College graduates, do not delay in grappling with your student loans.
Almost all student loans offer grace periods that delay the need to repay for six months. So if you graduated in May, the automatic payment deferral probably evaporates this month, making it high time to start beating down the loan balance.
And you don't have to graduate for the payment clock to start — if you leave school for more than six months, the loans usually come due.
Because your student loans are likely to be your first significant foray into the world of credit, it's imperative that you handle these loans wisely.
"Screw this up and you'll pay for it for years," said Liz Weston, columnist and author of "The 10 Commandments of Money."
Missing even one payment can trash your credit score. And a bad credit score can lead to higher costs for loans, higher insurance premiums and trouble when attempting to get a job or an apartment. "You've got to get this right," Weston said.
What do you need to do?
• Organize your loans: The typical graduate carries $24,000 in debt, which can include an array of loans at various interest rates. You want to organize your loans into three categories: Private loans, subsidized federal loans and unsubsidized federal loans. Then rank them by interest rate.
The aim is to accelerate payment of high-cost loans and stretch out repayment of the low-cost ones. Private loans should be at the top of the repayment list, even if they seem relatively low-cost now, because they have variable rates and can become high-cost quickly if interest rates rise.
Most federal loans issued in the last four years had fixed rates. If you defer payment, interest will accrue, resulting in a bigger balance. However, if the federal loan was subsidized by the government because you qualified for aide based on financial need , it was probably issued at a lower rate. In addition, the government pays the interest on subsidized loans while you're in school or if you can't pay because of a qualifying economic hardship.(
The bottom line: Unsubsidized federal loans should be second on the repayment list. If you need to defer payment on any loan — or stretch out repayment — pay subsidized federal loans last and slowest if you have them.
To keep track of your federal loans, look up balances and repayment status in the National Student Loan Data System at http://www.nslds.ed.gov. This database does not include information on private loans — for those, you need to check with the individual lenders.
• Choose a repayment formula: Standard repayment amortizes loans over 10 years. But if you owe a lot of money, standard repayment may demand bigger monthly payments than you can afford. If so, there are other options.
An income-based repayment plan calculates monthly payments based on a percentage of your discretionary income. If you have no discretionary income, according to the formula, no payments are due. Also, any loan balance that cannot be repaid within 25 years of sticking with this program is forgiven.
But again, don't delay. If you default on your loan, it's not eligible for income-based repayment.
There are requirements for getting these plans. More information is at http://www.ibrinfo.org.
If you can't qualify for income-based repayment, you may be able to stretch your repayment terms over a longer period, such as 20 or 30 years. This reduces your monthly payments but will cause you to pay more interest overall, because you're paying the principal balance off more slowly.
On the bright side, if your financial picture improves you can make additional principal payments to retire the balance faster. But make sure you send your lender a written request to apply the additional payments to principal. Otherwise lenders will automatically apply those additional amounts to future payments, according to the Project on Student Debt.
• Avoid default at all costs: If you find yourself falling behind, contact your lenders immediately and put your loans into forbearance or an economic hardship deferral. If you let them go into default, the cost is a killer, said Mark Kantrowitz, an education consultant and publisher of financial aid and college scholarship sites FinAid.org and Fastweb.com.
If you go into default, federal law allows lenders to apply 25% of each subsequent payment to collection costs, Kantrowitz said. To make matters worse, you'll be paying the balance down more slowly and thus paying more interest.
A loan that would normally take 10 years to repay would take 19 years to repay after a default, he said.
And, of course, a default will trash your credit rating too, which will raise the cost of other loans, such as mortgages, auto loans and credit cards.
"It's unfortunate, but the people who are least able to pay get hit with the highest costs," Kantrowitz said. "Make sure you don't default."