Graduating? Plan Your Attack on Federal Student Loans

This article is part of a series called Graduating? which focuses on personal finance advice for fresh college grads. Today’s article is about federal student loan repayment – if you have private loans, hold tight, the next article will be about those!

Freedom has arrived, and the last thing you want to think about right now is the shackles of having to repay your student loans. But if you take a few minutes right now to work out a plan of attack, you could save yourself thousands of dollars in interest payments!

Know Thy Enemies

If you’re anything like me, loan signing back in freshman year was all a blur. Perkins? Stafford? PLUS? Subsidized? Unsubsidized? Whatever! Where do I sign?

The very first thing you need to do is figure out what type(s) of student loans you have, and how much. Your school will probably send you an email telling you that you need to complete an “exit interview” for each of your federal student loans. The exit interview is extremely important – basically, it will give you all the information you need on how much you owe, who you pay it to, and the different “repayment plans” available to you. It will also tell you the date you can expect to receive your first bill.

PLUS Loans

Here’s something you shouldn’t really have to worry about. PLUS Loans are loans given to parents of dependent students – that is, if you have one, it’s a loan that your parents took out to pay for your education, and it’s their responsibility to pay it back. Just make sure you talk to your parents, and make sure that they know to be prepared for the bill!

Perkins Loans

Perkins loans are the sweet, awesome student loans. Well, as awesome as a loan can be, anyway. The interest rate is only 5%, and they have a 9 month grace period. (A grace period is the amount of time after you graduate before they start billing you for repayment of the loan.)

Stafford Loans

Stafford Loans have a six month grace period, and the interest rates are a little screwy. That’s because there are two types of Stafford Loans: Subsidized, and Unsubsidized. (If you’re unlucky and poor like me, you have both). Subsidized loans are interest free while you’re in school, Unsubsidized are not. The interest on Unsubsidized Stafford Loans piles up and up and up while you’re in school, and then “capitalizes” when you start repayment after the six month grace period. Capitalizing means they throw it in with your principal balance, and then all the interest after that is charged on that whole thing. Goodie.

Like I said, the interest rates on Stafford Loans are really complicated, so if you have them, you should hop on over to FinAid.org and read their explanation of Stafford Loan rates (about halfway down the page).

Batten Down the Hatches!

In your exit interview, you’ll be asked to choose a repayment plan. For Stafford, these come in four flavors: Standard, Extended, Graduated, and Income Contingent. (Seems that they’ve run out of Rocky Road.) Perkins Loans only have the Standard option.

Standard

Almost always your best best. You pay the same amount each month (at least $50) until you’ve paid off you loan in full. You have up to 10 years to fully repay the loan. This is clean and simple, and you pay the least interest out of any of the plans.

Extended

If you have more than $30,000 in loan debt, you can get the extended plan, which gives you 25 years to pay. Your monthly payments will be lower than the standard plan, but you’ll pay mountains more in interest. Ew.

Graduated

In the graduated plan, your payments start out small and increase every two years. The idea is that you’ll be able to afford higher payments as your income increases over time. You pay more interest with this plan than the standard plan because your little payments in the beginning will not reduce your balance very much.

Income Contingent

Basically, with this plan, they take your income each year, and determine how much you can afford to pay. This is pretty complicated, and since they use the previous year’s income to calculate it, you could get into some trouble if you experience a sudden drop in income. Also, you have to submit that income paperwork every year (fun!).

What should you pick? I think I’ve made it pretty clear that I have a love affair with the Standard plan. But you know yourself and your needs, so you be the judge. You can switch repayment plans once per year, so this isn’t a decision that will be set in stone.

Ready, Aim, Fire!

Your exit interview(s) should tell you what your payments will be. At this point, you might want to kick back and say “Time to kick back, wait for the grace period to end, and then start making those payments.” But wait! That’s what everyone does, and that’s not what will save you thousands of dollars in interest.

The payment they tell you is just a minimum payment – you’re allowed to pay more than that without a penalty. A good way to save on interest is to throw some extra money into each payment, and get the loan paid off faster.

YouCanDealWithIt.com offers up reasons why you want to start making payments before your grace period is up:

If you have a subsidized loan, making a payment in “grace” will benefit you BECAUSE, on a subsidized loan the government pays the interest during your grace period and any payments you make will be applied directly to the principal balance of your student loan. This lowers the total amount of interest you’ll have to pay over the life of the loan.

If your loan is unsubsidized, it will continue to accrue interest during your grace period. If you make payments while in “grace” you reduce or eliminate interest capitalized (added to your principal), reducing the total amount of interest paid over the life of the loan.

They even offer a nifty calculator to see how much money you could save making payments during your grace period. I ran it for the $30,000 in Stafford Loans that I have, and if I pay just $100 a month during my grace period, I will save myself three payments, and $588 in interest. Since my loan payments will be about $350, that’s a 75% return on my money! WOOHOO!

Bonuses

Depending on your loans, you might get bonuses for doing certain things. If you make on-time payments for a year or two, you might get something like 1/2 a percent knocked off your interest rate. This could also be offered to you if you set up your payments to be automatically deducted from your bank account.

A word of warning: don’t sign up for automatic payments unless you’re reasonably sure that you can keep track of that and make sure the money is there every month. If you end up paying fees when they try to take money that isn’t there, that could cancel out your bonus savings.

I hope this quick guide to repayment has been helpful. If money is really tight and you can’t take advantage of these money-saving tips yet, the most important thing is just to make sure you can make your minimum payments each month when they come due. This is really important to avoid late fees or worse: a wrecked credit history.

Student Loan Repayment Resources:
FinAid.org: Repayment Plans Guide
Federal Student Aid Calculators
Student Aid on the Web: Repaying Your Loans

Photo by obo-obolina