Today we welcome a guest blogger to Sense and Centsibility, freelance writer and personal finance enthusiast Dave Chen.
If you’re like many recent grads, you may be struggling with your student loans. Taking on large student loans may be the only way that many students can afford to pay for their undergraduate and graduate educations — but it can be quite a shock when the bills start to arrive, and borrowers are left with substantial monthly payments.
Fortunately, there are options for graduates who are battling student loan debt once they are out in the real world. Depending on your job, the type of loans you have and your financial situation, one of these three options may help you repay your loans more quickly — or pay less money in interest over the life of your loans.
Refinance Your Student Loans
If you have private student loans, refinancing is a method of getting a lower or fixed interest rate and consolidating multiple loans into a single loan. With refinancing, you apply for a new loan, and the proceeds of that loan are then used to pay off your other student loans. It can be used for private student loans, or a combination of private and federal student loans. However, borrowers should be aware that if they choose to refinance their federal student loans along with their private student loans, they will lose all of the protections and benefits that federal student loans offer, such as income-driven repayment plans and loan forgiveness.
Student loan refinancing is based on creditworthiness. As a general rule, to be eligible for a refinance, you will need to have a credit score of at least 660, a stable income, and a history of making regular, on-time payments. The stronger your credit history, the lower your interest rate will likely be. If you are approved for a student loan refinance, then you will likely save money on your loan by obtaining a lower interest rate than what you were able to obtain when you applied as a student, or by switching from a variable interest rate to a fixed interest rate. Some online sites such as LendEDU** have comparison tools that allow you to compare lenders to determine which option is right for you.
**Applying for refinancing with these sites may result in a hard inquiry on your credit report. A hard inquiry occurs when a prospective lender checks your credit report to make a lending decision. Hard inquiries can slightly lower your credit score and will typically stay on your report for two years.
Consider Income-Driven Repayment Plans
If you have federal student loans and have a lower income, you may want consider an income-driven repayment plan. The federal Department of Education offers these programs, which cap your monthly student loan payments to an amount between 10 to 20 percent of your monthly discretionary income. The loan term is increased from 10 to 20 or 25 years under income-driven repayment plans. Once you have completed this term, the balance of your student loans — if any — is forgiven.
Income-driven repayment plans are particularly advantageous for anyone who works in the public sector, such as service members, teachers or law enforcement. Public sector employees may be able to participate in this program as well as the Public Service Loan Forgiveness Program, which will allow them to have their student loans forgiven, tax-free, after making 120 payments.
If you do not work in the public sector, then an income-driven repayment plan will likely result in you paying much more in interest than you otherwise would because the loan term will be extend from 10 years to 20 or 25 years. You will also owe taxes on any portion of the loan that has been forgiven. However, income-driven repayment plans can be beneficial if you are having difficulty making your student loan payments, as your monthly payment amounts will be significantly lowered. Carefully consider whether you should participate in an income-driven repayment plan if you do not work in the public sector, given that you will likely end up paying more over time.
Consolidate Your Federal Student Loans
If you have federal student loans, you can also choose to consolidate your loans through the Department of Education. This option is available only for federal student loans; it cannot be used for private student loans. It is a process where multiple federal loans are combined into a single loan, and the loan term can be extended up to 30 years. The interest rate for a consolidated loan is based on a weighted average of the old loans’ interest rate. For this reason, federal student loan consolidation usually does not result in a lower interest rate for borrowers.
The biggest benefit of consolidating your federal student loans is that it can make it easier to have one single student loan payment to keep track of, rather than having to make multiple payments each month. Extending your payment term can also drop your monthly payments, although it means that you will end up paying more money over the life of the loan. If you want to consolidate your federal student loans, it can be done without charge through the Department of Education.
Dave Chen is a freelance writer who decided to start his own blog, MillennialPersonalFinance.com. Since graduating from college and starting his family, he splits his time between work, family, and side hustle.