4 Costly Student Loan Repayment Myths Busted

Student Loan Myths

The five-second rule for dropping food on the floor? False.

Apollo moon landing photos faked? Nope. Urban legend.

Cell phones interfering with a plane’s instruments, causing a crash? Not a chance.

TV’s MythBusters disproved all these wacky notions some of us believed to be true. But there are some claims about student loan repayment that are just as crazy. And what’s worse? Myths about student loan forgiveness, income-based repayment, and more cost borrowers like you thousands of dollars.

Here are four student loan myths that may be costing you some serious cash.

Myth #1: Borrowers can’t discharge student loans through bankruptcy

Reality: Discharging student loans through bankruptcy isn’t automatic or easy, but it’s far from impossible.

You’ve heard this one before, right? The media loves to play up the drama that borrowers are stuck with student loans and there’s no way out, including bankruptcy. But has anyone ever fact-checked this? If they did, they’d see that it’s simply not true.

In fact, this study found that 40% of student loan borrowers who sought to have their loans discharged in bankruptcy were successful. The key to a successful bankruptcy filing: you must exhibit “undue hardship.” This means you’re unable to pay now and it’s unlikely anything will change that will allow you to pay in the future.

This study notes that those who succeeded did have three key characteristics compared to those who failed. They were:

1. Less likely to be employed

2. More likely to have a medical hardship, and

3. More likely to have lower annual incomes the year before they filed for bankruptcy.

So why don’t we hear more about borrowers shedding student loans through bankruptcy? Most don’t try. It turns out 99.9% of those filing for bankruptcy don’t attempt to include their outstanding student loans.

Myth #2: Student loan forgiveness can help most borrowers

Reality: Borrowers with both average student loan debt and average income probably won’t have any debt left to be forgiven after 20 years of payments.

Student loan forgiveness sounds like a great plan. You make payments for 20 years and after that, your remaining debt is wiped out. Basically, free money, right? Unfortunately, when you run the numbers, the average college graduate will have already paid off all his or her debt within 20 years of starting repayment, regardless of the student loan repayment plan. Here’s an example:

Loan balance: $34,000

Weighted interest rate: 3.9%

Starting salary: $30,000

Projected Loan Forgiveness (for all but “Pay As You Earn”) program: $0

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Image source: StudentLoans.gov

So who can benefit from student loan forgiveness? As you might have guessed, those with large amounts of debt (think $100,000+) and low salaries are more likely to have enough debt for student loans forgiveness to work.

Loan forgiveness may also benefit high-income earners with extreme amounts of debt, like doctors or lawyers. Outside of these cases, you’re likely out of luck.

Myth #3: Income-based repayment plans always help borrowers repay loans

Reality: Typical borrowers could pay more interest with income-based repayment.

Like Myth #2, this one largely depends on the borrower’s income and student loan balance.

Income-based repayment allows borrowers to lower their monthly payments and pay only a portion (no more than 15%) of their discretionary income towards loans. This is helpful for borrowers who can’t afford to make their full student loan payments.

But, as with all loans, smaller payments mean you’ll pay more interest. How much interest? Here’s an example.

According to the Federal Student Aid website (click “Proceed” to view page after clicking link), the average graduate of a four-year, not-for-profit university will graduate with a student loan balance of $29,214 at 3.9% interest. Let’s assume a starting salary of $30,000. Based on these calculations, this graduate would pay $35,327 on a standard student loan repayment plan. With income-based repayment, this graduate will pay $38,943, about $3,600 more.

The trade off here is supposed to be loan forgiveness after 20 years of repayments. However, as I showed you in Myth #2, there won’t be any debt left to forgive for this borrower. In terms of savings, income-based repayment is a bust in this and many other cases.

Myth #4: Everyone should consolidate to make student loan repayment easier

Reality: Consolidating loans can cost you more money.

Consolidating does make managing loan repayments easier. But other than that, it can be a money-loser.

One reason: consolidation takes away options. You won’t be able to target higher-interest loans with increased payments or by refinancing.

Let’s say you have two outstanding federal student loans:

Loan #1: $16,000 at 3.68% APR

Loan #2: $15,000 at 6.8% APR

Let’s say you’re planning to pay $400 towards your student loans every month, which is more than the standard required monthly payment.

If you want to pay off these loans and pay as little interest as possible, you’d put any over payments towards Loan #2 since it has a higher interest rate. By doing this, the total amount paid for both loans including interest would be $36,780.

However, if you consolidated these loans, you wouldn’t be able to use this strategy. By consolidating, you’d have one loan with a principal of $31,000 and a weighted interest rate of 5.25%. Assuming the save $400 monthly payment, the total payoff would be $37,943. That’s $1,163 more than if you didn’t consolidate loans and used the fast-track payoff method instead. 

The overall lesson: Don’t believe what you hear. Instead, check the numbers. We even have student loan calculators to make this easier.

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Published in Public Service Loan Forgiveness, Refinance Student Loans, Student Loan Bankruptcy, Student Loan Calculator, Student Loan Repayment, Student Loan Repayment Options

  • Keenan

    Thanks for the information regarding certain myths and misunderstood ideas about student loan solutions. One thing I would like to see more of (with the understanding that it still seems to be a fledgling problem that has only been recently coming to light) is information regarding private loans and the avenues for solutions that are available to college graduates. In fact, being one of those college grads who is currently dealing with private loan issues, I would argue that the arising problem of private student loan debt is a far more serious problem and needs more attention due to the fact that there are more visible options for solutions with federal loan debt than there are private loan debt.
    Thanks again.

    • Hi Keenan,

      Thanks for your comment. That’s a great point, and something we’ll definitely look to cover more throughly on the blog soon.

      Are there any particular issues you’d like us to cover related to private loans? For example, repayment options for private loans, private loans vs federal loans, etc.?

  • Hello Jeffrey,
    Thank you for sharing these tips. I have read all the tips. You are right That student loan forgiveness sounds like really a great plan. I also agree with you that borrowers will pay more interest with income-based repayment.

  • Adam Russell

    Remember that these IBR Programs are projecting the future payments under the assumption the person is going to be making atleast 5-7% more money than the year before…so if your starting salary in year 1 is 20K per year…the assumptions made in projecting this program are that in year 20 you will be making over 50k….more often that not that is not the case. That being said you can not use that calculator verbatim.