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“How am I going to pay back all these loans?”

“I could be paying this the rest of my life!”

“I can’t afford these monthly payments.”

“Why me? Why couldn’t my parents have paid my tuition?”

Have you ever had one of these thoughts? Many people feel distraught or even hopeless when they see how much they owe in student loans, especially when they see what their loans translate to for a monthly minimum payment.

While there is no magic pill to make your loans go away overnight (unless you win the lottery), I’ve found that many borrowers lack knowledge about their repayment options. This lack of knowledge causes people to feel like they have no control over their situation and is a driver behind the large number of borrowers who default on their loans. After all, if you can’t afford the minimum payment, how can you be expected to make it month after month?

In this step, I will lay out your repayment options and how they relate to the types of loans you have. My goal is for you to have the key facts, pros and cons, and implications of each type of repayment plan. Additionally, we will go over things like refinance, forbearance, and deferment, and the implications of taking advantage of them.

Private Student Loan Repayment Options

While my wife was in grad school, we received what seemed like monthly mailers from a couple of banks that tried to get us to take out private student loans to supplement her federal loans. While we did not need to take advantage of these private loans, we did have private student loans from our undergrad years.

Having private student loans is becoming more common, whereas, not too long ago, banks had little on their balance sheets in terms of student loans. Now it seems like every bank wants to get in on them. And why not? Tuition continues to rise, and the amount of outstanding debt has rapidly increased over the past decade.

There is big money to be made in student loan refinancing. Banks are able to pick and choose which borrowers they refinance, and typically those with a solid credit history are the ones who get approved.

There’s a lot happening in this space, so let’s start by talking through private student loans that you either took out while in school or obtained through refinancing. Then we’ll discuss why refinancing is popular and how it may benefit you.

Repaying Private Student Loans

If you have private student loans, you either received them while you were in school or obtained them through refinancing. Either way, this debt differs from federal student loans in a variety of ways.

•Repayment Terms: Repayment varies by lender. More likely than not, the standard ten-year repayment plan will be used, but it is possible to get extended repayment (as with everything, depending on the terms the lender offers).

Another reason why refinance is popular is that you can pick and choose your repayment terms, as well as choose a fixed or variable interest rate. Some may even argue it’s easier to refinance (assuming you have the credit history that makes you eligible) than to work with your current lender.

•Interest Rate: Interest rates are typically variable on private loans, while federal loans are fixed. It’s not uncommon for a private student loan to have interest rates in the double digits (this is why refinancing at a lower interest rate is becoming more common).

•Forbearance and Deferment: Federal student loans offer forbearance and deferment options; private student loans will vary in their offerings. Some lenders may offer neither, while others may offer some variation.

•Hardship: If you are unable to make the monthly minimum payment on your private student loans, how the situation is dealt with will vary by lender. Some may offer “interest only” payments for a certain amount of time. Others may offer temporary forbearance.

•Forgiveness: It’s safe to assume there are no forgiveness options for private student loans. If your payment is too high, it may make sense to focus on staying current on your payments, build a good credit history, and refinance for a longer period of time. One way or another, the lender is going to pursue repayment.

When we walk through the federal repayment options, you’ll see that, despite the complexity and variety of repayment options, the rules are uniform. With private lenders, the rules are not uniform and can vary from lender to lender.

Whether you have some private student loans or have refinanced so all your student loans are private, I highly recommend spending some time contacting your lender to figure out what options are available to you.

You can use the questionnaire below as a starting point. You may already know the answers to some of these but, if you are unsure, do not be afraid to ask. You can’t have control over your loans if you don’t understand them!

Questions to ask your lender:

•What repayment plan am I on? Are there other repayment plans available to me?

•What is my interest rate? Is it fixed or variable?

•Is it possible to switch to a fixed interest rate? What is the process?

•Does my loan offer any sort of forbearance or deferment? If so, what are the details?

•If I lose my job or income and can’t make payments, what happens? Note: this should be explained in the answer to the previous question, but phrasing the question in explicit terms can be helpful if your lender’s answer isn’t clear.

•Is there a prepayment penalty if I pay off my loans early?

Getting the basic information around your private student loans is a key first step. You may be happy about what you find out, or your repayment terms and options may leave a lot to be desired.

Find out what the terms of your private loans are, as well as whether there are alternative payment plans.

The good news is that there is little risk in refinancing private student loans. We’ll go over that next.

Refinancing Student Loans

If you have student loans, you likely have been inundated with offers (I have) from private companies that want you to refinance your student loans. They promise lower interest rates and potentially thousands of dollars in savings.

When you’re in debt and someone offers to save you thousands of dollars, you listen.

Let’s use Rebekah as an example. Below are some of the details of her situation:

Loan Balance: $40,000

Type of Loans: Federal

Interest Rate (weighted average): 8.0 percent

Given these details, on a standard ten-year repayment plan, she will pay $485 a month. If she stays with this plan, she will pay approximately $18,200 in interest over the course of ten years.

If she refinanced all $40,000 of her loans at an interest rate of 6.0 percent, her monthly loans would drop to $444. After ten years she would pay approximately $13,290 in interest. That’s a savings of $4,947, or 27 percent.

To lock in a lower interest rate and save nearly $5,000 on interest, Rebekah may be willing to give up her rights to forbearance, deferment, income-driven repayment, and loan forgiveness.

Let’s take this a step further. If Rebekah was willing to sacrifice and pay $750 a month toward her refinanced loans instead of $444, she could pay them off in approximately five years instead of ten and pay just $6,640 toward interest. That’s an additional $6,650 in savings on interest for a total of $11,597, or 64 percent, on interest.

If she didn’t refinance to 6.0 percent and stuck with an 8.0 percent average interest rate but still made the higher payments, she would pay off her loans in approximately five and a half years and would still save significantly on interest, approximately $8,600, or 47 percent.

One thing to note is that if Rebekah stuck with the ten-year minimum monthly payment plan after refinancing to 6.0 percent and did not contribute anything beyond the required minimum monthly payment, she would still be paying approximately $41 less a month. $41 a month may not seem like much, but that translates to nearly $500 in savings a year. If she were to invest that in a retirement account, she would benefit from her investments gaining value, as well as potentially lower her taxable income (if the retirement account was a 401(k) or standard Individual Retirement Account (IRA)).

Interest rates matter!

This example illustrates exactly why refinancing has become so popular. The banks benefit because they can take the lower interest rate and still profit on other products they sell, while the borrower benefits because they can save hundreds or even thousands of dollars on interest payments.

Refinancing private student loans is becoming a no-brainer for those with good credit. As long as the new lender offers similar benefits to your current lender in terms of deferment, forbearance, hardship, and other factors, it usually makes sense to refinance to a lower interest rate.

With federal student loans, it becomes a more difficult decision. When you refinance with a private lender, you are eliminating your current federal student loans. The new lender is paying them off and, in turn, creating a new loan that is 100 percent private. That means the following benefits that come with federal student loans are gone:

•Opportunities for loan forgiveness: Public Service Loan Forgiveness (PSLF) and other forms of loan forgiveness are no longer available to you.

•Forbearance and deferment: You will no longer have the standard rights to forbearance and deferment that come with federal student loans. Make sure you understand how the new lender treats hardship situations such as a loss of income.

•Income-driven repayment: Income-driven repayment options help make otherwise unaffordable student loans affordable. They cap your payment at 10–20 percent of your discretionary income. These are only available for federal loans.

For some borrowers, refinancing may still make sense. For example, if you run the numbers and project you can reasonably pay off your student loans in three to five years without stretching your budget too far, you may want to refinance if it means saving thousands of dollars on interest.

At a minimum, I would encourage people to build a healthy emergency fund, eliminate credit card debt, and factor in retirement savings before they refinance federal student loans. Until these actions have been taken, it’s best to keep the protections of federal student loans in place.

Again, refinancing can’t hurt if you have private student loans, but proceed with caution if you have federal loans. You can always refinance later if it makes sense, but you cannot “undo” refinancing and go back to your federal loans.

This book spends a significant amount of time covering things like loan forgiveness and income-driven repayment, and I think those topics are important. But there are still many borrowers out there who will stick with the standard ten-year repayment plan and may benefit from aggressively paying off their student loans. Refinancing could be a part of their plan.

I am all for saving money on student loans through refinancing, but only if you fully understand what you are giving up by doing so.

Forbearance and Deferment

Before we look at federal student loan repayment options, it would be beneficial to spend some time going over deferment and forbearance in more detail. I’ve mentioned forbearance and deferment a few times already, and you are probably wondering what they are and how they work.

Deferment

In some situations, you are able to temporarily stop making payments on your loans by putting them in deferment. In fact, there’s a good chance you’ve taken advantage of at least one type of deferment (in-school).

Some common scenarios where you can apply for deferment are:

•In-school—You can take advantage of in-school deferment when you are enrolled at least half-time at an eligible college or career school, including graduate school. If you are a college grad, you almost certainly took advantage of in-school deferment while you were finishing your degree.

•Unemployment—You can defer your loans for up to three years during times of unemployment or when you are unable to find full-time employment.

•Economic Hardship—You can defer your loans for up to twelve months at a time during periods of economic hardship or while serving in the Peace Corps for a maximum of three years.

There are additional opportunities for deferment, such as when you are in an approved graduate fellowship program or when you are on active-duty military service in connection with a war, military operation, or national emergency.

Interest While in Deferment

Deferment is one reason subsidized federal student loans are the best type of student loans. While you are in deferment, interest typically will not accrue for this type of loan. Unsubsidized loans, on the other hand, will accrue interest and capitalize once you exit deferment or a grace period following deferment, such as when you graduate or are no longer enrolled at least half-time.

Capitalization is the process of accrued interest being added to the principal balance of your loans.

As most grad students learn, the interest on unsubsidized loans can add up. If you are in grad school for three years or longer, there may be a sizable amount of interest that will be capitalized once you finish. The total accrued can be a bit shocking, particularly if you have a lot of unsubsidized loans and haven’t been regularly reviewing your loans (which I would bet is the majority of students).

While deferring student loans during undergrad and grad school usually makes sense, ideally you would continue to make payments that cover the interest on your unsubsidized loans. This will prevent interest from accruing during deferment, which ultimately increases the amount owed. With that said, I know making these payments while in grad school is not realistic for many.

For more information on deferment, to access the forms necessary to request the various types of deferment, or to see additional deferment opportunities, you can visit studentaid.ed.gov.12 You can also reach out to your loan servicer for more information on how to defer your loans.

Forbearance

Forbearance is a period of time during which your payments are temporarily suspended or reduced for up to twelve months, at which point you need to reapply. It’s a less desirable option than deferment because interest continues to accrue on all loans, regardless of what type of loan they are. Once your loans exit forbearance, the accrued interest is added to the principal balance of your loans through capitalization.

With that in mind, deferment is always better than forbearance. And, to be blunt, forbearance should be avoided at all costs.

To illustrate this example, let’s say you have forty-five thousand dollars in federal student loans at a weighted average interest rate of 6.5 percent. Below you can see the impact interest will have on your loans, based on how many months you remain in forbearance:

Even if just a portion of your loans were subsidized, you would be better off in deferment. On the flip side, if these were all unsubsidized loans, it wouldn’t make a difference whether they were in deferment or forbearance; both would accrue interest that eventually would be added to your principal balance.

There are two types of forbearance: general and mandatory.

General forbearance is at the discretion of your borrower. General forbearances are granted for any reason that is acceptable to the loan servicer. Typical reasons include financial difficulties, unemployment, change in employment, and medical expenses.

There is no supporting documentation required for general forbearance, and you can have it granted through a simple phone call attesting to your reason(s) for needing to put your loans in forbearance. There is no formal limit on how much time you can spend in forbearance, as long as it does not exceed thirty-six months at a time.

Mandatory forbearance must be granted if you meet eligibility requirements. Supporting documentation is required. Circumstances that make you eligible for mandatory forbearance include:

•You are serving in a medical or dental internship or residency program.

•The total amount owed each month for all your student loans is 20 percent or more of your total monthly gross income.13

•You are serving in AmeriCorps (in a position where you received a national service award).

•You would qualify for Teacher Loan Forgiveness based on the teaching service you are providing.

•You would qualify for partial repayment of your loans under the US Department of Defense Student Loan Repayment Program.

•You are a member of the National Guard, have been activated, and are not eligible for a military deferment.

If you have received mandatory forbearance based on your financial situation (i.e. owing 20 percent or more of your total gross income), your ability to continue in it is typically capped at three years.

With all this in mind, should you apply for forbearance? It’s almost never an ideal option but, if you are behind on your student loans, applying for forbearance makes your loans current, meaning you will no longer be behind on your payments. This option should be taken only if you are ineligible for deferment and unable to make the payments necessary to cover your missed payments. Additionally, if you are facing economic hardship or unemployment, you should always look to deferment first. With that said, it’s better to temporarily enter forbearance than to fall behind on your payments and risk defaulting.

Forbearance should be viewed as a short-term option and only be used when absolutely necessary. To find out more about forbearance and how to apply, visit studentaid.ed.gov.14

Student Loan Default

Student loan default is a real problem today. According to a January 2018 report by the Brookings Institution, nearly 40 percent of student loan borrowers may default on their student loans by 2023.15

For most federal student loans, you will default if you don’t make a payment in more than 270 days. What follows isn’t pretty. You lose eligibility to receive Federal Student Aid and, even worse, you can face consequences like wage garnishment or tax refund withholding.

The general steps in default are:16

1.You haven’t made a payment for more than 270 days.17

2.The entire balance, both principal and interest, becomes immediately due.

3.You lose access to options like deferment, forbearance, and repayment plans.

4.You either make repayment arrangements with the holder of your loan, or your loan gets placed with a collection agency.

5.The collection agency will offer the option of a voluntary repayment agreement.

6.If you don’t enter into the voluntary repayment agreement, or fail to make the agreed payments, the collection agency will take actions such as wage garnishment. If you are self-employed and they cannot garnish your wages through an employer, the US Department of Justice may take legal action—by suing you—to collect on the defaulted loans.