Findtuition.com

Financing Your Education: The Lowdown on Loans

By Don Rauf

Student loans can be a great financial tool—if you handle them the right way.
Waiting tables and working for a surveying firm helped David Hilmer attend college at the University of Wisconsin, Madison. But while the money he saved was a good start, it wasn’t enough. “After about a year and a half, I was scrambling—wondering how I was going to cover my dorm expenses and tuition,’’ he recalls.

Now working in Connecticut as a senior account executive for a computer consulting firm, Hilmer looks back and says that student loans (a federal Perkins, Stafford, and a university loan) enabled him to graduate.

With the cost of a college education escalating every year, students are relying more than ever on loans to help make ends meet. Two-thirds of undergraduate students graduate with some debt, according to the National Postsecondary Student Aid Study, conducted by the National Center for Education Statistics and the U.S. Department of Education.

Unfortunately, interest rates for student loans have also been creeping up over the past few years. For borrowers who are just starting college, the rate on the federal Stafford Loan rose from 4.7% to 6.8% this year. For federal student loans disbursed on or after July 1, 2006, the interest rate will be fixed at the 6.8% rate for the life of the loan. But even with higher interest rates, federal student loans can help make college affordable, and you often don’t have to begin repayment until six months after you graduate.

To make smart decisions about borrowing, you need to plan ahead and understand your choices when it comes time for repayment. Here are some simple guidelines that apply to the major federal loan programs—Perkins, Stafford, and PLUS—as well as independent bank loans.

Set a Limit
Keep in mind that every dollar you borrow must be repaid, with interest, which can really add up over a 10-year repayment term (see chart).

“It’s easy to think a $200-a-month payment is not a big deal,” says Hilmer, “but those payments can take a big chunk out of your monthly income.”

To get an idea of how much you’ll be able to afford to pay back after you graduate, you’ll need to estimate your future salary and expenses. Estimating your future salary can be tricky, but a good place to start is the Bureau of Labor Statistics Web site (www.bls.gov/oco/home.htm), which includes a list of salary averages. Once you’ve got a ballpark idea of your income, list your monthly expenses: rent, utilities, food, clothing, car payments, insurance, etc. Then simply subtract your expenses from your income.

For more resources, including budgeting calculators, visit the Federal Student Aid Web site (www.ed.gov/offices/OSFAP/ DirectLoan/BudgetCalc/budget.html), Bank of America (www.bankofamerica.com/studentbanking), or Chela Financial (www.chelastudentloans.org).

Avoid Default At All Costs
If you wind up borrowing more than you can afford, you run the risk of defaulting, or failing to pay back your loan according to agreed-upon terms. These terms are specified in a promissory note, a legal document that binds you to make regular payments.

Loans are considered delinquent after 270 days of nonpayment, and default usually results after you miss payments for 360 days, according to the U.S. Department of Education. Many defaulted loans are sent to collection agencies that may charge costly late fees and take money from your wages. Worse, a defaulted student loan can haunt you later because it will be recorded as part of your credit history for seven years. Lenders refer to your credit history when you apply for any major loan.

“If you default on a student loan, you will not be eligible for federal aid if you decide to return to school, until the defaulted loan is resolved,” says Lori Bloomberg, assistant vice president and senior product manager for U.S. Bank Student Banking Division. If lenders see you have a defaulted loan, they may charge you a higher interest rate, or even deny you a credit card, personal loan, car loan, or mortgage.

Making your loan payments on time has advantages—many lenders offer a discount to students who make consecutive regular payments. Most lenders also provide students with charts to help them keep track of payments.

If for any reason you can’t make a monthly installment, immediately contact your lender or servicer (the company that owns your loan) to discuss the problem, advises Allison Hall, director of marketing for Academic Finance Corporation and EFSI. “Lenders have many ways to help a student repay.”

Understand the Terms
Knowing the terms of your loan—the conditions by which you have borrowed and are obligated to repay the money—can help you avoid default. Start by learning some basic loan terms:

Grace period. A period of time—usually lasting six months after you leave college—when many student loans don’t require repayment. After the grace period, a deferment or forbearance can temporarily suspend repayment.

Deferment. A period when a borrower who meets certain criteria may temporarily stop loan payments. Depending on your type of loan, the federal government may pay the interest on it during your deferment period. New borrowers might be eligible for a deferment if they’re enrolled in school half-time or full-time, unemployed, studying in an approved graduate fellowship or rehabilitation program for the disabled, or experiencing economic hardship.

Forbearance. The temporary suspension of repayment in cases of hardship. Anyone with student loans may claim forbearance for six months at a time, for up to a total of three years, but interest still accrues.

Loan consolidation. Combining several loans into one bigger loan from a single lender, which is then used to pay off the balances on the other loans. Consolidation can lower the monthly payments and extend the repayment period to a maximum of 30 years, but you’re likely to pay more interest.
Even if you have only one loan, you can often use consolidation to lock in a low rate. For loan consolidations, it pays to shop around because different lenders offer incentives and interest-rate reduction programs. Another advantage of loan consolidation, according to Doug Dolton, chief executive officer at Chela Financial: “Making one loan payment a month can simplify your life.”