With graduation season in full swing, thousands of new grads are realizing the transition from college to the “real world” can be pretty overwhelming. So much so that some important details can be overlooked, such as how to deal with student loans after graduation.
Early student loan mistakes can cost you big in the long-run. It’s important for all graduating college students to avoid the following six common student loan blunders post-graduation.
1. Racking up interest during your grace period
Students with subsidized federal loans are off the hook when it comes to accruing interest during the grace period. Unsubsidized federal loans, on the other hand, accrue interest while you are in school, during the grace period, as well as during forbearance.
However, you don’t have to pay that interest until it’s officially time to start making student loan payments. But that doesn’t mean it’s a good idea to wait.
If you do not pay interest on an unsubsidized student loan, the interest is capitalized – that is, added to the principal balance of your loan. That means your principal balance will not only get bigger, but you’ll pay even more in interest since it is calculated based upon your principal balance.
If you can afford to do so, make payments toward interest (at least) during the grace period so you’re not faced with an even bigger loan and higher payments when it comes time to start repaying your debt.
2. Deferring student loans past the grace period
Federal student loans offer students a generous grace period of six months between graduation and the due date of the first student loan payment. Six months should theoretically be a sufficient amount of time for new grads to find a job and get their financial ducks in a row.
But six months can go by in a snap, leaving some graduates still unemployed and scrambling to pay their first student loan payment. Since deferring student loan payments is one of the perks of federal student loans, it might seem like a no-brainer to apply for a deferment when the grace period doesn’t seem like long enough. Unemployment is one of situations that qualifies for a deferment.
However, unsubsidized loans will continue to accrue interest during the deferment period, which will be capitalized. While Uncle Sam will pay your interest on subsidized loans during deferment, it’s still not a great idea to defer your loans past your grace period if you are having trouble finding work. There are limits to the amount of time you can defer student loans due to unemployment (generally a total of three years).
3. Consolidating student loans after graduation for the wrong reasons
Direct Consolidation loans allow student loan borrowers to combine multiple federal education loans into a new, single loan. The main reason to consolidate your federal student loans into such a Direct Loan is to trade in multiple monthly payments for a single, convenient payment to one loan servicer or to get on an income-driven repayment plan.
Many graduates, however, mistakenly believe that consolidating their student loans will save them money.
While consolidation can help lower the monthly payment amount, it will not lower your interest rate; the new interest rate is the weighted average of the rates on your old loans, plus a small percentage on top. Plus, consolidating often means extending the repayment term. You might end up with lower payments, but you’ll pay more in interest over time.
4. Assuming you’re stuck with that monthly payment
The Standard Repayment Plan, which is the default repayment plan for federal student loan borrowers, is the financial equivalent of one-size-fits-most clothing. It assumes the majority of college graduates will be able to land a job that allows them to pay back their loans over a 10-year period.
Just because this plan fits many budgets does not mean it is right for you – your repayment plan isn’t written in stone and you can make monthly payments more affordable if necessary. You can apply for any of the following payment plans to lower your payments:
Pay As You Earn (PAYE) allows your monthly payments to be capped at 10 percent of your discretionary income and your payments will never be higher than what they would be through the Standard Repayment Plan.
Revised Pay As You Earn (REPAYE) is very similar to PAYE, except more borrowers are eligible. While payments are also capped at 10 percent of discretionary income, there is no limit to how high payments can be and it’s possible they end up higher than on the Standard Plan if your income increases.
Income-Based Repayment (IBR) caps your monthly payment at 10 to 15 percent of your discretionary income, depending on when you took out your loans. To qualify for IBR, you generally need to owe more than your annual salary.
Income-Contingent Repayment (ICR) caps student loan payments at the lesser of two options: 20 percent of discretionary income, or what the payment would be on a fixed, 12-year payment plan, adjusted according to income.
Graduated Repayment: If you anticipate that your income will increase over the years and you really just need a break right now as you get settled in your career, consider a graduated repayment plan.
With these plans, your payments start out lower but increase over time – generally every two years. You can expect payments under such a plan to be spread out over the course of 10 years, which makes this a good option for new grads in fields with strong future earning potential.
Extended Repayment: Borrowers are allowed to extend their repayment schedule for up to 25 years and make fixed or graduated payments during that time. Just remember that tacking more time onto your repayment timeline does mean you will end up paying more overall for your student loans.
5. Missing payments
Missing a single student loan payment may seem like nothing to worry about. You are going to make 120 payments over 10 years, so what’s the big deal if you are late once in awhile?
Unfortunately, a single missed payment can have pretty serious repercussions. First, your loan is considered delinquent the day after your missed due date and it remains delinquent until you make a payment or request deferment or forbearance. Then, you will likely be assessed a late fee by your lender and you may see a ding on your credit. After 270 days of delinquency, your loan is considered to be in default.
In addition, delinquency often disqualifies you for any rebates or interest rate reductions that you received on your loans.
Setting up automatic payments can be one of the smartest ways to avoid missing your monthly student loan payments. If you are worried about your ability to make a particular month’s payment, contact your lender to see about changing your due date or otherwise tweaking your payment to avoid delinquency.
6. Paying only the minimum on student loans after graduation
While some recent college grads might be living off of ramen in their parents’ basements, others are lucky enough to step into lucrative careers directly from college. Those graduates might be tempted to spend their hefty paychecks on a lavish place to live or a new car, but they would be better served by sending more money to their student loan servicers.
Making extra payments not only shortens your repayment period, but it also reduces the amount of money you will spend in interest. Because of the power of compounding, even a modest increase to your student loan payment – such as $100 per month – can have a huge long-term impact. See for yourself by plugging in the numbers below.
Student Loan Prepayment Calculator
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Plan for more than a sweet graduation party
Thinking about paying off your student loans after graduation is not nearly as much fun as celebrating the milestone. But taking the time plan for your student loans can help you avoid the common mistakes that could end up costing you for years to come.
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