Lana Oconnell
Student loans can be a daunting burden, but there are ways to ease the pressure. Understanding the unique traits of student loans can help borrowers make informed decisions and avoid defaulting on their loans. This includes knowing when interest starts accruing and what options are available to avoid delinquency, such as forbearance or deferment. While paying the minimum can prolong the loan period, it provides extra spending money each month. Alternatively, refinancing can reduce interest rates and speed up repayment without sacrificing spending money.
| Characteristics | Values |
|---|---|
| Interest accrues daily | Starting the day your loans are disbursed |
| Subsidized federal loan | The government will pay your interest while your loans are in a deferred status |
| Unsubsidized federal loan | You will be responsible for the interest that accrues during a forbearance |
| Private student loans | Reported delinquent after 30 days without payment |
| Federal loans owned commercially in the Federal Family Education Loan (FFEL) program | Considered delinquent at day 60 |
| Federal loans (Direct and FFEL) owned by ED | Reported delinquent at day 90 of no payment |
| Missed monthly payments on federally owned student loans | Between October 1, 2023, and September 30, 2024, they will not be reported to credit reporting companies, placed in default, or referred to debt collection agencies |
| Loan default | The lender can file a lawsuit against you to collect on the debt |
| Federal student loan default | Lose eligibility for federal student aid and face garnishment of federal tax returns, wages, and Social Security payments |
| Strategies to pay off student loans | Refinancing, paying more than the minimum each month, paying twice per month, and consolidating credit card debt |
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What You'll Learn
Understand interest accrual and how it impacts your loan
Understanding how interest accrues on your student loan and how it impacts the total amount you pay is crucial when considering how to prolong payments. Interest on student loans, both federal and private, accrues daily, starting on the day the loan is disbursed. This means that unless you have a subsidised federal loan, interest will begin to accumulate from the day your loan is issued, and you will end up paying more than the amount you originally borrowed.
There are two primary types of interest rates: fixed and variable. A fixed interest rate remains constant throughout the life of the loan, whereas a variable interest rate may fluctuate. For example, variable rate Sallie Mae loans applied for on or after April 1, 2021, use the Secured Overnight Financing Rate (SOFR) as the index, which can change over time.
During certain periods, such as a separation or grace period, or at the end of a forbearance or deferment, any unpaid interest may be capitalised. Capitalisation occurs when the unpaid interest is added to the loan's Current Principal, increasing the base amount on which interest is calculated. This can lead to a higher Total Loan Cost. Therefore, if you can afford to, it is advisable to pay off the accrued interest before it capitalises to keep your total loan cost down.
If you choose to request a student loan deferment, you won't have to make principal and interest payments during that period. However, your interest will continue to accrue, and at the end of the deferment, any unpaid interest will capitalise, increasing your Total Loan Cost. With careful planning and additional payments, you can work to minimise the impact of interest accrual and capitalisation on your loan.
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Explore refinancing to reduce interest rates
Refinancing your student loans can be a smart way to simplify your debt and reduce the amount you pay over time. When you refinance, you replace your existing student loans with a new loan, ideally at a lower interest rate.
Credit Score and Income
Your credit score and income are important factors in determining your eligibility for refinancing and the interest rate you will be offered. Lenders typically look for borrowers with high credit scores, preferably in the mid-700s. If your credit score has improved since you initially borrowed, you may qualify for a lower interest rate. A stable income will also improve your chances of qualifying for a lower rate.
Compare Lenders
Not all lenders will offer the same rate or terms for student loan refinancing. It is important to shop around and compare different lenders to find the best option for your needs. Consider factors such as interest rates (fixed vs. variable), repayment protections, and flexible payment options. You can use a student loan refinance calculator to estimate your savings.
Federal Loan Forgiveness
If you have federal student loans, refinancing them through a private lender will turn them into private loans, causing you to lose access to federal benefits such as income-driven repayment plans and loan forgiveness programs. Therefore, if you are eligible for loan forgiveness or plan to utilize income-driven repayment plans, you may not want to refinance your federal loans.
Loan Term
When refinancing, you can choose a longer loan term to reduce your monthly payments or a shorter one to save on interest. Extending your loan term can provide some financial flexibility, but keep in mind that you will pay more in interest over time. On the other hand, choosing a shorter loan term will help you pay off your debt faster and reduce the overall interest paid.
Automatic Payment Discounts
Many lenders offer interest rate discounts for borrowers who sign up for automatic payments. These discounts typically reduce your interest rate by 0.25 percentage points, which can add up to significant savings over the life of the loan.
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Make payments twice a month instead of once
One strategy to prolong paying off your student loans is to make payments twice a month instead of once. This is also known as paying biweekly.
The standard payoff schedule for a loan is via monthly payments. Interest on the loan is based upon a 360-day year, and the daily interest is added to the principal each day during the month. However, there are 52 weeks in a year, not 48, so by making biweekly payments instead of monthly payments, you are effectively making one extra payment each year. This will have a powerful impact on your payoff schedule. Your loan will be paid off sooner, and you'll pay less interest. For example, if you apply biweekly payments to a 10-year loan, your loan will be paid off in about nine years instead of 10.
Lenders are not set up to accommodate a biweekly payment schedule and will likely not adjust the interest to accommodate a biweekly payment. Instead, they work on a monthly payment schedule, and the interest will be calculated based on the principal balance at the beginning of the monthly cycle. Hence, it is essential to ensure that both biweekly payments arrive before the monthly due date of each loan. Otherwise, you could be penalized for failing to make minimum payments. One simple way to do this is to begin your biweekly payments at the beginning of the next payment cycle. That way, you can be sure that your payments will fall within the timeframe.
From the lender's perspective, you are simply making partial payments more often, and they will generally accept partial payments. However, note that some student loan servicers offer a small discount of 0.25% for setting up monthly auto-payments, so you may lose this benefit if you decide to make manual biweekly payments. Make sure that your payments are being allocated to pay off the principal (the loan balance) and not to future payments.
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Know the consequences of defaulting on federal loans
Defaulting on a federal student loan can have several negative consequences. Firstly, you may lose your eligibility for all federal student aid, which can be detrimental if you are still pursuing your education or plan to do so in the future. Additionally, your federal tax returns, wages, and Social Security payments may be garnished to repay the defaulted loan. This means that the money you expected to receive or the income you earn could be significantly reduced as it is applied to repay your loan.
Another consequence of defaulting is the potential impact on your credit score. Credit reporting companies are typically notified when you default on a federal student loan, and this information can negatively affect your creditworthiness. A lower credit score may hinder your ability to secure loans or favourable interest rates in the future, affecting major life decisions such as purchasing a home or starting a business.
Furthermore, once your loan is in default, the lender has the legal right to file a lawsuit against you to collect the debt. Student loans are unsecured debt, meaning there is no collateral to repossess, such as a car or a house. However, the lender can take legal action to recover the funds, which could result in additional legal fees and further damage to your financial standing.
It is important to note that there are options to avoid defaulting on your federal student loans. Reliable lenders are often willing to work with borrowers to find a solution. Federal loans offer rehabilitation and consolidation options, and private lenders may be open to negotiating a deal. Additionally, the U.S. Department of Education has introduced initiatives, such as the Fresh Start Program, to assist borrowers in getting their loans out of default and providing alternatives to traditional repayment plans.
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Take advantage of the temporary on-ramp period
The student loan "on-ramp" period, lasting from October 1, 2023, to September 30, 2024, is a temporary relief measure that offers benefits to borrowers who are unable to make their monthly student loan payments. This period was announced by the Biden administration after a three-year pause on federal student loan payments during the pandemic era.
During the on-ramp period, borrowers who don't pay their monthly student loan bills can expect the following advantages:
- Student loans won't fall into delinquency or default.
- Missed payments won't be reported to credit bureaus, and credit scores won't drop as a result.
- Borrowers will be shielded from most of the consequences of falling behind on payments.
Despite these benefits, it's important to understand that interest will continue to accrue on your debt during the on-ramp period. This means that if you forgo payments or make only partial payments, you'll likely end up with a larger bill when the on-ramp period ends. Therefore, if you can afford to make your student loan payments, most experts recommend that you do so to avoid a larger bill later.
However, the on-ramp period can be advantageous for those who truly need it. If paying your student loans will cause you to go into debt while paying other bills, it is advisable to take advantage of this period. This is especially relevant for recent college graduates who haven't found employment or started an emergency fund yet. By using the on-ramp, you can get yourself on solid footing and then start paying off your loans as soon as possible.
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Frequently asked questions
Private student loans may be reported delinquent as early as 30 days without a payment. Federal loans are considered delinquent at 60 days. Federal loans owned by the ED are reported delinquent at 90 days of no payment. After this period, borrowers risk defaulting on their federal loans. Defaulting on a federal student loan can lead to losing eligibility for federal student aid and wage garnishments.
Refinancing can help to reduce your interest rate and lower your monthly payments. Lenders will often offer a reduced interest rate to borrowers who have a shorter repayment period.
Paying more than the minimum each month will reduce the amount of interest you owe and help you pay off the loan faster. You can also pay twice per month instead of once, which will reduce the amount of interest added over time.
Contact your servicer immediately to ask about your options. Reliable lenders will want to work with you to help you get out of default. Federal loans offer rehabilitation and consolidation, and private lenders may be willing to negotiate.
