1/16/2012 3:12 PM ET | By Liz Weston,
There’s no easy way to escape from your college loans, but for most people, options such as repayment and forgiveness plans do exist. The point is to avoid defaulting.
Here are two things you need to know about student loan debt:
1. There’s no magic wand that makes it easily disappear.
2. The more desperate you are, the fewer options you may have for relief.
The rising default rate on federal student loans reflects these realities. The U.S. Department of Education in September said 8.8% of borrowers had defaulted in their first two years of repayment, up from 7% the previous year.
That’s just the tip of the iceberg. When the window is expanded beyond the first few years of repayment, the default rate soars. One in five federal student loans that entered repayment in 1995 has gone into default, according to a review by the Chronicle of Higher Education.
Still, most people have better options to deal with their education debt than to simply stop paying it. A smart repayment approach can get you out of debt faster or at least make your loans more manageable as you build the rest of your financial life.
Here’s what you need to know to start planning your escape from student loan debt:
Understand the Trade-Offs
Federal student loans offer a variety of repayment options. If the payments on the standard 10-year repayment schedule are too high, you may be able to get extended plans that lower payments by stretching your loan term out to as many as 30 years. Or you can ask for graduated payments that start smaller and get bigger over time. Or you can take advantage of repayment plans based on your income.
The longer you take to pay back the loan, the more interest you’ll pay. Switching from a 10-year to a 20-year plan, for example, will cut your monthly payment by about one-third but will more than double the total interest you’ll pay, said financial aid expert Mark Kantrowitz, the publisher of FinAid and Fastweb.
If you have a manageable amount of federal student loan debt and can afford to make the bigger payments, you should do so. But consider opting for lower payments, even though you may pay more interest, if:
- You really can’t afford a larger payment right now.
- You otherwise couldn’t save for retirement.
- You have private student loan debt in addition to federal loans.
Focus on Your Private Student Loans First
Unlike federal student loans, private student loans have variable rates. Even if the rates are low now, they likely won’t stay that way for long, Kantrowitz said.
Private student loans also have fewer consumer protections and repayment options than federal loans, plus no forgiveness options — more reasons to dispatch this debt as fast as you can. Consider paying the minimum possible on your federal loans so you can throw more money at your private loans. Your lenders can help you compare your repayment options; if you’re not sure who holds your loans, start your search here.
Consider Income-Based Repayment Plans
Federal student loans offer three repayment options that are tied to your earnings: income-contingent, income-sensitive and income-based. The income-based plan is the most generous and can even get your payments down to zero if you’re poor. The plan caps payments at 15% of your so-called discretionary income, which is the difference between your adjusted gross income and 150% of the federal poverty line.
This cap will fall to 10% in 2014. (The cap will fall this year for certain borrowers, who will be notified this month by mail if they’re eligible for lower payments. To qualify, the borrowers can’t have taken out any loans before 2008 and must have taken out one new loan in 2012.)
Explore Your Forgiveness Options
The balance of your federal loans can be forgiven after 25 years of on-time payments if you’re in the income-based repayment plan. That term will drop to 20 years starting in 2014 and will drop this year for a select group of borrowers — who, again, will be notified by mail if they qualify. The clock generally starts when you enter the income-based repayment program.
You can get your balance erased in just 10 years if you’re in the income-based repayment plan and work in certain public service jobs, including teaching, health, military and public safety jobs. (See a complete list here.)
You also can get some or all of your federal loans forgiven through volunteer work, military service or working in certain high-need areas. Service in AmeriCorps or Vista, for example, can earn you a $4,725 stipend toward paying off your loans. Participating in the Army National Guard can earn you up to $10,000 for loan repayment. Doctors and nurses can get loan forgiveness through the National Health Service Corps or the Nursing Education Loan Repayment Program if they work for a few years in areas that lack adequate medical care. Teachers have a number of options for forgiveness if they work in disadvantaged areas or with special-needs children. For more, visit FinAid’s page on loan forgiveness.
Don’t Ignore Your Debt!
Defaulting will trash your credit, which will make it harder for you to get other loans and may impair your ability to get a job. You could be sued and have your wages garnisheed. Your income tax refunds could be withheld, and you might not be able to get or renew professional licenses.
If you really can’t pay your federal loans, even under an income-based repayment plan, consider applying for a deferral or forbearance — which will allow you to suspend payments for a time without penalty, although interest will still accrue — rather than simply ignoring your debt. You must apply for deferrals or forbearance before your loans go into default. (Default is defined as being more than 270 days overdue on your federal student loans or 120 days overdue on your private loans.)
Private student loans have fewer options when you can’t pay, but a one-year forbearance may be available, or you may be able to get extended-payment plans.
If you’ve exhausted all your repayment and forgiveness options and still can’t pay, you should:
Understand Your Worst-Case Options
Student loans are different from most other debts. Education debts typically can’t be erased in bankruptcy court, and there’s no statute of limitations on how long a lender can pursue you for what you owe. Age or disability won’t protect you: The U.S. Supreme Court ruled against a 67-year-old disabled man who lived in public housing, deciding that he had to give up 15% of his $874 Social Security check to pay back defaulted student loans.
Because they have such powers to pursue you, student lenders aren’t going to settle your debt for a fraction of what you owe, as a credit card lender or collection agency might. But Kantrowitz said that people who have lump sums to offer may be able to negotiate small discounts on what they owe, such as 10% off the total amount or forgiveness of half the interest accrued since defaulting. Again, this assumes you have a lump sum, such as an inheritance or a loan from your parents. If you have to make payments, you’ll be stuck paying off the full amount you owe.
Bankruptcy almost certainly won’t help you get rid of your student loans. Of 72,000 filers who asked for discharge of their student loans in 2008, only 29 were granted any relief, according to student loan guarantor Educational Credit Management, the U.S. Department of Education’s designated provider for student loan bankruptcy services. Borrowers essentially have to prove not only that their financial situation is dire but that it’s unlikely to ever improve — which is a harsh standard to try to meet, Kantrowitz noted. If you’re permanently and totally disabled, you may have a shot; otherwise, fuhgeddaboudit.
Bankruptcy may, however, wipe out enough other debt to give you the ability to start repaying your student loans. Credit card and medical bills are among the debts that can be erased in a bankruptcy filing.
If you’re really up against a wall, consider talking to a bankruptcy attorney about your options. You can get referrals from the National Association of Consumer Bankruptcy Attorneys.
Liz Weston is the Web’s most-read personal-finance writer. She is the author of several books, most recently “The 10 Commandments of Money: Survive and Thrive in the New Economy.” Weston’s award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Click here to find Weston’s most recent articles.
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