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YOUR MONEY | FAMILY FINANCES / KATHY M. KRISTOF

Grads Should Do Homework Before Picking Loan-Payback Plan

June 16, 1996|KATHY M. KRISTOF

There may be an ominous strain running through the pomp and circumstance of this college graduation season.

That's because graduation day sets the clock ticking on student loan repayments, which generally start six months after students leave school. And never in history have students been quite so indebted.

Indeed, the number and size of student loans have exploded in the last four years, says David Merkowitz, spokesman for the American Council on Education in Washington.

The number of student borrowers has soared 53% since 1990, and the amount borrowed has more than doubled to $27.1 billion. A student who borrowed the average amount over the last four years is now graduating more than $13,000 in debt. And the debt burden is rising. In 1995, the average student borrower secured a $3,948 loan--just for the 1995-96 academic year. And many students take more than four years to graduate.

However, thanks to increased competition for the government-backed student loan business, graduates have a wide array of choices to ease their repayment burden. Moreover, a handful of lenders have instituted cut-rate programs that can save you thousands of dollars over the life of the average student loan.

Savvy graduates can use their six-month grace period to investigate the options and figure out which one will prove most advantageous.

The tricky part is that your options, to some degree, depend on who owns your loans. However, if you're not wild about your lender, you can sometimes switch by asking the lender to sell your loans to a secondary marketer, such as the Washington-based Student Loan Marketing Assn., also known as Sallie Mae, or by securing a consolidation loan with another company.

The vast majority of student loans are held by just four organizations: the government, through its direct-loan program; Sallie Mae; New York-based Citicorp; and New England Education Loan Market Co., or Nellie Mae, a nonprofit student lender based in Washington. (Chase Manhattan previously ranked as the nation's third-biggest student lender, rounding out the top five. But Chase recently merged with Chemical Bank and sold its student loan portfolio to Sallie Mae.)

They all offer four basic repayment options: a level-repayment plan, in which your payments stay the same for 10 years; a graduated plan, where the payments start low and rise gradually; an income-contingent plan, where the payment is based on the amount of money you're currently earning; and a loan-consolidation program, which allows you to refinance all your federal student loans and stretch the payments out more.

All federal student loans also offer payment deferrals for people who can't find work or who go on to graduate school or have an economic hardship that makes it impossible to start paying right away. Deferrals give you more time until payments are due; however, interest continues to accrue on unsubsidized loans.

By and large, the government offers the best deals for cash-strapped borrowers who have a lot of debt but are going into a low-paying profession. Specifically, the government's income-contingent loan program will stretch payments over periods as long as 25 years. If you can't pay off the balance in that period, the remaining balance is forgiven. But you have to pay tax on the amount you didn't pay--debt forgiveness is considered a taxable gift. (Also note that student loans cannot be discharged in bankruptcy.)

Although the other lenders also offer income-contingent programs, they all expect the loans to be paid in full, usually in 15 years or less. As a result, monthly payments are likely to be higher.

Many students are drawn to the income-contingent program because with the possibility of low monthly payments, it appears the most advantageous, experts say. But over the long haul, it can cost thousands of dollars more.

For example, Nellie Mae examined the total amount due from a borrower with $15,000 in loans who chose a standard level-payment plan lasting 10 years and compared that with someone who chose an income-sensitive plan that lasted 15 years. The level-pay borrower paid $183 per month, for a total of $21,839. The income-sensitive borrower's initial payments were $100 per month, but gradually rose to $236. In the end, the income-sensitive borrower paid $29,740--$7,901 more than the level-pay borrower.

Why so much more? Your interest charges are based on the unpaid balance each month, and when you choose the income-contingent program, your unpaid balance remains high for a longer period. Indeed, in some cases, initial payments may be set so low that your monthly payment won't cover the interest portion of the loan.

"Students might look at this and think, 'I want lower payments now,' but by spreading it out, they will pay much more over the life of the loan," says Sandy Baum, professor of economics at Skidmore College in Saratoga Springs, N.Y.

Of course, you can always pay off your loans early--generally without any penalty.

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