Anya Kamenetz Generation Debt

As a follow-up to my last column, I decided to take financial questions from real-life recent grads. Thanks to everyone who wrote in with suggestions!

Elizabeth, who is graduating from law school, asks:

I always wonder which debt to pay off first -- private student loans, federal student loans, or credit cards. And which to pay off first -- interest or principal.

Also, I think a clear explanation of the different sorts of repayment options might be interesting. 

Ideally, you'll cut back on other expenses and keep current on all debts. However, if you must prioritize repayment, there are two things to consider: interest rate and penalties.

Private student loans have a current national average interest rate of 8.36 percent, but many are above 10 percent. Also, they come with fewer repayment options and no bankruptcy protection, so you really want to stay current on private student loans as a top priority.

However, it could be a good idea to temporarily defer your federal student loans (Stafford, PLUS, or Perkins loans), which have a fixed rate of 6.8 percent, in order to pay down substantial high-interest credit card debt, since average credit card rates are above 11 percent and run up into the 20s or even 30s if you miss a payment.

Now, by "defer," I'm not suggesting that you skip a student loan payment. I'm talking about taking a formal deferment, which is among several repayment options for federal student loans. Here they are, briefly:

Standard repayment: a 10-year term. A rule of thumb for calculating your monthly bill under standard repayment is to take the first two digits of your loan balance and multiply by 11.5. For a $20,000 loan at 6.8 percent, your monthly payment is $230 a month; for $50,000, the monthly payment is $575.

Extended or Graduated repayment: With extended repayment, you stretch the payments out over 15, 20, or 30 years, which lowers your monthly payment but increases the total interest; this can double the full amount that you're paying back.

Graduated repayment is similar, except the payments start smaller and get bigger over time. You can compare repayment options for the same loan using this calculator.

Income-based, income-sensitive, and income-contingent repayment: These special plans allow lower-income graduates to repay loans based on their income, rather than a fixed amount. Income-based repayment becomes available to all lower-salaried borrowers starting in 2009.

Consolidation: Consolidation means combining your loans for each year of school into a single loan with a single interest rate. Consolidation can simplify your repayment process and maybe lower your monthly payments, but it may not save money on the interest. These loans are becoming less widely available due to the overall credit crunch. If you have at least one direct loan, you can consolidate into the Federal Direct Loan Program, which has some more borrower-friendly policies.

Deferments and forbearances: Deferments and forbearances involve putting off your loan payments because of illness, unemployment, graduate school enrollment, or other economic hardship. You must apply in writing to your lender and be able to prove your income. These are granted one year at a time for up to three years.

Prepayment: Finally, you can "prepay" both federal and private student loans without penalty. If you send in an extra or higher payment, it should always go toward the principal, and you must include a note to that effect with the check, or the money will be applied to your next month's bill. Prepay your higher-interest loans first.

Ben, class of '06, asks:

What are some affordable financial advising firms for post-college professionals? And how much risk should young people take in their investing strategy, assuming that there is no immediate need for the money?

If you want good investment advice that is both objective and personalized, I would suggest turning to a Certified Financial Planner. Find one who charges a flat fee or a percentage of your portfolio (typically 1 percent) rather than working on commission.

Many are thrilled to help young professionals and don't even charge for an initial consultation, and you can learn a lot from just one or two sessions.

Look for someone who is teaching a workshop at your local community center, college, or professional organization. Or go to the Financial Planning Association Web site.

And there are two aspects to investing: the bread-and-butter retirement planning and the more fun stuff. First, I would ask that you max out your 401(k) and/or IRA contributions and choose a strategy that will keep costs as low as possible -- that means reducing your overall number of transactions, rebalancing no more than once or twice a year. In your 20s it's fine to make your portfolio 100 percent stocks (in no-load index funds, of course), and if your risk tolerance is on the high side, you can buy more international and emerging-market stocks.

Finally, Sarah, '08, asks:

I'm just wondering how people deal with paying back student loans, saving money for the future, and still coping with all the costs that come with just graduating, like having to relocate for a new job and other expenses.

I would recommend checking out an online community of 20-somethings where you can share successful strategies with others in the same boat, such as wesabe.com, iwillteachyoutoberich.com, or Qvisory.org.

Also, go online and automate as much as you can. If your student loan payments, plus at least $50 into savings and $50 into a Roth IRA (more if you can afford it) are automatically deducted from your checking account each month, you'll have taken care of the most important financial priorities without having to do a lick of painful budgeting. You won't be tempted to spend the money if it's not in your account.