Avoid These Five Costly Student Loans Mistakes

Avoid These Five Costly Student Loan Mistakes When it comes to the repayment of student loans it seems everyone possesses some degree of expertise or an opinion on the matter. The individual that is not careful can find themselves pulled in every direction when seeking information on the subject.

The misinformation that is being circulated is dangerous to the college graduate in search of information that will allow them to best manage their student loans. The following is seven of the most common illusions being circulated regarding student loan debt.

Mistake #1 – Consolidating Loans to Reduce Interest Rates If you’re paying off multiple loans each month or feeling the ‘squeeze’ of a short repayment period, consolidating loans into one monthly bill can make financial sense. This might simplify your payments, spread out payments over a longer period, or even give you access to an income-based repayment plan.

But beware. Many graduates mistakenly believe that loan consolidation guarantees them lower interest rates. In fact, it typically does the opposite by increasing interest over a longer period of repayment. In fact, consolidation is irreversible and has some notable downsides. Borrowers may lose interest rate discounts, principal rebates, income repayment benefits, or progress made towards Public Service Loan Forgiveness.

In order to reduce your total debt, consider loan refinancing to take advantage of better interest rates (in some cases, it may make sense to first consolidate and then refinance). But when the challenge is the monthly payment, consider deferment, forbearance, or income-based repayments as alternatives. Just remember that these will shift the burden to you later on.

Mistake #2 – Overlooking the Tax Burden of Debt Forgiveness When someone cancels debt that you or your co-signers owe, it can be taxed as if they simply wrote you a check – even if deemed to be forgiven, uncollectible, negotiated or according to the terms of the contract. For instance, if $50,000 remains unpaid after a 20-year income-based repayment period, your income tax treat that as a lump sum payment through a Form 1099-C (Cancellation of Debt).

There are exemptions. As of 2018, student loan debt that is discharged due to permanent disability (or death) is no longer considered income. This applies to federal loans that those private loans with similar clauses. And the public service, teacher, law school, and national health repayment programs are tax-exempt as well.

Mistake #3 – Banking on Public Service Loan Forgiveness The Public Service Loan Forgiveness Program is a great opportunity for graduates to have the remainder of their student loan debt forgiven. However, the process is in no way automatic. There is a list of criteria the graduate must satisfy to be eligible for this benefit.

You must first secure full-time employment from a qualified public service employer. This excludes labor unions, political parties, government contractors, and nonprofits with a focus other than public service. Then, you must make 120 qualifying monthly payments while enrolled in a repayment program for your federal student loans.

Even after these ten years of payments, participation is not automatic – you must apply. Needless to say, ten years of public service employment is not a certainty, and minor lapses in payments can lead to ineligibility. Therefore, students should only seek loans they can afford to repay and graduates should plan accordingly.

Mistake #4 – Putting Repayment on Hold for Awhile There are times in life when a bit of procrastination is acceptable. Monthly loans payments are certainly not among them.

Borrowers typically have two options to ease the immediate burden of a loan – request deferment or forbearance. In either case, these must be approved in advance; you have the responsibility as the borrower to continue making payments meanwhile.

If you have federally-subsidized loans, the government will cover your interest during deferment while you are unemployed, experiencing economic hardship, enrolled half-time or more in a qualified university or serving in active duty military service or the Peace Corps. In each case, there will be a deferment form that must be completed and approved by your loan servicer.

Forbearance – or pausing payments – is typically the second option to avoid delinquency. You may have a legal right to forbearance if you are serving as a medical or dental resident, AmeriCorps volunteer or teacher in an area qualifying for Teacher Loan Forgiveness, or if your gross income is less than five times your monthly payment. Otherwise, you can request forbearance on the basis of financial hardship or other reasons. Interest will continue to accrue during forbearance, but it is still far preferable to risking default. Be aware that private student loans may charge a fee for forbearance.

Mistake #5 – Fearing Early Repayment Unlike mortgages and other loans that may penalize early repayment, graduates can reduce their student loan interest by making early repayments without fees or penalties. This can reduce not only the interest that you have to pay but also – by lowering your debt-to-income ratio – the cost of a mortgage in the future. And if you have a variable interest rate loan, early repayment can shield you from rising rates in the future.

That said, you might want to think twice if you are currently without an emergency fund, are preparing for a large purchase in the next two years or are missing out on matching employer contributions for retirement. But if these factors have been considered, the confidence of being loan free can permeate into other aspects of your financial life. What large milestone targets can you hit, and what will you learn in the process?

-Student loans can be the most valuable financial decision that you ever make or the costliest. Make it a priority to be financially literate to manage your student loan as an investment.

---Adam Jiwan, Co-Founder of Future FInance