Interest rate on new Stafford student loans doubles today
Congress allowed the interest rate on new Stafford loans, the most common type of college financial aid, to double — from 3.4% to 6.8% — today.
Lawmakers still have time to roll back the rate before checks go out to 7 million undergraduates enrolling for the fall semester.
But Democrats and Republicans remain far apart on how to do that, so it seems Washington may well make one of our biggest financial problems a little bigger.
The higher-cost Stafford loans will boost monthly payments by a third and double the interest borrowers pay over the life of their loans.
While existing loans are not affected by the rate increase, 37 million students and former students have already piled up a whopping $1 trillion in student loan debt — way more than the balance Americans are carrying around on their credit cards.
A Fidelity survey of 750 graduates in the Class of 2013 found that they'd left school with an average of $35,200 in college-related debt — an unimaginable burden just a few years ago.
So this seems like a good time to review our 5 smart moves for paying off student loans as quickly and painlessly as possible.
Smart move 1. Get informed and deal with it now.
Debt is like a health problem: Try to ignore it, and it will just get worse over time.
"People shouldn't bury their head in the sand. Once you fall behind or default, it can cause big problems," says Lauren Asher, president of the Project on Student Debt, with offices in Washington, D.C., and Oakland, Calif.
Start by gathering all of your paperwork and getting to know the details of your loans.
If you're like many, you may not pay attention to much beyond what you pay every month.
Find out the types of loans you have, the remaining balances, the interest rates you're paying and the repayment terms.
Federal loans can be pretty standard, but private loans can vary dramatically.
If you're still in school and nearing graduation, you'll also want to know your grace period. This is how long you have to wait after leaving school before you have to make your first payment.
Perkins loans have a grace period of nine months. For Stafford loans, it's six months, and it can vary for private loans.
If you're not too sure, visit the National Student Loan Data System, where you can find out exactly what kind of loans you have.
You'll want to at least know where you stand and prepare yourself in case rates rise.
Let's say you owe $30,000 and are on a 10-year repayment plan. At 3.4%, you'll pay $295 per month and $5,430 in interest over the life of the loan.
If that rate rises to 6.8%, your payment will rise to $345 per month, and you'll pay more than $11,000 in interest.
Smart move 2. Explore income-based repayment programs for federal loans.
Next, visit the Student Loan Repayment Estimator to figure out what kind of repayment plans are available and what you can expect to pay.
Asher says that, unless you selected a particular repayment option, you're likely in the default 10-year plan.
If you feel your payment is too big to handle, you could opt for a longer term.
That could significantly reduce what you owe monthly, but it would increase the interest you'll pay.
If you extend your $30,000 loan to a 20-year payment program at the current 3.4%, your payment would drop to $172 per month.
But you would eventually pay over $11,000 in interest during that time. Plus, you'd be making payments for 20 years.
Asher says there are a number of Income-Based Repayment (IBR) programs available for federal loans.
"A lot of people don't know that these programs are available. You can apply for IBR and attach your payments based on a modest share of your earnings," she says.
If you've been out of school and can show a "partial financial hardship," you may qualify for the Pay as You Earn program.
It will allow you to lower your payments based on your income.
Use this "Pay as you earn" calculator to see if you qualify.
Under this program, your monthly payment will be no more than 10% of your discretionary income. And typically, if you continue to make your payments for 20 years, the remaining balance will be forgiven after that period.
Asher says it's relatively easy to apply for a number of IBR programs all at once.
"You can apply for them all at the same time and see which ones you qualify for and which ones would have the lowest payments," she says.
In most cases, you must also submit annual documentation about your income and family size.
So, if your income rises or if you fail to submit documentation, you could be automatically put back into the standard repayment program.
You may also have to pay taxes on any loan amount that is forgiven after 20 years.
Nevertheless, if you're swamped with student debt, it's a good option to consider.
Smart move 3. Beware forbearance or deferrals.
There are certain circumstances where you might be able to receive a deferment or forbearance on your federal student loans.
This will allow you to postpone or reduce your payments to help avoid default.
You can generally get a deferral of up to three years due to economic hardship or unemployment.
During that time, the government will pay the interest on your subsidized loans, but not on your unsubsidized loans.
A forbearance is when you don't qualify for a deferral. It may allow you to stop making payments or reduce them for up to 12 months.
It can be granted at the lender's discretion for financial hardship or illness.
During this time, you will continue to be charged interest on all loan types. You can pay the interest or let it accrue.
In any case, deferral or forbearance don't do anything to minimize your debt. They just put off your problems for a later day.
"It's just a temporary fix, and the interest will accumulate. It's better to try to work out a reduced payment. You still want to pay something," says Anne Logue, writer, financial analyst and lecturer in finance at the University of Illinois at Chicago.
You might escape a mortgage by having your home foreclosed. You might escape a car loan by having your car repossessed. And you might escape credit card debt in bankruptcy.
But there is essentially no way to escape government-backed student loans.
"Your wages could be garnished, your tax refunds can be seized and even a share of your Social Security payment can be taken," Asher says.
Forbearance or deferrals might give you some breathing room, but they're not going to solve the problem.
You still have to work to pay it down.
Smart move 4. Contact private lenders.
Unlike federal loans, private lenders don't have any publicized special programs for people struggling with their payments.
Asher says you should still contact them, because they may be able to offer some kind of deal.
"You are ultimately at the mercy of the lenders, but if you're worried about your ability to make payments, get in touch with them and just ask what your options are," Asher says.
Whether it's a reduced interest rate, a reduced minimum payment or a specially negotiated forbearance, they may do something.
The lenders still ultimately want you to pay, even if it's less.
Logue says people are often embarrassed to call, but there's nothing to be ashamed of — millions of Americans are struggling with their student loans.
"They hear it all the time. They would still rather [work a deal] than have to bring in a collection agency or something like that. Don't assume they won't try to help you," she says.
Some lawmakers are trying to push private lenders into more flexible repayment programs. They'd like to see extended grace periods, permanently reduced interest rates or modified payments for long-term hardships.
Asher says to get the ball rolling and contact them before you fall behind on payments.
"Once you default, you are really in a tough spot. It's an entirely different type of financing, but you can at least try to work something out," she says.
Smart move 5. Explore forgiveness options.
Finally, if you're open to the idea of a career change, there are a number of ways you can get loan forgiveness through employers or public service.
Ask your employer if there are any programs for loan repayment assistance.
You might qualify for the Public Service Loan Forgiveness Program (PSLFP) if you go to work for a federal, state or local government agency.
It's also available if you work for a nonprofit organization that has been designated as tax-exempt by the IRS.
But your loans aren't totally forgiven. You still have to work in the eligible job for 10 years and continue to make monthly payments for a total of 120 in all.
After that point, your remaining balance is forgiven.
If you did this with a 10-year repayment plan, you wouldn't have anything left to forgive.
So why do it? Because you can maximize your benefit by repaying your loans on the Income-Based Repayment (IBR) plan or the Income-Contingent Repayment (ICR) plan.
Under the ICR plan, your payments are capped at no more than 20% of your discretionary income, and your term can be stretched to 25 years.
It's probably not worth it if you've got $30,000 or under in student loans. But if you're carrying six figures, it could save you tens of thousands.
Finally, there's the military. It varies by branch, but the Army and Navy will repay up to $65,000 of student loans for qualifying soldiers after a year of active-duty service.
Of course, you'll have to enlist for four to six years and accept all the things that come with military life. This includes moving around and the possibility of being sent abroad or to war.
"It's not for everyone, but if you're willing to consider it, you can talk to them and see what loan benefits they can offer," Logue says.