Top 10 Student Loan Mistakes
Student loans are among the largest sources of consumer debt, second only to home mortgages. Therefore, mistakes involving student loans can have some of the most severe financial consequences.
The following are among the top mistakes students and parents make when choosing a student loan. These mistakes cost the most money and cause the most stress. Read on to learn how to avoid these money traps.
- Borrowing too much money. Just because you can borrow to the limit doesn’t mean you should. Borrow only what you need to pay college bills. The financial aid “refund” is not free money. Every $1 you borrow will cost about $2 by the time you repay the debt. If you don’t keep your student loan debt in sync with your income after graduation, you could end up with more debt than you can afford to repay. Minimize student loan debt by applying for grants and scholarships and by working a part-time job. Tuition installment plans are also a good alternative to long-term student loan debt.
- Failing to shop around for the best interest rates. Each lender sets its own interest rate and fees. The lowest advertised rate might not be the interest rate you get. Very few borrowers qualify for the best rates. Before you choose a lender, compare the actual interest rates and fees offered by several lenders, including the federal government.
- Cosigning a loan without understanding the consequences. Do not cosign a student loan unless you are willing and able to repay the loan entirely on your own. A cosigner is a co-borrower and equally obligated to repay the debt. Cosigning a student loan is like giving the student, who might not manage money responsibly, control over your financial future. If the borrower is late with a payment, it hurts the credit scores of both the borrower and the cosigner. Even if the lender offers a cosigner release option, less than one percent of borrowers succeed in obtaining a cosigner release. You might not get out of the obligation until the loan is paid off.
- Relying on student loans for living expenses. Student loans should be used for educational expenses, such as paying for tuition and textbooks. Student loan debt is good debt when it is used to invest in your education, because it ultimately helps you earn money to repay debt. But using student loans for luxuries like a spring break vacation or a shopping spree will set you back. Don't give in to this temptation.
- Borrowing private instead of federal student loans. Students should borrow federal first because federal student loans are cheaper, more available and have better repayment terms than private student loans. Federal student loans have three-year deferments and forbearances, while private student loan forbearances are limited to a year. Federal student loans have death and disability discharges, while only half of private student loans offer similar benefits. Additionally, federal student loans offer income-driven repayment and loan forgiveness, while private student loans do not.
- Missing opportunities to save money. Sign up for automatic payments, so the monthly payment is automatically transferred from your bank to the lender. Not only will you be less likely to miss a payment, but many lenders also offer an interest rate reduction to borrowers who sign up for auto-debit. Also, claim the student loan interest deduction on your federal income tax return.
- Choosing the wrong repayment plan. Students have a tendency to choose the payment plan with the lowest monthly payment instead of the highest payment they can afford. But the payment plan with the lowest monthly payment also has the longest repayment term, which increases the total interest and ultimate amount you will pay.
- Postponing payments when it is not necessary. Don’t take a deferment or forbearance when you can afford to make monthly loan payments. If you don't pay, interest will continue to accrue on some or all of your student loans during a deferment or forbearance. Thus, postponing payments will unfortunately dig you into a deeper hole.
- Failing to update your contact information with the lender. Student loan payments are still due, even if you don't receive a monthly statement. It is your responsibility to tell the lender about changes to your contact information. If you are late with a payment, you can be charged a late fee of up to six percent of the late payment. If you miss enough payments, your loans will go into default. This comes with serious penalties like collection charges of as much as 20% of each payment, garnishment of up to 15% of your wages and the offset of income tax refunds and Social Security benefit payments.
- Refinancing student loans without checking if it saves money. Refinancing student loans with a longer repayment term might reduce the monthly payment, but this will actually cost money in the long run. Refinancing also might increase the average interest rate. If you have multiple student loans, you can save money by targeting the highest-rate loans for quicker repayment instead of refinancing the loans.
As a final tip, never pay a fee to change a payment plan, reduce monthly payments, get student loan forgiveness or consolidate your student loans. You can do this on your own for free.
Paying attention to these potential pitfalls can help you avoid these student loan mistakes. So the fewer mistakes you make, the more likely you are to survive your student loans with your finances intact.