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
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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