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How to Minimize Student Loan Debt

More students graduate each year with excessive student loan debt.

Mark Kantrowitz

April 11, 2011

How to Minimize Student Loan Debt
Try to avoid overborrowing for your college education. Do not treat loan limits as targets. A good rule of thumb is that your total education debt for your entire college education should be less than your expected starting salary after you graduate. Ideally your student loan debt should be less than half your expected starting salary. Other signs of over-borrowing include borrowing more than $10,000 for each year in school or needing to borrow private student loans. If you borrow more than your expected starting salary, you’ll have to repay your loans with an alternate repayment plan like extended repayment or income-based repayment instead of standard 10-year repayment. These repayment plans reduce the monthly payments to more affordable levels by increasing the term of the loan, but this also significantly increases the cost of the loan. For example, switching a Federal Unsubsidized Stafford loan from a 10-year term to a 20-year term will cut the monthly payments by about a third, but it will also increase the total interest paid over the life of the loan by a factor of 2.2. If you borrow more than twice your expected starting salary, you will be at high risk of defaulting on your debt. You can’t get away from this debt, as the federal government has very strong powers to compel repayment. The federal government can garnish up to 15% of your wages and intercept your income tax refunds without a court order. They can even garnish Social Security benefits. A student loan default on your credit history will make it more difficult to get credit cards, auto loans, home mortgages. It can even affect your ability to get a job or rent an apartment. Student loans are almost impossible to discharge in bankruptcy. A successful discharge requires demonstrating undue hardship in an adversary proceeding, a very harsh standard.

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Education debt can also have a big impact on your lifestyle after graduation. Students who graduate with no debt are almost twice as likely to go on to graduate and professional school as students who graduate with some debt. Student loans also affect career choices. An extra $10,000 in debt corresponds to a 5% to 6% decrease in the likelihood of a college graduate pursuing a public service career. Students who graduate with excessive debt or who default on their loans are more likely to be depressed. They often delay getting married, having children, buying a car and buying a home. Live like a student while you are in school so you don’t have to live like a student after you graduate. So how do you minimize your student loan debt? Here are several tips on ways to reduce the need to borrow for college costs and cut the cost of borrowing.

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Save before enrolling in college. Every dollar saved is a dollar less you will have to borrow. If you save $200 a month at 6.8% interest for 10 years, you will accumulate about $34,433. If instead of saving this money, you were to borrow it at 6.8% interest, you will pay $396 a month for 10 years, almost twice as much. The difference is that when you save, you earn the interest, while when you borrow, you pay the interest. Search for scholarships on free scholarship-matching sites like Fastweb.

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Every dollar you win in scholarships is also a dollar less you have to borrow. You can win scholarships even after you’ve already enrolled in college, not just in high school. Ask each college about its outside scholarship policy. Most colleges will reduce the need-based aid package by the amount of the private scholarships you win. But some colleges will reduce the loans first, letting you save money by substituting scholarships for debt. Enroll at a less expensive college. One of the best ways to cut debt at graduation is to enroll at an in-state public college. In-state public colleges often provide a quality education at bargain prices, yielding among the best possible returns on your investment. You don’t need to attend a brand-name school to get a good education. The primary differences between colleges are not in the faculty or facilities, but in the students. Enrolling in a public college can save you several thousand dollars in debt by the time you graduate. Among students graduating with Bachelor’s degrees and education debt in 2012 – 13 (the most recent year for which data is available), the average debt at graduation was $25,600 for students graduating from public colleges and $31,200 for students graduating from private non-profit colleges. Students enrolled in public colleges are also less likely to graduate with debt, with 59% of Bachelor’s degree recipients at public colleges graduating with federal or private student loan debt, compared with 64% of Bachelor’s degree recipients at non-profit colleges. Starting off at a community college and transferring to a 4-year college can save thousands of dollars. However, enrolling at a community college may not be the best strategy for students who want to get a Bachelor’s degree. While some states have programs where graduates of the state’s community colleges are guaranteed admission to one of the state’s 4-year public colleges, students who take a community college detour on the way to a Bachelor’s degree might not reach their destination. An analysis published by the National Bureau for Economic Research found that students who intended to obtain a Bachelor’s degree and started off at a 2-year college were 14.5% less likely to obtain a Bachelor’s degree than students who started off at a 4-year college. Students enrolled at 4-year non-profit colleges are more likely to graduate and to graduate sooner than students enrolled at 4-year public colleges, based on data concerning full-time students who first enrolled in college in 2002 seeking a Bachelor’s degree. The 4-year graduation rate is 29.9% at 4-year public colleges and 51.0% at 4-year non-profit colleges. The 5-year graduation rate is 49.2% at 4-year public colleges and 61.3% at 4-year non-profit colleges. The 6-year graduation rate is 54.9% at 4-year public colleges and 64.6% at 4-year non-profit colleges. So about two fifths of students at 4-year public colleges may need an extra year to graduate, as compared with students at 4-year non-profit colleges. But even with the extra year, the students who graduate from in-state public colleges with a Bachelor’s degree in 5 years still graduate with less debt than students who graduate from private non-profit or for-profit colleges in 4 years. If you enroll at an out-of-state public college, try to establish residency first so that you can qualify for in-state tuition.
Rules for state residency vary from state to state, but generally require living in the state for 12 or 24 consecutive months before first enrolling in college. Some states also require the student to have graduated from a high school located in the state. Very few states allow you to qualify for in-state tuition after you’ve already enrolled in college. Ask about regional exchange or consortium programs, as some states will allow students from neighboring states to qualify for in-state tuition, especially if the student is majoring in a field of study that isn’t offered by the public colleges in their home state. Consider enrolling at a college with a “no loans” financial aid policy. More than six dozen of the most selective colleges have adopted generous financial aid policies where they replace loans with grants in the need-based financial aid package. Students can still borrow to pay their share of college costs, but they usually graduate with much less debt. The bottom line cost at these colleges is often lower than at many in-state public colleges. Compare colleges based on the out-of-pocket cost. The out-of-pocket cost is the difference between the total cost of attendance and the gift aid, such as grants, scholarships, tuition waivers and other money that does not need to be repaid. It is a better measure of your bottom line cost, the amount of money you will need to earn, pay or borrow to cover college costs. Think of it as a discounted sticker price. Debt at graduation correlates very strongly with a college’s out-of-pocket costs. Live at home with your parents. It’s better to live at home while you are in school by choice than to be forced to live at home after you graduate. Students who live at home with their parents graduate with less debt than students who live on or off campus. Among students graduating with Bachelor’s degrees from public colleges in 2007-08, 51.5% graduated with student loans and the average debt at graduation was $16,870. This compares with 63.1% and $20,718 for students who lived on or off campus. (Living off campus may not save any money, unless you split the costs with a roommate. Among students graduating from public colleges in 2007-08, 64.0% of those living off campus graduated with an average of $21,093 in debt, compared with 58.8% and $18,798 for students living on campus.) These statistics apply only to students enrolling at public colleges. The cost differences for students living at home or on/off campus are much lower at non-profit and for-profit colleges. There are a few drawbacks to living at home with your parents. You will lose out on some aspects of college life, such as studying for tests and working on assignments with other students. It may be more difficult to study at home. You will also have to pay for transportation and parking costs. Commuting also takes time. Borrow federal first. Federal student loans are cheaper, more available and have better repayment terms than private student loans. The interest rates on federal education loans are fixed, while the interest rates on most private student loans are variable and will probably increase over the life of the loan. Pay attention before signing any promissory note. Read the fine print. Ask about interest rates, fees, how the interest rate may change, the monthly payments, total interest and total payments. Federal student loans offer income-based repayment and public service loan forgiveness as options. Private student loans do not. If you are interested in pursuing a career in public service, income-based repayment can reduce your monthly payments to affordable levels while public service loan forgiveness cancels any remaining debt (including accrued but unpaid interest) after 10 years of full-time employment in a public service job. Public service jobs include working in a variety of occupations and for a variety of employers, including police, fire, EMT, military, government (at the local, state or federal level), public interest law, public defender, prosecutor, teaching in the public schools, public librarian and working for a tax-exempt charitable organization. Before buying something with student loan money, ask yourself whether you’d still buy it at twice the price. Every dollar you spend will cost you about two dollars by the time you pay back the loan, given typical interest rates and repayment terms. Suddenly, that $10 pizza doesn’t seem as attractive at $20. Plus, spending $10 a week on food or entertainment will cost you $2,000 by the time you graduate. The $4 daily specialized coffees or juice drinks add up to $4,000 over 4 years. Better yet, sell off extraneous possessions on eBay or other auction sites to raise money to pay college bills. You’re in college to get an education, not to collect a lot of tchotchkes and gadgets. If you economize while you’re in college, you’ll be able to buy better stuff after you graduate. Pay the interest on unsubsidized loans during the in-school and grace periods to prevent the loan balance from growing larger. Most student loans allow borrowers to defer repaying the loans during the in-school and grace periods. If the borrower does not pay the interest at it accrues, the interest is capitalized (added to the loan balance). This is a form of negative amortization. It can increase the loan balance by 15% to 20% by the time the borrower enters repayment. Both federal and private student loans do not have prepayment penalties, so nothing prevents you from paying the interest during the in-school period. Just send an extra check to the lender in a separate envelope with your loan id number on the check and a cover letter asking the lender to apply the check to the loan balance. If you can’t afford to pay the full amount of interest, try to pay something, as this will save you money in the long term. Some lenders will give you a lower interest rate or other discounts if you agree to make payments during the in-school period. Work part-time during the school year and full-time during the summer to earn money for college. Working 10-15 hours a week during the semester helps academic performance by forcing you to learn time management skills. Working more than 15 hours a week, however, will take too much time away from academics. Students can earn up to $5,250 in 2011-12 and $6,000 in 2012-13 before the income affects their eligibility for need-based financial aid. Aid eligibility is reduced by half of after-tax income above these income protection allowances. The more you earn, the less you will have to borrow. Graduate with a Bachelor’s degree in four years, not five or six. Graduating on time can save you an extra year or two of college costs. Take a full course load or even an extra class if you can handle it. Plan out your path to the degree, to ensure that you take the prerequisites as soon as possible. Students can run into trouble when a class they need isn’t offered every year. Take AP classes in high school and advanced standing exams in college to get college credits quicker. Don’t switch majors or transfer colleges. Students who change course mid-stream take much longer to graduate and graduate with more debt. Among students who first enrolled in college in 2003-04, those who changed majors took an extra semester or two to graduate and graduated with about $1,600 more debt. Students who transferred graduated with about $3,400 more debt. If you will be pursuing a lower-paying field of study like art, humanities or sociology, consider double-majoring to get a second degree in a more lucrative field of study. Art students should pick up a useful skill like web page design. That way you will be able to pay the rent and repay your student loans while pursuing your dreams on the side. After you graduate, accelerate repayment of the highest cost loan first. Make the required payments on all your loans, but use extra money to prepay the highest cost loan. The highest cost loan is the loan with the highest interest rate. This will save you money by reducing the total interest you will pay over the life of the loan. Credit cards and private student loans usually have the highest interest rates.

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