Lana Oconnell
Student loan debt is a significant issue in the United States, with 42.7 million borrowers owing more than $1.6 trillion. While federal student loans offer flexible repayment options and protections, many borrowers struggle with timely repayment, accruing interest, and potential scams. The U.S. Department of Education has implemented measures to assist borrowers in repayment, including a temporary program for those impacted by the pandemic pause and communication campaigns to provide clear information on repayment options. Understanding student loan traits and seeking free qualified help can aid borrowers in managing their debt effectively and avoiding common pitfalls.
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What You'll Learn
Student loan interest accrual
The interest rate on a student loan is a percentage of the amount borrowed that must be paid back in addition to the principal, i.e., the cost to borrow money. The interest rate on a loan is calculated based on several factors, including market conditions, the type of loan (federal or private), loan term, income, credit history, and the income and credit history of a potential cosigner.
There are two main types of student loan interest rates: variable and fixed. Variable-rate student loans adjust the interest rate at a set frequency (usually monthly or annually) over the course of the loan term. Fixed-rate student loans offer the same interest rate over the loan term. Federal student loans offer fixed rates that are set on an annual basis. Private student loans may have fixed interest rates or variable interest rates that a lender calculates based on its own formula.
Interest can begin accumulating at different times depending on the type of loan, which can significantly impact the total amount repaid over time. For example, subsidized federal loans do not accrue interest while the student is in school or during deferment periods. In contrast, private student loans may offer deferment with interest accruing, which is added to the principal after the pause.
Student loan deferment allows borrowers to temporarily postpone loan payments due to specific circumstances, such as returning to school, unemployment, economic hardship, or active military duty. For subsidized federal loans, deferment can pause interest accrual, preventing an increase in the loan balance.
Student loans typically generate interest daily. The annual percentage rate (APR) is divided by 365 days to determine a daily interest rate, and borrowers are charged interest each day on the total amount owed. This interest is added to the total balance, and borrowers are then charged interest on the new balance, resulting in interest accruing on the interest until the loan is paid off.
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Income-driven repayment plans
Income-driven repayment (IDR) plans are designed to help student loan borrowers manage their debt by setting payments as a fraction of their discretionary income, rather than a fixed amount. This provides borrowers with insurance against unaffordable payments when their income is low. Under existing IDR plans, borrowers whose income falls below a certain threshold (between 100-225% of the federal poverty line) are not required to make any payments at all.
However, the IDR system has faced legal challenges and, as of July 2025, most IDR plans are in limbo due to litigation against the newest IDR plan proposed by the Biden administration. The House has passed a bill to address this situation, which includes major changes to the student loan program. Under the proposed Repayment Assistance Plan (RAP), existing IDR plans would be closed to new borrowers. One key difference between RAP and earlier IDR plans is that RAP would require a minimum monthly payment of $10, regardless of the borrower's income.
The RAP has both benefits and drawbacks. On the one hand, it encourages responsible borrowing and timely repayment, and establishes accountability for students. It also ensures that borrowers see their balance decline by at least $10 per month as long as they make on-time payments, which could have psychological benefits compared to situations where loan balances increase due to interest. Additionally, requiring at least a token payment may help borrowers, especially younger ones, understand their repayment obligations and develop good habits around loan repayment.
On the other hand, even a $10 monthly payment can be a real hardship for some borrowers, and may not even cover the cost of collecting the payment. For borrowers with stagnant incomes, making only the minimum payment will result in very slow progress in reducing their loan balance, and the extended length of repayment may deter some borrowers from switching to this plan.
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Credit card repayment pitfalls
Credit cards can be a useful financial tool, but they can also cause financial strain if not used correctly. Here are some common credit card repayment pitfalls to avoid:
Minimum Payments
Making only the minimum monthly payments can significantly increase the time it takes to repay your debt and lead to paying more in interest than the principal amount owed. For example, if you have a debt of $1,424 and make a minimum monthly payment of $28, it would take 12 years to repay and result in $1,238 in interest. During this time, if you continue to use your credit card, your overall debt will grow rather than shrink. Instead, it is advisable to send the highest payment you can afford and reduce spending in other areas to accelerate debt repayment.
Interest Charges
Credit cards often charge high-interest rates, typically 20% or more. If you do not pay off your balance in full before the grace period ends, you will be charged interest. This interest can quickly add up, especially if you have a high balance and interest rate. For example, a debt of $2,500 with a 19% interest rate and a minimum monthly payment of $50 would take 9 years to repay and cost $2,493 in interest. To avoid this pitfall, aim to pay off your credit card balance in full by the due date to avoid interest charges.
Annual and Other Fees
Some credit cards charge an annual fee, which you will have to pay regardless of how much you use the card. Additionally, there may be other fees such as late payment fees, balance transfer fees, and cash advance fees. These fees can add up and increase the overall cost of using the credit card.
Maxing Out Your Credit Limit
While credit cards make it easy to spend up to your credit limit, it is important to stay within your budget and only purchase what you can afford to buy with cash. Maxing out your credit card is not only bad for your credit score but can also lead to financial strain. Know your spending habits and stick to a budget to avoid this pitfall.
Automatic Payments
While setting up automatic payments can help ensure you don't miss a payment date, it is important to monitor these payments closely. Accidental overdrafts can occur due to payment timing, especially if you have multiple cards with different due dates. Keep track of your payment schedules and, if possible, pay off your credit cards manually to avoid unexpected fees or charges.
Privacy and Security
Financial companies may share your contact information with partner companies for advertising purposes. This can lead to an increase in credit-related junk mail, putting you at risk for identity theft if your mail is stolen. Review privacy statements and opt-out options to protect your personal information.
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Student loan forgiveness
If you have old student loan debt, there are a few ways you may be able to get it forgiven, depending on your situation. Here are some options to consider:
Public Service Loan Forgiveness (PSLF)
If you work or have worked in public service, you may be eligible for the PSLF program. This program allows qualifying federal student loans to be forgiven after 120 qualifying payments (10 years) while working for a qualifying public service employer. Public service employers include government (federal, state, local, or tribal) and certain non-profit organizations. To qualify, you must have made 120 monthly payments on your federal Direct Loans and be employed full-time by a qualifying public service organization during that time. You can use the PSLF Help Tool provided by the U.S. Department of Education to figure out your next steps and submit the suggested forms to document your qualifying employment and receive credit for your monthly payments.
Income-Driven Repayment (IDR) Plans
Most federal student loans are eligible for at least one income-driven repayment plan. IDR plans cap your monthly payments based on your income and family size, and if your income is low enough, your payment could be as low as $0 per month. Under IDR plans, the remaining balance on your loans may be forgiven after 20 or 25 years of repayment. On April 19, 2022, the Department of Education announced changes to bring borrowers closer to forgiveness under IDR plans, including a one-time adjustment to count certain deferment and forbearance periods toward loan forgiveness. To benefit from this one-time adjustment, borrowers with FFELP loans held by commercial lenders or Perkins loans not held by the Department of Education must consolidate their loans into Direct Loans by June 30, 2024.
It's important to note that student loan forgiveness is typically only applicable to federal student loans, and private student loans generally do not qualify for these programs. Additionally, beware of scams; no legitimate student loan forgiveness program will ever ask you to pay a fee to receive forgiveness. You can visit the websites of the Consumer Financial Protection Bureau and the U.S. Department of Education for more information on student loan forgiveness and to explore your specific options.
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Overseas repayment rules
Moving overseas can be a strategic way to handle student loan debt. However, it is important to understand the repayment rules and the implications of residing abroad on student debt repayment plans.
Firstly, relocating abroad, even for a short period, can impact student loan repayment plans. For those with federal loans, the borrower protections and income-based repayment options make federal loans advantageous for those spending time overseas. In contrast, private loans may be less flexible as their terms are based on creditworthiness.
Secondly, it is crucial to understand the concept of the Foreign Earned Income Exclusion (FEIE). FEIE allows US citizens to exclude a certain amount of their income earned abroad from their tax returns. For example, in 2024, an individual could exclude up to $126,500 of foreign-earned income from their US tax return. This strategy can result in lower or even non-existent monthly loan payments. However, it relies on maintaining an income-based repayment plan, which may be subject to changes and updates.
Additionally, when moving overseas, it is important to notify the relevant student loan authorities. For example, in the UK, individuals planning to live outside the country for more than three months must update the Student Loans Company (SLC) and complete an 'Overseas Income Assessment Form'. Failure to do so may result in penalties. Similar processes are likely in place in other countries, and it is important to understand and follow these procedures to avoid complications.
While moving overseas can provide some relief from student loan debt, it is not a perfect solution. For example, a non-existent monthly payment due to a low AGI and an income-driven repayment plan will cause the loan balance to grow over time. Additionally, in 20 to 25 years, taxes may be owed on the forgiven balance, including any accrued interest.
Overall, while relocating overseas can provide some benefits in managing student loan debt, it is not a foolproof strategy. It is important to carefully consider individual circumstances and seek professional advice to navigate the complexities of student debt repayment when living abroad.
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Frequently asked questions
Yes, you do. If you have defaulted on your federal student loans, the U.S. Department of Education's Office of Federal Student Aid (FSA) will begin collections on your defaulted loan portfolio.
Contact your servicer to discuss your options. You can also reach out to credit counselling nonprofits or search for free student loan advice. Additionally, the FSA will provide resources and support to assist borrowers in selecting the best repayment plan.
Here are some key points to remember:
- Interest accrues daily, starting on the day your loans are disbursed.
- Do not pay for help with your student loans. Many companies sell support services for a fee, but free help is available.
- Do not use credit cards or home equity to pay off student loans. You will lose the flexible repayment options offered by federal student loans.
