Talk to just about anyone who is currently repaying their student loans and they will likely tell you that there are lots of things they didn’t know or wished they would have done differently when they got their student loans.
One of the most popular misconceptions about student loan debt is that it is “good debt”. Though it’s true that going into debt to pay for school is probably a better idea than going into debt to pay for a big screen TV, in the end both debts have to be paid back. Debt is debt, no matter what you call it.
For students getting ready to go to school this fall, acquiring a student loan has arguably never been easier. Numerous banks, credit card companies, and financial institutions offer instant approval over the Internet or by phone. Speaking from personal experience, when I was funding my education, my thought progression went as follows: the school I am attending costs X dollars, I am Y dollars short, I will get a loan for Y dollars.
Things like interest rate and repayment terms took a back seat to speed and efficiency. In my case I decided I needed a loan for $6,000. I went to my bank’s website, entered in my information, and I was instantly approved. Some schools make it even easier – sign a Master Promissory Note once when you’re a freshman (that takes 5 minutes), and they’ll instantly approve your loan for each quarter until you graduate – no thinking at all.
I never for a second considered whether or not I could afford the debt I was getting into. The goal of this article is to illustrate the things each college student and cosigner need to consider before they apply for student loans.
Student Loans Compared to Other Forms of Debt
Student loans are a unique form of debt unlike all others. The most important difference between student loan debt and most others is that student loan debt can almost never be discharged through bankruptcy. For the 18 year old who is about to enter college, bankruptcy is probably the furthest thing from their mind. However, it is a critical consideration, because anyone who is about to sign for a student loan needs to understand that no matter what they do, that debt will follow them. If you don’t pay your student loan bills, you go into default, your lender can garnish your wages and you are powerless to stop it. Just remember the story about the lady who was getting her Social Security garnished to pay her student loans.
ALL borrowers, no matter how confident they are in their job prospects, need to understand this dynamic. First of all, if you are borrowing on a loan with almost no bankruptcy protection, you should make sure you are getting a lower interest rate. The lender is taking less of a risk, and that should be reflected in the terms of your agreement. Secondly, because the lenders know they can always collect on these loans, they have no incentive to work with you to assist repayment. Compare this to a credit card company. If you owe $20,000 and tell your credit card company you are struggling with payments and are considering bankruptcy, they will go to great effort to see to it that they collect as much as possible from you. A student loan company has no incentive to do so; they know they are getting their money from you.
Therefore, we are left with one undeniable fact: If you borrow a student loan, you better be certain you can pay it back. The collateral of the student loan is YOU – your ability to repay it in the future based on your income.
Can I Afford My Student Loan?
In order to fully understand whether or not you can afford a student loan, you need to know your loans interest rate, origination fees, and when you will start paying it back. For the sake of example, lets assume you have some scholarships, a bit of help from home, and because you were smart enough to go to a state school, you only need to borrow 10k a year. Guess how much a month that will cost you when you graduate?
In order to get that 10k for your first year, lets say you are able to find a loan with an interest rate of 5% and a loan origination fee of 2%. Some will find these numbers high, others low, but they are definitely reasonable and they make the math a bit easier. If you borrow that 10k, it immediately becomes $10,200.00 due to the origination fee. Because you are in college, you likely won’t be able to make payments on the loan so the interest will continue to grow. Assuming it compounds monthly, if you take out a loan for $10,000 your freshman year, it will have grown to $12,453.13 four years later. The exact same loan from your sophomore year will have a balance of $11,847.02, the 10k loan from your junior year will have grown to $11,270.40, and your most recent 10k loan will already have a balance of $10,721.85. Meaning if you take out only 10k a year for four years, by the time you graduate you will owe a total of $46,292.40.
On the standard 10-year repayment plan you will have to pay $491.00 per month. That means even if you find a good job paying 60k a year, nearly 10% of your income will be going to student loans for the next decade. What will you do if you can find a job at that level of income?
The point of this exercise is not alert you to be ready to pay $500 a month when you graduate, nor is it to scare people out of going to college. Instead, the point is for everyone who is considering student loans to go through and do the math. Put together a plan A, a plan B, and a plan C. Compare this math to what it would be if you just paid the interest on your loans while you are in school. Investigate the repayment plans that your lender may be offering. The federal government has a great variety of repayment plans and even some forgiveness programs, but the low undergraduate loan limits mean people will often have to resort to private loans.
A Checklist Before You Apply for Student Loans
Here is a checklist for responsible student loan borrowing:
- Determine how much money you already owe, and how much you will need for each remaining year of college
- Find out your student loan interest rate and how often it compounds
- Add any origination fees
- Calculate the total debt you expect to have when you graduate
- Review the available payment plans
- Estimate conservatively how much you expect to be making when you graduate
- Ask yourself honestly if this is something you can afford
The price of college has never been higher. Americans owe over 1.1 trillion dollars in student loan debt. For the amount you are borrowing, you could probably buy a nice car or even a house. With this kind of money changing hands, be smart about your research. Before you sign your name on the dotted line, know exactly what you are getting yourself into.
This is a guest post by Michael Lux, from The Student Loan Sherpa. After being utterly disappointed with the lack of helpful information available regarding student loans, he created his site. Michael now spends his spare time trying to keep his lenders happy and helping others satisfy their student loan overlords.