Since the early days of the Web, Mark Kantrowitz has been my go-to source tor information on college financial aid and student loans. A mathematician and computer scientist by training (he holds seven patents involving novel statistical methods) he founded FinAid.org in 1994 as a public service and helped create the scholarship match service Fastweb.com the next year. Mark is publisher of both those free and ever-so-useful sites (now owned by Monster Worldwide) and has written three books on student aid. With the college commencement season now in full swing, I asked Mark to offer some advice to new graduates.
Advice for New College Graduates on Managing Money and Student Loan Debt
By Mark Kantrowitz
Congratulations college graduates! You are about to embark on a new adventure. But you will also face new challenges, such as repaying student loans and managing your money.
Here are several tips to help you get started.
First, get organized. After four years in college, most undergraduate students graduate with 8-12 loans. Graduate students may have twice as many loans, including the loans from their undergraduate education. It is easy to lose track of a few of these loans.
Compile a list of all your loans, including the name, web address and contact information for the lender, the loan ID number, the current loan balance, the interest rate and the date the first payment is due. FinAid’s Student Loan Checklist can help you organize this information. Put all correspondence for each loan into its own file folder, labeled with the loan ID number.
Add a reminder to your calendar at least two weeks before the first payment is due. You are required to make payments on your student loans even if you don’t receive a coupon book or statement from your lender. Students often forget about their loans during the 6-month grace period between graduation and the start of repayment.
Plan for how you will make the first payment on your loans. Of borrowers who miss a payment on their loans, the majority misses the very first payment. Sometimes this happens because the borrower fails to tell the lender about his or her new address. But it can also occur because newly minted college graduates face a lot of startup expenses that demand a slice of the borrower’s bank account. Landlords often require tenants to provide a security deposit on the apartment plus the first and last month’s rent. Utilities may also require deposits. Then there’s the cost of furnishing an apartment, buying business attire and money for the down payment on a new car. Money will be very tight when you are first starting out and there will be many potential distractions.
Sign up for auto-debit. With this service, the monthly loan payments are automatically transferred from your checking account to the lender. Not only does this save you on postage and the hassle of writing a check each month, but education lenders often give borrowers who make their payments by auto-debit a small interest rate reduction, typically 0.25% or 0.50%.
If all of your loans are with the same lender, most lenders will offer unified billing, where you will get one bill listing all of your loans. Otherwise, you may wish to consolidate your loans, which replaces all of your loans with a single loan. This will streamline and simplify repayment of your student loans. (You cannot, however, consolidate federal and private loans together. Consolidation loans for private or alternative student loans are offered by a variety of lenders. A list is available at www.finaid.org/privateconsolidation.)
Consider consolidation carefully. There are some reasons why you might not want to consolidate your loans. Consolidating federal loans does not save you money. The interest rate on a federal consolidation loan is based on the weighted average of the interest rates on the loans, rounded up to the nearest 1/8th of a percent and capped at 8.25%. This preserves the cost of the loans. Consolidation may provide access to alternate repayment plans that can reduce the monthly loan payment, but this will ultimately cost you more money by stretching out the term of the loan.
Private consolidation loans, on the other hand, are similar to a more traditional refinance. They are new loans with a new interest rate based on the current credit score of the borrower and cosigner, if any. Credit scores tend to decrease with each year in school, due to the increasing loan balance. It takes several years of paying every debt on time as per the agreement to build a better credit score. Until then, a private consolidation loan will have a higher interest rate. Note that you must repay all your debts responsibly, not just the student loans. There is also no tolerance for bad behavior, as even a single late payment can ruin an otherwise good credit history.
But in both cases there are drawbacks to consolidation. If your loans have significantly different interest rates, you may be able to save money by accelerating repayment of the highest interest rate loan first. There are no prepayment penalties on student loans, so you can make extra payments on the most expensive loan after making the required payments on all your loans. Making extra payments on the loan with the highest interest rate will reduce the average interest rate on your loans. But if you consolidate your loans, you will replace them with a single loan with a single interest rate, preventing you from targeting the highest rate loan for earlier repayment.
Don’t miss the tax break. When you file your federal income tax returns, be sure to claim the student loan interest deduction every year. You can deduct up to $2,500 per year in interest paid on federal and private student loans on your federal income tax returns. This deduction is taken as an above-the-line exclusion from income, meaning that you can take it even if you don’t itemize.
Options if you can’t pay. If you encounter financial difficulty, call your lender to explore options for financial relief. There are options that provide short-term and long-term relief.
Federal student loans offer temporary suspensions of the obligation to repay the debt, such as deferments and forbearances. These are best for short-term financial difficulty, such as medical or maternity leave or job loss. But since interest continues to accrue, digging you into a deeper hole, it may be better to continue making some payments on your loans, albeit at a reduced payment amount.
Alternate repayment plans, such as extended repayment and income-based repayment, provide a lower monthly payment. These are best for long-term financial difficulty, such as income insufficient to repay the debt. Extended repayment reduces the monthly payment by stretching out the term of the loan. Income-based repayment bases the monthly payment on a percentage of the borrower’s discretionary income, as opposed to the amount of debt. Borrowers whose total federal student loan debt at graduation exceeds their annual income will benefit from income-based repayment.
But increasing the term of the loan will increase the borrower’s costs by charging interest for a longer period of time. For example, increasing the term of an unsubsidized Stafford loan from 10 years to 20 years will reduce the monthly loan payment by about a third, but it will more than double the total interest paid over the life of the loan. If you can afford it, you should stick with the shortest repayment term you can afford, such as the standard 10-year repayment plan.
Don’t ignore your loans. If you ignore your debt, you will only make a bad situation worse. Borrowers who default lose options, such as access to deferments and forbearances. Default increases the cost of the loans, since up to 25% of every payment will be deducted for collection charges before the rest is applied to the interest and principal balance of the loan. The collection charges slow the repayment trajectory, so a loan that would normally take 10 years to repay before default ends up taking 19 years.
There’s also no getting away from student loans, since federal and private student loans are almost impossible to discharge in bankruptcy. The federal government has very strong powers to force repayment of defaulted loans, such as garnishment of up to 15% of disposable pay and Social Security disability and retirement benefits. The federal government can also offset federal and state income tax refunds and lottery winnings, and block the renewal of professional licenses, all without a court order.
Become financially literate. This means learning about how to manage your money, not just repaying student loans. There are two good introductions for people who are just starting out: Beth Kobliner’s Get a Financial Life: Personal Finance in Your Twenties and Thirties and Suze Orman’s The Money Book for the Young, Fabulous & Broke. These books will teach you how to set and meet your financial goals. You should also subscribe to Consumer Reports. Other book recommendations can be found in Fastweb’s list of the best money books for new college graduates.
Build an emergency or rainy day fund to cover unanticipated expenses. Typically this should be at least $1,000 and eventually 3-6 months’ salary in a bank account or other liquid investment. The goal is to save enough money to cover your expenses until you get a new job if you were to lose your job. Some people recommend saving 6-9 months’ salary since the credit crisis has increased the average duration of unemployment.
Build a descriptive budget. A descriptive budget can help you manage your money. Building a descriptive budget involves tracking all of your expenses for at least a month. Get a receipt for every expense, no matter how small, or record it in a small notebook. Transcribe the receipts every night into a spreadsheet or personal finance program like Intuit’s Quicken or Microsoft Money or at Mint.com. Categorize the expenses into broad categories, such as food, clothing, shelter, transportation, medical care, student loans, insurance, taxes and entertainment. Also tag expenses as to whether they are mandatory (needs) or discretionary (wants). Be realistic: cell phones, tablets, cable TV and other gadgets are luxuries, not necessities. At the end of the month, compare your spending with your income. Just being aware of how much you are spending will help you exercise control.
Be careful about using credit cards. Spending $500 on a credit card feels the same as spending $5, making it easier to spend too much. Pay off the credit card balances in full each month. Otherwise you will be living beyond your means.
Make difficult choices, if needed. If your mandatory spending exceeds your income, you will have to make some difficult choices. Start with big ticket items, like housing and transportation. You can cut housing costs by finding a cheaper apartment, getting a roommate to split the costs or moving back in with your parents. Sell your expensive car and either replace it with a cheaper car or use public transportation. (My first car was a used Chevy Corsica that I bought for $600. The air conditioning didn’t work and I painted over the rust spots with a can of Rustoleum, but it got me from point A to point B.) Don’t eat out or participate in paid entertainment unless someone else is paying. Sell excess belongings on eBay to raise money to pay down debt. Get a second job (on evenings and weekends) to not only earn more money to pay off debts, but also to limit the time available for shopping.
Don’t rush into graduate school just because you can’t find a job. Sometimes students who are having difficulty finding a job decide to go back to school to get another degree, either to switch occupations or to make themselves more marketable. But debt for graduate and professional degrees is often unavoidable. (B.A. means Borrower Anxiety, M.A. means More Amortization, M.S. means More of the Same, Ph.D. means Piled Higher and Deeper, M.D. means More Debt, J.D. means Just Debt and LLB means Loan-Loving Borrower.)
Also, while repayment of current and previous student loans can be deferred while a student is enrolled on at least a half-time basis, the interest will continue to accrue, increasing the amount owed. If a student is struggling to repay his or her loans, sometimes the last thing he or she needs is to pile on more debt. The rule of thumb that total education debt at graduation should be less than the borrower’s annual starting salary still applies. An added concern is that older students who are closer to retirement may have less time available to repay the debt.
Mark Kantrowitz is publisher of Fastweb.com and FinAid.org, the leading web sites about planning and paying for college.