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 seeking a student loan. These student loan mistakes cost the most money and cause the most stress.
- 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 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, 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 ruins the credit scores of both the borrower and the cosigner. Even if the lender offers a cosigner release option, less than 1 percent of borrowers succeed in obtaining cosigner release. You might never be able to get out of the obligation until the loan is paid off in full.
- 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 helps you earn the money to repay the debt. Using student loans for consumption, such as a spring break vacation or a shopping spree, forces you to pay big bills long after you received the benefits. If you use student loan money to splurge on entertainment and clothes, you also are likely to run out of money midsemester.
- Borrowing private student loans 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 in total duration. Federal student loans have death and disability discharges, while only half of private student loans offer similar benefits. 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, where the monthly payment is automatically transferred from your bank to the lender. Not only will you be less likely to be late with a payment, but many lenders 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 repayment plan with the lowest monthly payment, instead of the highest payment they can afford. The repayment plan with the lowest monthly payment has the longest repayment term. This means you will still be repaying your student loans when your children go to college. A longer repayment term also increases the total interest you will pay.
- Postponing payments when it is not really necessary. Don’t take a deferment or forbearance when you can afford to make the monthly loan payments. Interest continues to accrue on some or all of your student loans during a deferment or forbearance. If you don’t pay the interest as it accrues, the unpaid interest will be capitalized by adding it to the loan balance. This will cause interest to be charged on interest. Postponing payment digs you into a deeper hole.
- Failing to update your contact information with the lender. Student loan payments still are due, even if you never received a monthly statement or coupon book. It is your responsibility to tell the lender about changes in your mailing address and other contact information. If you are late with a payment, you can be charged a late fee of as much as 6 percent of the late payment. If you miss enough payments, your loans will go into default, with very serious penalties, such as collection charges of as much as 20 percent of each payment, garnishment of up to 15 percent of your wages, and the offset of income tax refunds and Social Security benefit payments.
- Refinancing student loans without checking whether it really saves money. Refinancing student loans with a longer repayment term might reduce the monthly payment, but it does not save money because it increases the total interest you will pay over the life of the loan. Refinancing also might increase the average interest rate you pay. If the new interest rate is higher than the interest rates on all but one or two of your student loans, you could 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 repayment plans, reduce your monthly payments, get student loan forgiveness or consolidation your student loans. You can do this on your own, for free, pretty easily.
Paying attention to these potential pitfalls can help you avoid these student loan mistakes. The fewer mistakes you make, the more likely you are to survive your student loans with your finances intact.