Personal Finance 101: So much student debt. Should I skip payments?

Personal Finance 101: So much student debt. Should I skip payments?

A back-to-school adulting series

More than 40% of all U.S. citizens who went to college — 31% of all adults in the country — have student loan debt, according to the Federal Reserve. The bill adds up to $1.6 trillion.

Between skyrocketing tuition and a depressed job market, those loans aren’t going away anytime soon. So what’s the best way to manage student debt?

Planning for a lower-debt education

If you still have time, says Stephen Talbott, author of the e-book “How Much Should I Borrow for College?”, make a plan to avoid accumulating too much debt in the first place.

If you’ll need to take out loans to get a four-year degree, attending a community college for the first two years will be much cheaper. Future employers will mostly care about the school name on your diploma, he says, and working a part-time job while taking community college classes for two years can allow you to start at a four-year school in your third year, debt-free.

Just make sure the credits are transferable.

“I went to community college for a couple of courses, and I went to about five different schools. But people know that I graduated from Albany State University in New York,” Mr. Talbott said.

Have a strategy for your classes. He recommends looking at the career you want, figuring how much it’ll cost to train for that career, and then researching how long it’ll take to pay down debt based on a realistic post-college salary.

Mr. Talbott recommends you ask yourself: “How can I come up with a plan from the beginning that gets me to the goal I want with the least amount of debt?”

What if I already have debt?

Once you’ve accumulated debt, it’s important to understand your options.

Federal and private loans can both be reorganized to help you pay them off faster or with lower or more stable interest rates.

Federal loans can be consolidated, which means several different loans are combined into a single loan with a fixed-interest rate calculated from the weighted average of the interest rates of the loans pre-consolidation. Federal loan consolidation can also make you eligible for certain forgiveness programs.

Private loans, on the other hand, can be refinanced. A private lender will pay off the full loan at once, and then give you a new loan to pay back at a lower interest rate. Lowering your interest rate by a few percentage points can save thousands of dollars over the repayment period.

And, as the economy struggles through 2020, now might be a good time to start thinking about applying for a refinanced loan.

“The interest rates right now are quite low. So the opportunity for refinancing may involve older loans that have higher interest rates, especially older fixed-rate loans,” says Mark Kantrowitz, the publisher and vice president of research at Miami-based company

Protecting your credit while refinancing

Credit bureaus recognize that people may apply to more loans than they’ll need in order to see what quotes they get back, so it won’t necessarily hurt your credit score to apply to several different lenders.

“[Credit bureaus] know that if you apply for five loans, you’re not actually going to take out five loans, but [are] rather seeking one loan,” Mr. Kantrowitz said.

One protection measure you can take is to ask if the lender will conduct a “soft” or “hard” credit inquiry. “Soft” inquiries are only visible to you and won’t affect your credit score, while “hard” inquiries stay on your credit report for two years and can lower your score for the first year of that period.

If you’re approved for a loan, the lender will perform a “hard” inquiry, but many lenders only do “soft” inquiries pre-approval.

What happens if I just … don’t pay?

Failure to pay off a loan is called default. Private student loans are considered to be in default after three months of missed payments, while federal student loans have a longer non-payment period before the payer is officially in default — 270 days.

Consequences for default are serious, and they differ between the two types of loan.

Defaulting on a private student loan gives the lender the power to seize your assets, sue you in court, pursue your cosigner for payment, and report you to the U.S. credit bureaus, among other things. The damage to your credit score will be serious, and the lender may also charge heavy fees on the missed payments.

Meanwhile, if you default on a federal student loan, the U.S. government will be able to take 15% of your disposable income and decrease any potential Social Security payments by 15% to pay off the cost of the loan, intercept your tax refunds, make you ineligible for deferment or forbearance (more on those in a minute) and even bar you from receiving federal student aid in the future.

Defaulting on a loan can actually end up costing you more than the total price would have been otherwise.

The options if you can’t pay now

There are two primary options to delay or reduce the amount you owe in the near future on student loans: deferment and forbearance.

When dealing with federal student loans, a deferment will allow you to stop paying the loan for a period of time, sometimes without accruing interest (on certain types of loans).

Meanwhile, a forbearance delays or reduces your monthly payments, while interest continues to accrue.

Of the two options, deferment on federal loans that won’t accrue interest will ultimately be cheaper — though it won’t reduce the total amount you owe. But unless you’re currently enrolled in school or are living in one of a few very specific circumstances, like undergoing cancer treatment or physical rehabilitation, being unemployed, or working in the Peace Corps or armed forces, you may not qualify.

Forbearance is easier to qualify for and is available from private lenders as well as on federal loans. Choosing to delay payments with a forbearance means committing to additional interest that will accrue during the nonpayment period. However, it’ll help you avoid going into default and won’t affect your credit score.

Is bankruptcy a way out?

Declaring bankruptcy is sometimes an option to deal with severe debt. In a bankruptcy proceeding, the filer’s assets are liquidated to pay creditors and the remaining debt is forgiven.

But student loans are “almost impossible” to discharge in bankruptcy, Mr. Kantrowitz said. “There’s a section of the U.S. bankruptcy code which says there’s an exception to the discharge of qualified education loans and certain other types of student loans,” he said.

All federal student loans and most private loans are considered qualified educational loans, according to Mr. Kantrowitz.

There’s a small exception. According to the law, the debts can be discharged if “repaying the debt would pose an undue hardship on the borrower and the borrower’s dependents,” he said. Congress has not defined what “undue hardship” means.

There are existing “tests” to determine if a person qualifies for the exception, but, Mr. Kantrowitz noted, “The statistics show that very few borrowers ever succeed in getting even a partial discharge of their student loan debt in bankruptcy. You can get rid of your credit card debt, medical debt, but not student loan debt.”

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