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Lowdown on Loans

By Don Rauf

Sure you'll have to pay them back with interest, but loans can be a great financial tool if you handle them the right way.

Waiting tables and working summers for a surveying firm gave David Hilmer a nest egg to help pay for college at the University of Wisconsin-Madison. But although the money he saved was a good start, it was far from what we needed.

"After about a year and a half, I was scrambling-how was I going to cover my dorm expenses and tuition?'' he re-calls. Now working as the director of business development at Little Tornadoes, an Internet consulting firm in New York City, Hilmer says that without numerous student loans (a federal Perkins, Stafford, and a university loan) he might not have been able to graduate.

More than ever, students are now relying on loans to help pay for college. Two-thirds of undergraduate students are in debt when they graduate from college, according to the National Postsecondary Student Aid Study conducted by the National Center for Education Statistics and the U.S. Department of Education.

To make smart decisions about borrowing, you need to plan ahead and understand what your options will be when it comes time for repayment. Here are some simple guidelines that apply to the major federal loan programs-the Perkins, the Stafford, and the 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 long repayment term. (See chart on page 21 for examples.)

"It's easy to think now that a $200-a-month payment won't be a big deal," says Hilmer, "but those payments can take a big chunk out of your monthly income. Most high school students don't realize how many bills they're going to have when they live on their own."

To get some idea of how much is too much, you need to estimate how much you'll be able to pay back once you graduate. That involves examining your future salary and expenses.

The best way to do this is to use a budgeting calculator available on the website of a major lender, such as Bank of America or Chela Financial. Calculators let you estimate monthly expenses-rent, utilities, food, clothes, car payments, insurance, etc. Then you compare those expenses to your estimated salary. Some calculators provide salary information. By subtracting your estimated expenses from your estimated salary, you can predict how much you can afford in monthly loan payments. (You can find Bureau of Labor Statistics salary averages at www.bls.gov/oco/home.htm)

"Lenders offer incentives and interest rate reduction plans, so it pays to shop around." says Shawn Lindstrom, president of eStudentLoan.com.

Avoid Default at All Costs.

If you do wind up borrowing much more than you can afford, you run the risk of defaulting, which means 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.

Default usually results after you miss payments for 180 days. Many defaulted loans are sent to collection agencies that may charge costly late fees and take money from your wages. Worst of all, a defaulted student loan can haunt you later, because it will be recorded as part of your credit history for a minimum of seven years.

"If you default on a student loan, you will not be eligible for federal aid if you decide to return to school until the loan is paid in full," says Lori Bloomberg, assistant vice president for the U.S. Bank Student Banking Division.

And if other lenders see you have a defaulted loan, they may deny you a mortgage, car loan, credit card, or personal loan-or charge a significantly higher interest rate. There's also a financial incentive for paying back your loans on time: many lenders will give a 1% discount or more to students who make consecutive regular payments.

Students are usually provided with charts to help track repayments. But if you can't make a monthly installment, you will need to contact your lender or servicer (the company that owns your loan) to discuss the problem. "Letting the servicer know that you're having difficulty is really important," says Allison Hall, director of marketing for Academic Finance Corporation and EFSI. "Lenders have many ways to help a student repay."

Understanding Loan Language

It's important to understand the terms used in describing loans and loan repayments.

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 also temporarily suspend repayment. (See explanations below.)

Deferment: Periods 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 may be eligible for a deferment if: they are still 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 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'll have to pay more interest.

"Even if you have one loan, you can use consolidation to lock in a low fixed rate," says Lindstrom. Plus, as Doug Dolton, chief operating officer at Chela Financial says, "Making one loan payment a month can really simplify your life."

All in all, loans can be a viable option for paying for college-as long as you borrow within your means and keep up with repayment.

Paying your student loans on time affects your credit report. Read on to see how your credit report works.