Managing Student Loan Debt

At last, you graduated from school. The commencement ceremony was inspirational, and you looked picture-perfect in your cap and gown. You savor the exciting moment as you prepare for the next phase of your life. However, your excitement is short-lived when you receive a statement from the federal student loan servicer.

The Purpose of Student Loan Debt

If college is an investment, then interest on the student loan debt is an investment expense. Thus, just as an investment requires a hurdle rate – or minimum rate of return – to justify borrowing, so too must student debt. Student debt helps you pay tuition and invest in your career but needs to be repaid when you can afford it. Accordingly, choose a reasonably priced college and a degree that is in-demand so that the return of investment will enable you to repay the debt.

Understanding Your Student Loan Options

There are several repayment plans available to pay off student debt, and it is crucial to choose a plan that works for you.

• Standard Plan: The default payment plan is comprised of fixed monthly payments – with a minimum of $50 a month – for up to 10 years. Although this plan usually results in the least amount of interest, this plan is recommended only if you can afford regular monthly payments. If you’re eligible, you can extend the term of the payments for up to 25 years – which results in a lower payment amount but collectively more interest.
• Graduated Plan: A graduated payment plan is available where monthly payments are made over 10 years. However, the payment amount – which must exceed the interest amount – increases gradually over time. This plan is logical only if your monthly income is expected to increase over time. This plan can also be extended for up to 25 years, depending on eligibility.
• Income-Driven Options: Student debt can be paid gradually over 25 years with a payment amount that depends on factors such as your income, family size, and loan amount. This plan results in higher interest, and the monthly payment is adjusted annually based on your annual recertification. However, the remaining balance on the debt can be forgiven after 20 and 25 years.

Choosing Your Repayment Plan

Although carrying debt is a burden, it is not always prudent to pay off the student loan early. Student debt is low-interest debt, has flexible payment options, may be eligible for a tax break, and may be forgiven. However, student debt increases your debt to income ratio and may disqualify you from buying a home or financing a car. Also, student loans are generally not discharged in bankruptcy and will result in wage garnishment, withholding of tax refunds, and retention of Social Security retirement and disability benefit payments if you default on the loan.

• Pay off the debt: If you are in a strong financial position and do not borrow money to support your lifestyle (i.e., credit cards), then pay off the debt using the 10-year payment plan with accelerated payments. Note that there are no prepayment penalties on student loans.
• Don’t pay off the debt: If you do not have an emergency fund, do not earn enough to set aside money for retirement, or maintain debt other than student loans, then do not pay off the student loan early. Instead, opt for an income-driven option until you can afford to accelerate payments.

Paying Off Student Debt

Your plan to pay off student debt should include setting aside money to repay the debt – beyond the required monthly amount and signing up for autopay so that you don’t miss a payment. Also, capitalized interest should be paid off early – during the grace period – so that you don’t pay interest on the accrued interest. You can also refinance the loan at a lower interest rate through a private lender. Some providers reduce your rate if you enroll in an autopay option. Obviously, as with everything in life, living within your means and being fiscally responsible will help you rid your debt.

By Shulem Rosenbaum, Professor of Accounting at Touro and Senior at Roth & Company LLP