequences of default can be expensive and may include collection charges of as much as 20 percent of each loan payment, wage garnishment of up to 15 percent of each payment, and the offset of federal and state income tax refunds.

There are several tools that can be used to find a list of the borrower’s loans and lenders. My Federal Student Aid lists all of a borrower’s federal student loans and their servicers. Federal student loans should also be listed on the borrower’s credit reports, along with private student loans. Get a free credit report from each of the three major credit bureaus once a year at annualcreditreport.com. The college’s financial aid and/or business office can also help alumni track down missing student loans.

Borrowers should also add a reminder to their calendars about two weeks before each loan’s first due date. The payment is due even if the borrower does not receive a statement or coupon book from the loan’s servicer. Borrowers are required to notify the lender about any changes in the borrower’s postal mailing address and contact information.

Beginning Repayment

At the start of loan repayment, the borrower will need to choose a repayment plan. If the borrower does not choose a repayment plan, the borrower’s loans will be on a standard 10-year repayment plan. Borrowers should choose the repayment plan with the highest monthly payment the borrower can afford, since this will reduce the total interest paid over the life of the loan.

Standard repayment is a good choice for loan repayment because it has one of the shortest repayment terms. The monthly payments under standard repayment are about one percent of the original loan balance at repayment. So long as the total student loan debt is less than the borrower’s annual income, the borrower should be able to afford the monthly loan payments under standard repayment.

Borrowers should also sign up for direct-debit loan payments, also known as auto-debit, where the borrower’s bank automatically transfers the monthly loan payment from the borrower’s bank account to the lender. The borrower remains in control of the payments and can tell his or her bank to stop making the payments at any time. Not only is the borrower less likely to be late with a payment with auto-debit, but many lenders offer an interest-rate reduction of between 0.25 and 0.50 percentage points to borrowers who sign up for auto-debit.

Consider Loan Consolidation

Some borrowers may wish to consider consolidating their federal and private student loans to simplify and streamline the repayment process. Federal and private student loans cannot be consolidated together (but they may be refinanced together), each type of loan may also be consolidated separately.

Consolidation makes repaying student loans easier to manage by replacing several loans with a single loan. If the borrower has several loans with a single lender, the borrower can also simplify repayment by asking the lender for unified billing. The lender will then send the borrower just one bill each month listing all of the borrower’s loans instead of multiple loan statements.

Consolidation does not necessarily save the borrower money.

• Consolidation replaces two or more loans with a single loan. This will prevent the borrower from targeting the loan with the highest interest rate for quicker repayment. Accelerating the repayment of the highest-rate loan can save money and lead to quicker repayment if there are significant differences in the interest rates on the individual loans. There are no prepayment penalties on federal and private student loans.
• The interest rate on a federal consolidation loan is based on the weighted average of the interest rates on the borrower’s loans, rounded up to the nearest 1/8th of a point. This more or less preserves the cost of the loans, assuming that the repayment term remains unchanged.
• A private consolidation loan is similar to a traditional refinance, replacing the existing loans with a new loan with a new interest rate based on the current credit scores of the borrower and cosigner (if any), and current market rates. Since credit scores tend to decrease each year in school due to increased credit utilization, consolidating immediately after graduation may yield a higher interest rate, not a lower interest rate. Instead, the borrower should manage his or her credit responsibly, making on-time payments on all debts, not just student loans. After a few years, the borrower’s credit scores should increase enough to yield a lower interest rate on a private consolidation loan.
• Borrowers who consolidate their loans often choose a longer repayment term. A longer repayment term may reduce the monthly payment, but will also increase the total interest paid over the life of the loan.

Private consolidation can also be a way of releasing a cosigner from the obligation to repay the borrower’s private student loans, if the new private consolidation loan is made to the borrower without the cosigner.

Borrowers can consolidate their federal student loans for free at StudentLoans.gov. Borrowers can find lenders offering private consolidation loans at PrivateStudentLoans.com.

Other Repayment Recommendations

Borrowers may deduct up to $2,500 in interest paid on federal and private student loans on their federal income tax returns. The student loan interest deduction is claimed as an above-the-line exclusion from income, so the borrower does not need to itemize to claim the deduction.

Before a borrower accelerates repayment of the highest-rate loan, it is a good idea to build an emergency fund with about half a year’s worth of annual income.

If a borrower encounters financial difficulty, he or she should talk to the lender to explore options for financial relief. Ignoring the problem will not make it go away and can make it much worse. Borrowers may be eligible for deferments and forbearances, which temporarily suspend the repayment obligation while the borrower’s finances improve. Partial forbearances, which require interest-only payments, may provide some financial relief while preventing the loan balance from growing. Alternate repayment plans, like extended repayment and income-based repayment, may reduce the monthly payment by increasing the term of the loan. These options may be lost if the borrower defaults first.