The biggest student loan nightmare stories are often a result of simply not knowing enough about student loan debt and the options that are available for repayment. Staying informed is the key to staying above the red, especially as the number of graduates who have defaulted on their student loans continues to soar. The good news is that there are some disasters you can avoid if you know when to maneuver and when to go another route.
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Don’t become chained to your student loan payments. Here are four examples of what to avoid and how to do it.
1. Income-based repayment will force you to pay thousands in a one-time tax. Income-based repayment looks like a good option on the surface: Instead of paying monthly increments which may be more than you can afford, the government decides how much you owe each year depending on your projected income. About 15 percent of your estimated salary for the year becomes the total of debt you are required to pay off and after up to 25 years, the rest of the debt is forgiven. The problem is that the federal government still taxes forgiven debts in a large, one-time tax payment. For those who have post-undergraduate degrees and six figures of debt, for example, this tax would likely amount to a five-figure sum, requiring payment immediately.
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2. Student loan debt could prevent you from buying a house. Although student loan debt doesn’t affect your credit score, it is calculated in your debt-to-income ratio — an important measure taken into consideration when banks decide if they will give you a mortgage or not. If you know homeownership will be important to you down the line, consider a faster repayment method so the amount of debt you still have will be lower when you look to secure a mortgage.
3. Co-signers take a credit score hit too. It’s honorable that you would try to do the right thing and help a child or grandchild out with their loans. But know that as the cost of education continues to rise, the default rate is higher than ever. Graduates with debt will take a credit score hit if they default, and so will any co-signers on the loan. And if you aren’t financially prepared to save both of you from that disaster, don’t sign on. Baby boomers and senior citizens have their own important costs, like retirement, to worry about and fund.
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4. High interest will drive up the total amount owed after consolidating private loans. The main benefit from consolidating is that you will have one monthly payment instead of scattered bills that can fall through the cracks. Consolidating will also decrease your monthly charges, although it will increase the amount of time you will spend repaying the loans, and thus the amount you pay in interest. Private loan companies are known for sky-high interest rates that can tack on thousands to your total debt. One way to avoid this, according to the nonprofit FinAid.org, is by consolidating your loans when your credit score has significantly improved by 50 to 100 points. Because private loan interest rates depend on your credit score, you should consolidated at an optimal time, like after working at a good paying job or improving your credit history, to snag a better rate.
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