4 Big Mistakes People Make When Choosing Their Student Loan Repayment Terms
If you’re looking to take out a student loan to pay for an undergrad or grad degree, you’re about to join the club of Americans also carrying large amounts of student loan debt—$1.4 trillion total across the U.S., in fact. While taking out the loan may be the right move to pay for school, that decision is also paired with another one that could have impacts down the line on your long-term financial goals: your student loan repayment terms.
Student loan repayment terms can factor heavily into how long it takes to back your student debt, so you’ll want to make the right call out the outset. To make sure you can pay off that debt faster later, steer clear of these four common mistakes when choosing your loan terms:
Mistake #1: Not understanding all your options
There are two types of student loans: federal and private. Federal loans come from Uncle Sam—think Stafford and Perkins loans. They’re based on financial need and have flexible terms with lower interest rates. Private loans are funded by banks, credit unions, or education lenders, and are based on credit worthiness, instead of financial need. As your credit score improves over time, you might be eligible for better interest rates with a refinanced loan that consolidates all of your student debt (both federal and private), so keep that in mind (more on this later).
While private student loan repayment terms depend on the lender, if you go with a federal loan, you’ll have a number of repayment options:
Standard repayment: Ten-year term—the best option for saving money, as you’ll pay less in interest over time.
Keep in mind: Payments are fixed.
Extended repayment: Based on debt size, your term can be 12 to 30 years. You’ll have lower monthly payments, depending on the interest rate.
Keep in mind: You might feel some relief with having more time to pay off your loan—but you’ll pay a lot more interest.
Graduated repayment: Payments (at least equal to the interest) increase every two years for a 12- to 30-year term, depending on the debt amount. If you earn a good salary and stand to make more as time goes, this is a viable option, despite paying more interest.
Keep in mind: Thirty years is a long time. When you get a raise, pay more each month to shorten that time frame.
Income-contingent repayment: This option is available to borrowers of low-interest, need-based Direct Loans. Payments are based on annual income, family size, and total debt, so you’ll potentially pay less per month. However, lower payments result in an extended loan term, which means—you guessed it—more interest. Debt forgiveness is an option if you’re still paying off loans after 25 years, though.
Keep in mind: Unless you want to continue paying for your loans into your 40s, refinancing could be a better option.
Income-sensitive repayment: For a 10-year term, payments are based on a percentage of your gross salary. This is a good option for people who would otherwise struggle—or face default—with higher monthly payments.
Keep in mind: Keep your tax returns handy. If you opt for an income-sensitive repayment plan, you need to reapply every year and show proof of your income.
Income-based repayment: If you have a financial hardship, you can reduce your payments to 15% of your discretionary income. Additionally, your loan can be forgiven after 25 years of payments. This is helpful to low-income earners, though there is much more interest paid over time.
Keep in mind: You might eventually have your loan forgiven, but think of how those 25 years of interest might add up.
Aside from any repayment plan, you might still be eligible for loan forgiveness, depending on the industry in which you work. The Public Service Loan Forgiveness program allows eligible nonprofit and government employees to have their student loans forgiven—without tax implications—after 10 years of payments.
Mistake #2: Not considering your future income potential
If you are in a field where your income will increase considerably as you advance in your career—think healthcare or law—you can pay off your student loan debt much faster.
Determine the highest monthly payment you can afford—experts recommend that your monthly debt should not exceed 10% of your earnings before taxes. Use a student loan comparison calculator to see how long it will take you to pay off a loan.
Once you’ve settled on a loan option, consider making one extra payment each year—you’ll be surprised how much interest you’ll save. Build up to larger principal payments as your salary increases, and learn as much as you can about student loan refinancing, so you can make that move when the time—and paycheck—is right.
Mistake #3: Making student loan repayment your only financial goal
At some point, you’ll want to invest more toward your retirement, and maybe buy a home or start a family. It might be hard to look past your student loan debt before you’ve even made a payment, but when choosing your student loan terms, be sure to consider your entire financial situation.
If you choose to postpone funding your retirement account to focus on your school debt, and don’t take advantage of employer-matching 401(k) benefits (if they’re offered), you’ll miss out on thousands of free dollars. Let’s say your employer offers a 3% match of your 401(k) contribution. If you make $75,000 a year, that’s $2,250 deposited into your account—on the house, so to speak. The money your retirement fund will earn over the next decade will likely surpass any amount of interest you’d save by paying down your debt faster.
If you’re aiming to become a homeowner or start a family before your student debt is paid off, refinancing when the time is right could help you do that. You may be able to save cash for a down payment on a home, as well as for shoes for those little feet that might eventually pitter-patter through it.
Mistake #4: Setting yourself up for more debt
If you choose your monthly payment and student loan term length wisely, you’ll be able to pay down your debt while simultaneously saving for your future. But if you don’t consider your options carefully, you may find yourself relying on your credit cards to cover monthly expenses, which is the last thing you want to happen.
The point is to get out of debt, not incur more. So, if after time you do fall victim to this mistake, and watch your credit card balances increase as your loan debt decreases, consider refinancing your student loans. You’ll be able to consolidate your private or federal student debt into a single loan with lower monthly payments and, potentially, a better interest rate.
When or if the time to refinance comes, remember the following:
– Know your credit score and how to manage it—Lenders use your score to determine approval for credit, as well as the interest rate you’ll pay on loans.
– Compare interest rates—ultimately, you want to qualify for the lowest rate possible
– Consider a variable interest rate loan, but know that the rate can rise as the economy fluctuates. If you make a good salary, you can likely handle a variable rate.
– Inquire about borrower protection. Is there any leniency if you lose your job and can’t make payments.
Once you refinance, more manageable monthly loan payments will make it easier to stay out of credit card debt and save for your future.
Be smart about student debt
Don’t let these mistakes stand between you and your long-term financial goals. You’ve already proven how smart you are by earning your degree(s)—prove it again by choosing a student loan repayment term that works for you now and in the years to come.
When you’re ready, check your rate for refinancing your student debt with SoFi. See which payment term is right for your budget and financial goals.