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Our Facebook and Twitter followers were asked to submit their most urgent personal finance-related queries. Now John Ulzheimer, a Credit Sesame expert, weighs in.
According to the Federal Reserve Bank of New York, about $1 trillion in student loan debt is currently held by millions of former college students. This number is at least $200 million higher than the total amount of credit card debt our country owes. Additionally, even while paying for a college education can lead to a career that is more financially rewarding, the idea of having a debt of five figures in student loans can be daunting.
I have consistently argued that debt is debt. Some claim that debt can be divided into two categories: good debt and bad debt. Student loan debt is best referred to as hybrid debt because it is easily classified as both “good” and “bad” debt.
Student loans are installment loans, just like a mortgage or car loan, so you’ll have a set payment for a certain amount of time. This is crucial because installment loan debt that is responsibly managed can be forgiven by credit rating systems. In the past, installment loans had a lower default rate than other forms of debt. As a result, it is possible to have very high installment debt levels and still have excellent credit scores.
Additionally, student loans are used to pay for schooling. There truly is no disputing the fact that a college degree opens up career and earning opportunities, even though college tuition and student loan debt have increased dramatically over the previous 20 years.
Finally, you can usually deduct the interest you pay on student loans from your taxes. Additionally, such interest rates are typically quite modest. The holding of student loan debt so at least partially offsets your taxable income. You cannot make that statement regarding credit card or vehicle loan debt.
A bad debt
Both the case for “good debt” and the case against it (that student loans are “bad debt”) are rather strong. First of all, you are still obligated to repay your student loans even if you do not complete your degree program.
Second, it’s not legally possible to discharge most student loan debt in bankruptcy. If you find yourself in a tight financial spot, you might be able to pay off all of your credit card, mortgage, and auto loan debt, but not your student loan debt. Either you will repay it or you will pass away with it.
According to the Fair Credit Reporting Act (FCRA), depending on the item, the majority of negative information stays on your credit report cards for seven to ten years. Student loans are the only issue that the FCRA does not address. The Higher Education Act, which states that student loans can remain on your credit reports until they are paid, governs how long a defaulted student loan can be on a credit record.
Finally, it’s incredibly simple to accumulate significant student loan debt. A person under 21 cannot obtain a credit card due to the CARD Act, but there is no rule that forbids an 18-year-old from accruing student loan debt. How can an 18-year-old be responsible enough to conclude that spending $20,000 year for the next four years is a wise financial move when they aren’t even responsible enough to acquire a credit card?
Interest rates for student loans
Due to the rising expense of college, students who are unable to pay their tuition with only federal loans have few options except to turn to private student loans, which can be extremely expensive.
Private student loans are based on the applicant’s credit score, whereas government student loan rates are based on the 91-day Treasury bill (currently 6.8% for Stafford loans and 7.9% for PLUS loans). (And since the majority of college students cannot obtain private student loans based solely on their credit, they must enlist their parents as co-signers.)
According to Finaid.org, private student loan interest rates can reach double digits because they are connected to the LIBOR plus a margin that can be as high as 14.25%. Borrowers who would only be eligible for the highest private student loan rates due to their credit ratings should give serious consideration to the prospect of repaying a debt that might ultimately be more expensive than their credit card debt. and the fact that student loan debt cannot be canceled in bankruptcy, in contrast to credit card debt.
Which leads us back to the original query: Was it worthwhile to take on all that debt?
What Is “Worth It”?
Will you be able to earn enough after college to repay these loans quickly? is the main question that determines whether student loans are “worth it.” Here, the easiest rule of thumb is that you shouldn’t borrow more money than your anticipated yearly beginning wage. With a median beginning income of $32,400 per year for elementary school teachers, according to Payscale.com, borrowing $80,000 for four years of college would not make financial sense.
As you can see from the example above, your major (and the industry you choose to work in after graduation) have a significant impact on your financial future. Although you could be interested in urban sociology and Renaissance art, these majors don’t initially pay very well. According to PayScale’s 2011–2012 College Salary report, the majority of the highest-paying college majors are in engineering, hard sciences, computer sciences, mathematics, and business.
Different Ways to Avoid the Student Loan Trap
There are other options for people who desire to broaden their personal and professional horizons than piling up mountains of student loan debt.
Community colleges give you the chance to complete your general education needs on the cheap or learn about topics of interest without going over your budget. You can save tens of thousands of dollars by attending a community college for two years before transferring to a four-year university.
Technical and career institutions provide specific professional training, which is frequently a more surefire route to work than a typical four-year college degree. While certain technical professions are in decline (such as machining), others are expanding (such as computer-aided drafting and design), and yet others are constantly in need of new talent (welding). The Department of Labor has identified the health care industry as having the fastest economic growth, and it offers a wide range of professions, from those requiring one-year certificates or two-year associate’s degrees to those requiring advanced medical degrees.
Instead of a constant buildup of debt, apprenticeships offer on-the-job training and remuneration. The majority of apprenticeships take place in manual and technical trades, while some of those professions, including ironworker, operating engineer, and HVAC technician, can pay well and present good career options.
You can decide if a college degree is good for you by carefully budgeting for it and evaluating your life goals. You can also figure out how to pay for it.
But what if you’ve already borrowed money for college?
The average college graduate owes around $29,400 in student loans, according to the Institute for College Access & Success’ Project on Student Debt. According to the Federal Reserve Bank of New York, more student loans than any other type of household credit are 90 days or more past due—nearly 12 percent of them.
There is no doubt that student loan borrowers need assistance with their debt, but is refinancing the solution? Possibly.
Similar to refinancing a mortgage, you have a better chance of getting a reduced interest rate if you have good credit and a high credit score.
Refinancing isn’t appropriate for everyone as a result. If you have bad credit, it’s doubtful that you’ll be approved for a refinance; even if you are, you won’t get a better interest rate than you could currently have. In that situation, it is advisable to continue with the loan conditions you now have.
However, if you have decent credit, you should only think about refinancing your student loans if the interest rate will go down. After all, you could easily lengthen your loan to reduce your monthly payment (in which case your interest rate might stay the same or even go up), but doing so would wind up costing you more in the long run.
A word of caution: Be sure to take into account the protections you might be sacrificing when refinancing your student loan. Refinancing a government debt converts it into a private loan, preventing you from being eligible for an Income-Based Repayment Plan or the Public Service Loan Forgiveness Program or from having the loan forgiven. It’s also crucial to keep in mind that the majority of government loans have fixed interest rates that won’t fluctuate over the course of the loan, but private loans frequently have variable rates that could rise at a later date.
Be aware that not all lenders provide this option if you’re wanting to refinance a private student loan. The Education Refinance Loan was first made available in January by RBS Citizens Financial Group, which also owns Citizens and Charter One banks. You don’t have to be a client of either bank to apply for this refinance, which is fee-free for borrowers and offers a fixed interest rate as low as 4.74 percent (the variable rate starts at 2.9 percent). Although it appears to be a terrific deal, there is a catch. Only debtors with private loans qualify. (Those who have Direct loans or Perkins loans are ineligible.) Both federal and private loans may be refinanced through SoFi, a financial firm that specializes in student loans, and major bank Wells Fargo also provides this option with their Private Consolidation Loan product.