NEW YORK (MainStreet) —Have you ever wanted to change a stranger’s life? That was what happened to me one night over beers with some colleagues from firm. When our waitress overheard that we were all practicing attorneys, she mentioned that she was applying to law schools herself and asked if we had any advice.
“Yes,” my friend Kate said. “Don’t go.” Our waitress laughed. We did not.
According to a recent article in the Chronicle of Higher Education as many as six out of ten lawyers urge young people to stay away from their profession, and in the four years since graduating myself, I’ve only ended one conversation by telling the applicant he’d made a good decision. Yet most of us continue to practice anyway, grinding away at the very job from which we so strongly urge others to save themselves. Why is that?
In a word, debt. Nationwide student loans are crushing young graduates, pushing back plans to buy homes, start families or take professional risks. According to the nonprofit group American Debt Assistance, nearly 37 million Americans have outstanding student loans, and the problem is growing. Debt manager Steve Blutza of the Chicago-based Heartland Financial Services says that he’s seeing student debt become an increasingly large section of his practice, particularly as more and more loans are privatized.
“If it’s federally guaranteed, we can pretty much guarantee they’ll walk away with a smile,” Blutza says of his work helping people with student debt. “Even if they’re in default, with federally guaranteed loans we can pretty much make them virgins again.” With private loans, however, “it’s a different ball game.”
So what can we do?
For many of us, the answer usually boils down to throwing more money in the hole and hoping to fill it up. This isn’t fun, or even necessarily economically efficient, but it’s clear and stops the collection calls for another few weeks. Happily there are better solutions out there than just pay and pray, ways to make your student loans maybe a little bit more manageable over the long haul.
Over the last several years the lending industry has taken a huge hit, and the upshot is that interest rates have plunged on everything from credit cards to mortgages. Even the Federal Reserve’s “prime,” the rate by which most of the marketplace is set, has dropped to historic lows. Unfortunately, and in many ways unsurprisingly, student borrowers have been largely left out of this windfall. We continue to pay approximately twice as much as the average mortgage, and we borrow at almost three times the rate of the government.
This is where refinancing can come in, a process by which you renegotiate the interest on a loan, or have a third party purchase it outright at a lower rate. Considering how much money gets sucked down by interest, the right refinancing package can save you thousands of dollars over the lifetime of a high value loan.
Unfortunately this can be tricky for student debt and won’t always be available. Right now the government doesn’t allow borrowers to renegotiate federal loans without consolidation, discussed below, but your private lender might. If a large portion of your debt comes from these third parties, it’s worth a phone call to find out what your options are. After all, what works for a speedboat can work for a medical degree, and a few points off that interest rate will make a very real difference in the long run.
Consolidation is similar to refinancing but with the bonus of added convenience.
With loan consolidation you roll all of your existing debts into one simple, if horrifying, monthly bill. Instead of having to keep track of multiple separate bills each month, and running the risk of late fees by missing one, you have just one payment to make. Potentially more important in the long run, consolidation can also help reduce your interest rate. Like refinancing, this tactic functionally replaces old debts by taking out a new one in their place, and sometimes that can come at a renegotiated rate. It’s a strong option for graduates looking to manage their debt, according to Butza.
The Department of Education addresses consolidation directly on its website. It has an established program that’s a common way for people to turn their pile of multiple debts into one, easier to manage system. Consolidating federal loans can also lower monthly payments by extending your plan to as long as 30 years, although that means you’ll end up paying more in interest over time. Still, if you’re more worried about making rent next month than the state of your 401k, a long payment plan might not seem so bad.
Income Based Repayment (IBR)
For a generation of students not quite ready to give up on their hopes of becoming a starving artist, or journalist as the case may be, IBR might just be the answer that far too many people overlook. As the name suggests, Income Based Repayment is a program that fixes payments to your earnings. The less you make the less you pay, and done right it can work wonders.
First, the caveats: IBR is not for everyone or every debt. You can only join if the monthly payments would be higher under a 10 year Standard Repayment Plan than with IBR; in other words, you have to fall below a certain income to qualify. It also only works for the Federal Direct Loan and Family Education Loan programs, so nothing private. Finally, any loans currently in default aren’t eligible for the program, so if you’ve fallen catastrophically behind you’ll need to catch up first.
Now here’s the good news. Under IBR your monthly payments get capped at 15% of discretionary income for the next 25 years, after which the entire debt is forgiven. “Discretionary” is a key word here, since payments weighted by income and family size will likely be somewhat less than 15% in reality. Interest accrues, but if your plan won’t pay both the principal and the interest the government subsidizes your interest payment.
Roberta Frick, Director of Student Finance at the University of Connecticut Law School, advises borrowers to consider not just how much they earn but what that income is relative to debt when evaluating IBR.
“[It’s for] when their expected income is going to be very law compared to their debt,” Frick said. “Even if a student makes $70,000 their first year out of law school, if they have $120,000 in debt, the income based repayment might be a good option.”
The fact that you can change plans annually helps this analysis, Frick said, since students can enter or leave the program as their circumstances change.
Still, no good thing comes for free. While pegging your monthly payments to income does make them considerably more manageable, remember that it will still take a quarter-century before those loans are gone for good. You’ll probably be paying off debt when your children enroll in college. That lengthy plan will also let a lot more interest add up over time, meaning more money that never touches former tuition. Finally, and I can’t stress this enough, it won’t help you out with any private lenders, so make sure your loans are federal before making a plan.
That said, IBR is an excellent program for people worried about how they’re going to follow their dreams without defaulting on their loans. You might not want to keep writing checks for the next 25 years, but as a way to ease the pressure next month it might be just what the doctor ordered.
Under graduated repayment, your loan is restructured to a lower payment that increases steadily every two years. Payments are calculated based on your income, and can go as low as just the interest on the loan if need be. Like IBR, Graduated Repayment is a federal plan, so it only applies to public loans not private. It’s largely an unpopular program, according to Frick, as students opt more and more for either income based repayment or loan payment in full.
“Most people want to be [on the Standard Repayment Plan] obviously, because they can pay it off in ten years, but some people just can’t afford it,” Frick said, noting that she sees fewer and fewer people opt for graduated repayment.
Still, she noted, it’s an option worth at least considering for people who are in a difficult position but anticipate things getting better. It allows a borrower to keep on top of their interest, while at the same time making life easier with reduced payments.
This is a small issue, but taxes still bear mentioning. According to the IRS, interest payments on a student loan are tax deductible up to $2,500. It may not mean much depending on what you pay in taxes these days, but it’s money on the table and a lot of people leave it there.
Last but not least, many lenders offer benefits for borrowers who subscribe to various payment programs. The most common are rewards for switching to electronic statements and automatic bill pay. Systems like this save the lender money, since they don’t have to print out mailers or track you down every month, and they try to pass some of that along as incentive for you to sign up.
Usually the perk is a small adjustment to your interest rate, nudging it down by a quarter of a percent or so. Don’t laugh it off. Those numbers might seem small today, but over the lifetime of a loan that quarter percent can mean real money back in your pocket.
Plus, it’s that much less junk mail on the table every Friday.
Overall, Blutza and Frick agree that the best way to manage your debt is to stay active and have a plan.
“When a student leaves here we do offer individual counseling sessions,” Frick said of her law school. “We go over how much they’ve taken out, and I ask them what their plans are.”
“Don’t put your head in the ground and [think] maybe they’ll overlook me,” Blutza said. “It’s similar to a health kind of comparison. If you see a problem you’re going to go to a doctor. Better to do it sooner rather than later.