There’s no one-size-fits-all approach when it comes to paying off student loan debt. You need to know what works for your personal situation. What helps one person could actually harm someone else.
Here are five common pieces of advice that don’t always pan out so well for borrowers. Read on to learn what’s wrong with these student loan tips and what you should do instead.
1. Switching to an income-driven repayment plan saves you money
If you have federal student loans, switching to an income-driven repayment plan can help lower your monthly payments. There are four income-driven repayment plans and each caps your monthly payment at 10 to 20 percent of your discretionary income. If you’re struggling to make your current payments, one of these plans could ease the burden.
But switching to an income-driven repayment plan also has downsides. To lower your monthly payments, these plans extend your repayment term to 20 or 25 years. Adding a decade or more to your standard repayment plan means you’ll pay a lot more in interest over the life of your loan.
After you make payments for 20 or 25 years, the remaining balance of your student loans is forgiven. It’s not free money though — the forgiven amount will be treated as taxable income. So even if your debt is forgiven, you could be hit with a hefty tax bill.
So before jumping onto an income-driven repayment plan, assess your financial needs. Perhaps you can increase your income or lower your cost of living to better afford your student loans. Maybe you can qualify for a student loan repayment assistance program.
If you can find a way to stay on the standard 10-year repayment plan, you could save a lot of money in the long run.
2. Refinancing your student loans is always beneficial
You may have heard about all the benefits of refinancing student loans. Depending on your creditworthiness and income, you could refinance for lower monthly payments and a better interest rate. Plus, you’ll simplify your monthly payments so you only have to deal with one loan servicer instead of multiple ones.
But before refinancing, make sure you understand the possible drawbacks. When you refinance with a private lender, you give up federal student loan programs. You’ll no longer have access to income-driven repayment plans or federal loan forgiveness programs, like Public Service Loan Forgiveness (PSLF).
If you’re worried about losing your income or working toward federal loan forgiveness, refinancing could be a mistake. Refinancing has major benefits for some borrowers, but it’s not right for everyone.
3. Consolidation and refinancing are the same
It’s easy to confuse student loan consolidation with student loan refinancing. Both combine multiple loans into one new loan, but the similarities largely end there.
Consolidation refers to taking out a Direct Consolidation Loan from the federal government. You can only consolidate federal student loans such as Stafford, Perkins, and Direct PLUS loans.
Your new interest rate will be the average weighted interest rate of your old loans, rounded up to the nearest one-eighth of a percent. That means that consolidating does not lower your interest rate. It can help you by extending your repayment plan and it also helps rehabilitate student loans that have gone into default.
Refinancing, on the other hand, means combining all your private and federal student debt into one new loan with a private lender. It can help lower your interest rate and save you money in the long run. But, as mentioned above, refinancing means you lose access to certain federal loan programs.
People commonly confuse consolidation and refinancing, but the two processes are different. If you’re interested in simplifying your monthly payments, make sure you understand which approach is better for your individual situation.
4. You shouldn’t start paying back your loans right away
When you take out federal student loans, you have six months after you graduate before you have to start paying off student debt. This grace period gives you time to look for a job before your student loan bills come rolling in.
Unfortunately, unsubsidized student loans collect interest during this grace period. In fact, unsubsidized loans collect interest from the day they are disbursed.
So if you wait until the grace period is over, you might spend a long time paying off interest before you even make a dent in the principal. If possible, try to start paying your loans even before the grace period ends.
If you don’t have the means to start, at least review your loan terms and get a repayment plan in place. That way, you’ll be prepared when you have to start paying off student debt.
5. It helps to put your student loans into deferment or forbearance
Deferment and forbearance allow you to pause payments on your student loans. Often, borrowers defer their loans for up to three years when they go to grad school. Similarly, those faced with a short-term emergency, such as the loss of a job, can use forbearance for up to 12 months.
But there are risks with both of these options. If you have unsubsidized loans, your debt will continue to accrue interest. After months or even years, your student loan debt could get out of control. Once the deferment or forbearance period ends, you could be left with a huge bill that’s impossible to handle.
Be cautious about exercising either of these options and calculate exactly how much your student debt will grow if left in deferment or forbearance. Come up with a plan in advance so you’re not left scrambling in the future.
Educate yourself before accepting student loan advice
Before acting on student loan tips, make sure you understand all the benefits and drawbacks. A financial move that works for one person might not be right for you.
The best student loan tips take into account your unique circumstances. Make sure you see the whole picture before taking action on your student loans.