Avoid The Dark Side Of Debt: How Best To Take Out Student Loans

May 12 2014, 7:49am CDT | by

EDITOR’S NOTEThis post is adapted from the Forbes eBook, The Millennial Game Plan: Career And Money Secrets To Succeed In Today’s World, by Laura Shin. If you’d like to learn more about how to take out student loans, decide whether to attend grad school and/or find funding for grad school, the title is available now for download at Apple (iBooks), Amazon, (Kindle) and Vook (Nook, etc.).

Leeanne, a 31-year-old video producer who asked that only her first name be used, graduated from college with $20,000 in debt. One reason it wasn’t higher was that her parents had taken out loans themselves.

But her husband, Christopher, 28, who had been the first in his family to go to college, had more than $100,000 in loans—nearly all of them private loans, which are harder to pay back because they offer less flexibility.

With his $800 monthly loan payment and her $120 one, they were shoveling almost $1,000 a month toward their debt.

A few years after college, Christopher, who was working on HIV at a nonprofit, soon found that many of the jobs he desired required a master’s in public health. For a better and more fulfilling career, they decided that he should pursue one. The two-year program costs $50,000 per year, adding another $100,000 in loans to their debt. When he graduates next year, their monthly loan payments will be $1,720.

The burden is affecting all of their major life decisions. They’ve already delayed having kids for two years and will reassess how much longer they should wait next year, after he graduates.

“I keep crunching the numbers for the student loan monthly payment: Our rent, food, utilities, bus passes, etc., and adding daycare onto that sounds impossible! This is why we haven’t had kids yet. Every day I just want to cry. It’s so overwhelming and so stressful. My husband is working so hard in grad school right now to be able to get a good job because nowadays having just a bachelor’s degree isn’t enough—but who knows if he’ll even be able to find a job,” she wrote to me.

Their situation also underscores how difficult it is to dig out of debt. One common strategy to reduce payments consists of signing onto an income-based repayment plan, but these are only applicable to federal loans. It won’t help with the bulk of his undergrad loans. Then, the only way they can pay the loans is if they both work, but if they make too much money, then they won’t qualify. Finally a glance at the baby/student loan math shows they can’t afford daycare, but they also can’t afford for Leeanne to quit her job and stay home with the baby.

The debt has impacted more than their baby plans. “It’s in every single conversation about our future and about money,” she told me by phone. “Whenever we try and dream about the future, it always gets really bogged down and depressing, and the thought of buying a house is just impossible: ‘That’s not going to happen.’ And retirement—we’re both pretty smart and we know what we should be saving, but it’s like, how’s that going to happen? … We’re both very loving and accepting and we treat each other as equals—but there’s this thing where he feels guilty because he’s the one incurring more debt … That’s a thing that comes up: ‘I’m sorry that I’m burdening our relationship with more debt and more stress.’ The person with more debt feels bad, and it’s this weird, terrible underlying current to our entire relationship.”

Leeanne and Christopher aren’t atypical for their generation. Millennials, which includes adults born after the year 1980, are the most educated generation compared to previous ones, according to a February 2014 Pew report: Thirty-four percent of those ages 25 to 32 have a bachelor’s degree or more, compared with 25% of Gen Xers, 24% of Baby Boomers and 13% of the now mostly retired Silent generation at that age.

But, on the flip side, this cohort also has struggled more with student loan debt than previous ones. Student loan debt is at a record high. Seventy percent of college seniors graduate with debt while the average student loan debt is $29,400. From 2008 to 2012, debt at graduation increased 6% a year, according to the Project on the Student Debt.

As shown in Leeanne and Christopher’s story, the impact of debt isn’t confined just to one’s school years. It can affect every other major life decision, from buying a house to having kids to saving for retirement.

The lesson to learn from their story isn’t that all student loan debt is bad, but that it’s important to take on debt in a way that helps instead of hinders you in achieving your life goals. Here are five tips:

1. Avoid taking on debt that exceeds your expected first year’s salary.

This applies to student loans for both undergrad and graduate school. (When making the calculation for graduate school, including any remaining undergraduate debt you have.)

If your loan debt is more than that first year’s salary, you’ll struggle to make those loan payments and may need alternative payment plans such as extended repayment or income-based repayment. “And that stretches out the term of the loan to reduce the monthly payments, and you’ll be paying more interest over the life of the loan than you otherwise would and you’ll still be in debt when your own children go to college,” says Mark Kantrowitz, senior vice president and publisher of Edvisors, publishers of more than a dozen websites about planning and paying for college./>/>

2. When you have to borrow, go with federal loans before private loans.

Federal loans have fixed interest rates whereas private loans offer variable rates. Even if you find a low rate from a private lender, nothing will stop it from jumping the next month. Given how low today’s interest rates are, it has nowhere to go but up. A fixed rate will provide some predictability to your budget.

Federal loans also offer the advantage of a deferment period, in which the borrower doesn’t have to make payments such as when he or she is enrolled in school, unemployed, experiencing economic hardship or serving in the military, among other situations.

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3. If you decide you have to take out private loans, do so only after you have maximized your federal loans.

Keep in mind that if you need to take on a private loan to make up for any gap between your need and your financial aid package, you may be taking on too much debt.

It’s hard to compare private loans because they don’t do upfront pricing. “They don’t say, ‘This is the interest rate you’re going to get,’” says Kantrowitz. “You have to apply first, and then they’ll tell you what the interest rate is going to be. So, you should shop around.” The lender with the lowest advertised price may not offer you your best rate. They may offer you your worst rate.

4. If you attend school on student loans, live as cheaply as possible.

Live at home or with a roommate, don’t get a car and buy used textbooks—and then sell them at the end of the semester. If you’re under 26, stay on your parents’ health insurance, or forgo the meal plan and instead cook your own meals. Take prerequisites more cheaply at a community college before enrolling in the program.

5. Don’t forget the various education tax benefits. 

Make sure to get the American Opportunity Tax Credit, the Lifetime Learning Tax Credit or the Tuition and Fees Deduction, which give you a little bit of money back on your federal income tax return based on the amount you pay for your education.

Speaking of taxes, only the portion of any money you get that goes to tuition will be tax-free. “When you’re receiving money that’s a fee for services, like a [graduate] teaching assistantship, that money is taxable. Even the tuition waiver portion may be taxable. When you’re receiving a graduate fellowship where no services are required to receive that fellowship, only the amount for tuition and fees will be tax free. Any amount for living expenses is going to be taxable,” says Kantrowitz.

Education is usually a step toward a better life as long as it’s done right. If you decide to pursue the next level degree, don’t expect that it will take care of your future for you. Effort can and does reap rewards. As you would in the professional world, approach college or grad school as a place you need to prove yourself to others and as a launching ground for what will eventually become your full-fledged career. While the next step in education may seem like a large financial investment, you won’t realize the opportunities it dangles before you unless you also invest your time, energy and effort.

You can buy The Millennial Game Plan: Career And Money Secrets To Succeed In Today’s World,” at Apple (iBooks), Amazon, (Kindle) and Vook (Nook, etc.) now. Learn how to forge a career in a nasty job market, earn more, finance your own ventures, focus in an age of distraction, make the grad school decision and manage your money.

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