Repaying Student Loans In Tough Times

If you're having trouble with student loan payments, you're hardly alone. Default rates on such debt are skyrocketing as the recession continues to take its toll. But in this column, Early Show money maven Ray Martin spells out numerous possible approaches to copping with the problem.

As the recession drags on, folks with student loans are being hit especially hard.

Student loan defaults are at their highest rate in over a decade and are likely to head higher.

At the center of this "perfect storm" are high unemployment, lower-paying jobs and cutbacks in states' programs that had offered loan forgiveness.

And while federal student loans offer some payment relief and modification options, private loans offer fewer options and require repayment immediately.

Most students (65.7 percent) turn to loans to pay for some or all of their college costs. Studies report that undergraduate seniors at four-year institutions carry loans averaging about $22,500 for the four years.

One last-ditch option available for many other forms of debt -- discharge relief through bankruptcy - is not easily available for student loans. Folks at the end of their financial rope who have student loans must claim an "undue hardship" to seek bankruptcy protection from those loans. According to reports, there is a 50 percent chance of such a claim succeeding.

There is no statute of limitations for collection of student loan debt, and lenders have very strong powers to collect on defaulted student loans. For instance, lenders can garnish up to 15 percent of your take-home pay, seize your federal and state tax refunds and prevent renewal of professional licenses. For these reasons, paying back student loan debt is a financial priority.

There are also financial incentives for paying back student loans: You can deduct up to $2,500 in student loan interest even if you do not itemize deductions on your income tax return.

Folks having difficulty paying their student loans should not simply give up. Student loans offer more flexibility, delay and repayment options than any other debt and credit obligations. For example, folks with student loans can apply for deferment or forbearance (in which loan payments can be temporarily suspended due to hardship situations, such as unemployment). There are steps individuals can take to make the process of student loan repayment more manageable:

Talk to Your Lender: If you are struggling to repay your loans, speak to your lender before you stop making payments. If you default before contacting your lender, you may become ineligible for deferments or forbearance. Just ignoring the problem will make it worse, as interest will continue to accrue.

Consider Deferments or Forbearance: Lenders may offer deferments (for up to three years for federal loans and one year for private loans) or forbearance. For example, while in deferment, the interest on subsidized federal loans does not have to be repaid, but continues to accrue for unsubsidized loans. Under forbearance, you may be permitted to reduce or stop making payments for a set period of time, but the interest continues to accrue. These options should only be used for short periods.

Consider Income-Based Repayment: A new option, available July 1, 2009 for federal loans is the income-based repayment plan. Under this option, your payment is capped at 15 percent of discretionary income (defined as your income that exceeds 150 percent of the poverty line). Under this option, any loan balance that remains after 25 years of payments is forgiven. This option may be available even if you have already defaulted on your loans. This option may be suitable for borrowers with high debt, low incomes and very little possibility of ever getting a higher-paying job.

Consolidation Loan: One way to make your student loan payments more manageable is to consider a transaction called "loan consolidation," in which individuals with qualifying student loans can combine all their loans from various lenders into one single loan with a single lender. One of the main benefits of "student loan consolidation" is a smaller monthly payment, which is typically the result of stretching out payments over a longer period of time and receiving discounts provided by lenders competing for your loan.

Loan consolidation also provides for simplicity: You go from having to make payments to multiple lenders to making a single payment to a single lender on a single loan. Finally, you can also gain some certainty: When you replace all of your variable rate student loans with one single loan with a fixed interest rate, you'll have the certainty that your rate and payment will be fixed and will not change for the life of the loan.

Before you shop around for a consolidation loan, you'll want to check to see if this will save you on the interest rate - the rate of the consolidation loan is the weighted average of the variable rates on your existing loans, typically rounded up by the next eighth of a percentage point. Use the calculator tool at the Federal Direct Consolidations loan Web site to run the numbers for your situation.

Under consolidation loans, you will need to choose a repayment plan. There are four categories of repayment options that apply to most consolidation loan programs:

Standard Repayment Plan: This payment schedule provides for a fixed monthly payment for a maximum of ten years. This option has the largest monthly payment.

Graduated Repayment Plan: Monthly payments are initially set at a lower amount for the first several years (typically two-to-five years). After that, payments increase to provide for repayment over ten years. The concept is that you can begin with a lower payment, and after your income increases, your payments will rise. You will pay more interest over the life of the loan compared to the standard repayment plan.

Extended Repayment Plan: This provides for a fixed monthly payment schedule ranging from 12-to-30 years, depending on the amount borrowed. The monthly payment will be smaller than the standard repayment plan, but you will pay more interest over the life of the loan.

Income Contingent Repayment Plan: Monthly payments are based on the borrower's income, family size and total loan amount, and can be repaid over up to 25 years.

While loan consolidation for many may seem like a no-brainer, the repayment plan requires a little more thought. When deciding, consider this advice: Commit to a repayment schedule that allows for the payments to be no more that 15 percent of your monthly gross income. For folks with a high debt burden and low initial earnings - such as lawyers or doctors - this may be impossible. But also consider the possibility of rising income in your choice of repayment schedule.

If the higher payment of the standard repayment schedule cramps your cash flow, leaving nothing with which to pay down credit card debt or to contribute to an employer's retirement plan, consider the lower payments offered by the graduated or extended repayment schedules. The downside is that, if you never make additional payments on these extended schedules, you will have paid several thousand dollars in additional interest over the life of the repayment on a typical amount of student loans. But if your income rises later on and there is extra cash flow, you can make extra payments on your student loans early without any penalty, and save on additional interest.

The graduated and extended payment plans offer the payment relief of lower payments early on and the flexibility later to pay more when it may be more affordable to do so. But if you do not make larger payments later, know that while the extended payment option can make your payments more manageable now, it will ultimately cost more interest over the life of the loan.

Finally, if you cannot handle your current student loan debt, try to resist the temptation to delay dealing with your loans by going to graduate school and taking out even more debt to do it. Consider the economics of repaying more loans for graduate school on top of your existing loans and the amount of income you'll need to earn to be able to afford a reasonable repayment plan. And remember this -- an advanced degree does not always result in a higher paying job.