USA TODAY International Edition
Student loan strategy can backfire
Tempting as it is to hit a pause button on student loan payments, it’s a move that could trigger financial grief – especially if you do it repeatedly.
Borrowers who frequently seek a deferment or forbearance to suspend student loan payments for a time often have a hard time getting back on track. Many end up owing more than their original balances in the long run.
It’s an important warning to consider as we enter “repayment season” where recent college graduates and families start paying back their federal student loans after the end of a sixmonth grace period. Borrowers have options; they just need to make the right moves now.
A new report from The Pew Charitable Trusts offers insights when it comes to showing how some college borrowers make the wrong moves that could drive them into default. The report, released
Nov. 6, focuses on in- depth interviews and data from borrowers in Texas, a deep dive that’s not available at the national level. National benchmarks offered more data as well.
Every year, 1 million student borrowers default on nearly $ 20 billion in federal loans. Defaulters are more likely to be older and many have trouble getting out of default, according to a report from the Center for American Progress.
A federal student loan enters default when a borrower fails to make a payment on it for 270 consecutive days, according to the center’s report.
“When this happens, the borrower’s
Defaulting on a student loan is serious business because it triggers hefty collection fees, garnishing of your wages, the possibility of the federal government taking your tax refund.
loan is transferred from the student loan servicer – a private contractor responsible for collecting payments on behalf of the federal government – to the Debt Management Collections System. Borrowers then have 60 days to come to a repayment arrangement with the Education Department. If no agreement is reached, the loan is transferred to a student loan debt collector.”
Defaulting on a student loan is serious business because it triggers hefty collection fees, garnishing of your wages, the possibility of the federal government taking your tax refund to cover past- due student loans, and even ineligibility for some other programs, such as help with home ownership.
But taking the wrong road to avoid default also can end up harming some students.
Texas borrowers tend to lean more heavily on student loans to pay for college than students nationwide. Borrowers in this group entered repayment during and shortly after the Great Recession when jobs were tough to find and starting salaries were low. Even so, the experience of this group has some takeaways.
Those first payments can foreshadow trouble
About a quarter of borrowers defaulted within five years of starting to repay their student loans, based on the Texas data. Most had tried to deal with their overload of debt by suspending payments through deferment and forbearance. Many, of course, are told that stopping or reducing their payments could help avoid default. It didn’t help in the long run in many cases.
Sarah Sattelmeyer, manager of Pew’s project on student borrower success, said borrowers who repeatedly used deferment and forbearance to deal with debt that they couldn’t afford ended up with student loan balances that grew over time.
For some, a better option could be dealing with longer- term challenges by trying to lower monthly payments through an income- driven repayment plan.
The Pew study showed that many of those who suspended their payments had showed signs of potential distress almost immediately.
“When you’re earliest in your career, it’s often when your income is the lowest over the course of your career,” said Will Sealy, co- founder and CEO of Summer, a New York- based startup that offers software to help borrowers keep track of their student loans.
The Summer online platform guides borrowers through their repayment options, helping them enroll into the best savings plans digitally.
College grads can sign up for free at www. meetsummer. org.
Sealy, who previously worked with the Consumer Financial Protection Bureau on student debt issues, said the federal government provides incomedriven repayment plans, which are intended to help people.
But it can be difficult for people to navigate the best option for their situation.
Yet it’s important that they spend time investigating the overall costs and options of such plans, he said, in order to avoid future missed payments and default.
“You can fall very quickly in a very unforgiving direction,” Sealy said.
Your student loan debt can easily go higher
After five years of repayment, about 21% of borrowers ended up owing more than their original balances, according to the Texas data. Debt grew as borrowers paused payments repeatedly for several years.
“Among borrowers who owed more after five years in repayment, a third had balances of 125% or more of their initial principal,” according to Pew’s research.
So if you started out owing $ 30,000 in student loans, you could soon owe $ 37,500 after five years in repayment.
Not all borrowers face the same risk
Borrowers who owe less than $ 10,000 but didn’t complete a degree default at higher rates. Borrowers of color, particularly African Americans and first- generation students, face default at higher rates than their peers.
To be sure, there are good reasons for seeking a deferment. Most borrowers who use deferments do so while enrolled in school, unemployed or facing financial hardship.
The U. S. Department of Education has made a new deferment program available to those undergoing cancer treatment, for example.
Borrowers who qualify for a deferment or forbearance typically can postpone payments for up to a year at a time.
One of the big red flags for trouble, though, is trying to address longer- term issues with what should be a short- term option.
Many times, borrowers aren’t getting much guidance about their repayment options before struggling to make payments. Some aren’t aware of longerterm repayment options, such as income- driven repayment plans, which could help them stay on a better track.
And some may be getting bad information.
“According to federal law, schools may lose their ability to participate in federal student aid programs if a significant percentage of their borrowers default on their student loans within the first three years of repayment,” according to a 2018 report on default rates by the U. S. Government Accountability Office.
“To manage these three- year default rates, some schools hired consultants that encouraged borrowers with past- due payments to put their loans in forbearance, an option that allows borrowers to temporarily postpone payments,” the GAO report stated.
“While forbearance can help borrowers avoid default in the short- term, it increases their costs over time.”
Some grads need to make decisions now
College graduates receive a sixmonth grace period before they have to start paying down their federal student loans. Most private loans offer a six- month or nine- month grace period. Getting a diploma in May means many will begin to repay those loans in November.
The U. S. Department of Education outlines a variety of repayment options – and has a repayment estimator – at StudentAid. gov/ repay. You have to enroll in these plans to take advantage of them, and you have to pick the right one to fit your circumstances.
Sealy maintains that the Summer calculations at www. meetsummer. org offer a more accurate look at estimating the total costs of any repayment program based on wage growth expectations.
Income- driven plans offer lower monthly payments that reduce the likelihood of missing payments, he said.
At the same time, he said, an income- driven plan can free up muchneeded money to help someone cover medical costs, invest in retirement savings and start saving to maybe one day have children and buy a home.
Based on the latest data, the student loan default rate nationwide was 10.1% for fiscal year 2016. The Department of Education calculates a cohort default rate – the percentage of borrowers who enter repayment in a given fiscal year who then default within a three- year period – for each school to hold them accountable for high default rates.
The U. S. Department of Education released borrower default rates by state in August. The borrower default rate in Michigan was 11.5%. States with higher rates included Nevada ( 18.1%), West Virginia ( 14.6%), Mississippi ( 14.9%) and Indiana ( 14.2%).
States with lower rates included Massachusetts ( 5.8%), Vermont ( 6.1%), Rhode Island ( 6.2%) and North Dakota ( 6.2%).
A better option could be dealing with longer- term challenges by trying to lower monthly payments through an income- driven repayment plan.