I recently had a chat with a young woman who was a great student with many skills, but she couldn’t move ahead financially because of her college debt.
Had she known how much these loans would have held her back as she now struggles with her repayments, she said she would’ve never borrowed the money, which she used to cover student housing expenses.
This is the time of year when many families are pulling together college applications. But how many are looking at the total cost of college down the road if they have to borrow? You need to ask some basic questions before you even apply.
The most important piece of one’s higher education should involve becoming “debt-smart.” Know how much debt will cost you in the future, not just in terms of monthly payments, but in total interest and how that debt could prevent you from living the life you want.
Being debt-smart now means running the numbers before you even consider loans, although few do this.
According to a recent report by the Global Financial Literacy Excellence Center (GFLEC), “student loans have the highest delinquency rates out of all consumer debt products.”
Why are graduates increasingly not paying back their loans? In many cases, they didn’t find jobs that would pay enough to cover their repayments in addition to basic living expenses such as food, rent and insurance. Such was the case with my young acquaintance.
The flip side of this problem is not being debt-smart.
If you don’t project how much your repayments will cost you in terms of monthly amounts over time, you can’t have a realistic budget for living on your own.
More than half of those surveyed in the GFLEC study said they hadn’t even figured out their monthly payments before they took out their loans. And if they had a chance to go back and revisit their borrowing decision? Some 53 percent said they would make changes.
This debt knowledge gap hurts graduates in the future. Only half of those surveyed said they were on time with their payments. Two in five said they were behind at least once over the past year.
“Evidence thus far shows that many borrowers are unprepared,” the study noted, “when taking out their student loans and not fully aware of the debt burden they are assuming.”
Of course, the lack of “financial literacy” has led to plenty of hand-wringing. But being debt-smart is about early intervention with some simple information when students are in high school. Along with math, English and driver’s education, students should be required to know how to calculate future debt obligations (which should also be a standard piece of the college selection process).
The remedy is straightforward, and all of the necessary information is free. It just needs to be on the table when families apply for college and consider financing options. Here’s what everyone needs to know:
When applying to colleges, target those that are more likely to offer grants over loans. To qualify for an all-grant program, you need to find a university with a “no-loan” policy. If you meet certain income and asset hurdles, you won’t be saddled with debt. Edvisors.com has a list and some background information.
If you need to borrow, look at all of the options. Favor federal loans over private borrowing. Pick the best loan package at the lowest cost -- but only after asking the college to replace loans with grants, tuition discounts, work-study and scholarships in the aid offer. Understand the different types of loans and how and when they will be repaid.
Know all of the income-based repayment options. Explore all of the federal loan program’s income-based repayment plans. If your post-graduate income isn’t adequate, you can actually lower your repayments. There are four basic options to explore.
Know how to take advantage of the flexibility of loan programs. If you enter a public service profession, for example, you can have your loan balance forgiven after 10 years. You can also consolidate loans to lower your overall interest payments and refinance private loans.
Do the Math! With countless free loan repayment calculators available, there’s no reason not to. The numbers don’t lie. For example, say you were to borrow $20,000 over five years at 6 percent annual interest rate. That would translate into a $387 monthly payment, or $4,644 per year. Could your aftertax salary handle that payment and still allow you to live (and save money)?
To get a good picture of how much a loan will cost after you graduate, look at monthly repayments plus living expenses in the city of your choice. That’s the real big financial picture for any future graduate.
Ultimately, being college debt-smart also means something even more important in the future: The ability to qualify for low-cost credit. You probably want to buy a new car, home and appliances.
If you get in over your head now with student debt -- and default on your loans -- it will damage your ability to get credit in the future. Those with the worst credit records pay the highest rates for financing.
A little preparation and knowledge go a long way. Those who get debt-smart now will be enjoying their wise decisions later.