Grads need sound plan to repay student loans

June 7, 2010
Monday

Millions of college graduates are about to ask this question: Was it worth it? And it's a question that students just entering college should be asking as they start looking at taking out student loans to finance their college degree.

It's not the education, or the college experience that's the issue. It's how you will repay those student loans.

Today's college graduates enter a job market that has few jobs available. Yet, within months of graduation, they must work out a plan to repay the loans that made their degree possible. Those loans now look like the worst deal they could have made, because many carry high fixed rates of 6.8 percent, or more.

Even a fixed-rate 30-year mortgage would cost less than 5 percent annual interest these days. Plus that mortgage interest is deductible. And if your mortgage loan doesn't work out, you could always default.

But student loans stay with you for the rest of your life. Not even bankruptcy can wipe out this obligation. And since the government has guaranteed those loans, they will find a way to catch up with you.

The time to think about repayment is immediately after graduation. If you don't make some decisions within six months of graduating, those decisions will be made for you. Standard repayment on a federal student loan provides level monthly payments that cover accruing interest and a portion of principal. This program actually pays off your loans in the shortest amount of time.

To get an idea of what those payments will be, go to www.Sallie Mae. com and click on the "monthly loan payment calculator."

Most grads will be overwhelmed by the payment -- especially if they haven't landed a job. For example, if you have $30,000 in student loans, you'd have to pay as much as $345 every month for 10 years.

But there are ways to defer, extend, and otherwise lower that monthly payment. Just be aware that the longer you take to repay the loan, the more interest you will be paying. That can double or triple the amount you'll repay over the long run.

The newest option is called IBR -- income-based repayment. You must demonstrate financial hardship to qualify. It caps the bill at 15 percent of discretionary income. After 25 years, if the balance has not been repaid, you may be eligible for forgiveness of the remaining loan balance.

The most important thing to remember is that you should contact your student loan lender immediately after graduation. You'll probably want to consolidate your loans, but check all your options because subsidized federal student loans carry different rates, and some may be lower than the consolidation rate being offered.

For example, loans disbursed before July 1, 2008, may carry that high, fixed 6.8 percent rate, but loans made for the year starting July 1, 2008, carry a 6 percent rate. And loans made after July 1, 2009, are 5.6 percent. New loans, disbursed after this coming July 1, carry a fixed 4.5 percent rate.

All unsubsidized loans carry the fixed 6.8 percent rate! So be sure to check carefully the rate that applies to your loan -- and the consolidation rate. And note that PLUS loans made to parents carry a floating rate, currently 3.28 percent.

Here are two Web sites that will help you understand your loan repayment options:

• www.SallieMae.com.

• www.SimpleTuition.com.

For all those just starting down the road to student loans, here are several warnings. The loan process has just changed -- cutting out the bank lenders as middlemen. So you'll be working through your college financial aid office to get loans directly from the federal government student loan program.

If you've qualified, these federal loans are your best choice. If your parents are going to help, they'll have to decide between a home-equity loan or a PLUS loan, both of which carry floating interest rates -- and could rise rapidly.

There are also many private student loan plans offered. Most carry floating rates. And here's where the warning comes in. It's a strange quirk that could cost you a fortune in the future. Make sure you understand the "index" to which your floating rate loan is tied. Many choose the LIBOR rate -- the London Interbank Offered Rate. Typically that's about the same as U.S. Treasury bills, and they historically have moved in tandem.

But now, with debt woes in Europe, LIBOR has moved sharply higher vs. short-term U. S. Treasuries. And any loans tied to LIBOR will adjust upward sharply, while those tied to either U.S. Treasury bills (or a "cost of funds" index based on what banks are paying on savings deposits) are likely to adjust downward.

Yes, it's exciting to head off to college. But make careful borrowing choices now, or you'll be paying for your education, as well as benefitting from it, for the rest of your life. That's the Savage Truth.

Terry Savage is a registered investment adviser and a co-host of ''Monsters and Money in the Morning'' on WBBM-Channel 2 from 5 to 7 a.m. weekdays.

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