College students don’t always have a healthy relationship with credit. For instance, Stephen Swift (managing attorney for Southern Colorado Bankruptcy Law Firm) relates that bankruptcy attorneys are “seeing younger and younger clients who are seeking bankruptcy protection because they got in over their heads with credit cards.” Unfortunately, credit cards aren’t the only concern for students – in 2015, the average college student graduated with $30,100 in student loan debt; in 2016, 11.2 percent of student loan debt was in default or delinquent by 90+ days. Even more, the student loan situation is getting worse, not better. In 2005, the average student loan payment was $227 (when adjusted for inflation) – 10 years later, the average payment was 50 percent higher ($351).
A recent study conducted by Sallie Mae also highlighted some concerning statistics regarding the behavior and understanding of college students as it relates to credit cards.
- 35 percent of students use their credit cards “sometimes” or “regularly” to make purchases that they don’t have the money to pay off.
- Older students (21 to 24 year-olds) have an average balance of over $1,000 on their credit cards.
- Only 31% of college students demonstrated that they have a working knowledge of basic credit-related concepts. Only a slim percentage could answer all three questions that relate to interest accumulation, the effect that payment behavior has on the cost of credit, and the effect that the repayment term has on the cost of credit.
The study mentioned above also highlights a problem that stems from an overreaction to the abuse of credit – 44 percent of college students don’t use credit cards. When students stay away from credit all together, it leads to a general lack of credit history after graduation which is a big problem when it comes time to buy a house or a car. A lack of credit history can also magnify the impact of credit blunders on students’ credit scores.
Where Parents Fit In
Some parents may assume that their students will learn proper credit habits and financial behavior in college, but that assumption may not be correct. In fact, 71 percent of college students say they learned money management from their parents, and the percentage is higher (81%) for younger students. Only 12 percent indicated that they learned about financial management from a college course.
A University of Minnesota Professor points out that checks were the preferred method of payment just 20 years ago. “The use of credit cards is a learned social behavior, and parents play a key role in shaping their children’s credit behaviors.” Dr. Serido also notes that credit card companies target college students by inundating them with mailers and phone calls. “That’s why it’s important to talk to your students about how to use credit,” she asserts. “If you don’t, the credit card companies surely will.”
Overall, parents should help their students find the balance between misusing credit and staying away from it all together. No parent wants their students to graduate with a ton of debt that will haunt them for years to come. To help avoid this, parents can teach their students to view credit as a tool, and they can help them learn how to use it responsibly. Modeling healthy financial and credit behaviors and setting clear expectations are the best ways for parents to secure their student’s credit future.
The Purpose of This Guide
We wrote this guide to empower parents to help their college students (or young adults of similar age) transition to the real world by avoiding credit pitfalls and developing solid financial habits that will set them up for success.
Part 1: Personal Finances
Credit Reports and Scores
Only 50 percent of college students say that they have viewed their credit report. Additionally, only 50 percent of younger students (ages 18 to 20) are even sure that they have a credit report, and only one-third have actually viewed them. These statistics clearly indicate that many students don’t understand the importance of credit reports, and it implies that they don’t fully comprehend how their credit history impacts their credit score. Since most high schools and colleges don’t require students to take personal finance courses, most students rely on their parents to educate them about credit reports and scores.
The Difference Between a Credit Report and a Credit Score
A credit score is a numerical indication of how likely the consumer is to pay back a loan on time, while a credit report gives an in-depth look at the last 7 to 10 years of a person’s credit history. There are three credit reporting agencies (Experian, TransUnion, and Equifax) that keep records of consumer’s credit behavior, but there’s only one main credit scoring company (FICO).
What’s on a Credit Report
Credit reports list things like:
- Personal information (name, birthdate, etc.)
- The payment history, credit limit (or amount), and balance of credit accounts
- Records of collection activities
- Public records (liens, foreclosures, bankruptcies, etc.)
In general, negative items are removed from a person’s record after seven years, except most bankruptcies which stick around for 10 years.
How Credit Scores Are Determined
Credit scores are determined by running a person’s credit history through a model that applies different weight to certain aspects which indicate the risk of lending money to that person. While different companies can choose which factors to consider, they aren’t allowed to consider certain characteristics like gender, race, and religion. The primary credit score that students should be concerned with is the one that is determined by the Fair Isaac Corporation (FICO) since 90% of lenders use that score to evaluate potential borrowers.
The main indicators that drive a consumer’s FICO score are:
The Impact of Credit Scores on Day-to-Day Living
While certain side-effects of bad credit are obvious (such as high interest rates on loans or credit applications being rejected), there are other downsides to a low credit score that might not be immediately apparent to some. Poor credit can impact:
How Students Can Build Good Credit Quickly
Since most lenders’ viewpoint is that it takes several years to establish a pattern of positive credit behaviors, the sooner students get started building credit, the better. The following is a list of steps students can take to start building credit:
Note: Students should be especially wary of store credit cards – many times cashiers will pressure shoppers to open a credit account at that store for a chance to get a certain percentage off their shopping trips. Store credit cards can be a good way to build credit, but be wary of how many credit lines are already open, and how long it was since the last time a credit application was processed.
How Students Can Check Their Credit Reports and Credit Scores
First, know that checking credit reports and scores doesn’t hurt a person’s credit. Everyone is entitled to a free credit report every year, and the only legitimate source for that report is annualcreditreport.com. As was mentioned earlier, there are three credit reporting agencies that may have slightly different information.
Consumers are allowed one free report from each in a 12-month period. All three reports may be accessed at the same time, or a person can stagger requests for a report from each agency. While there are certain circumstances that allow for more free reports (like unemployment or identity theft), credit bureaus typically charge a small fee for each additional credit report within the 12-month time-frame. Credit scores are not included with free credit reports.
FICO’s score is the main credit score students should check since it’s used by 90 percent of lenders. Students should consider a credit card that comes with a monthly credit score update for free. It’s also possible that those with a credit card can get access to their credit score for free by activating that feature. Students should check with their bank or credit card company to determine if they qualify. Otherwise, a student’s FICO credit score can be purchased from myfico.com.
Students should check credit reports yearly, and credit scores as often as possible. Spending time with a credit report every year is advisable as that process can reveal errors (which should be reported to the credit bureau) and identity theft. If students have access to a service that provides credit scores every month, seeing an upward swing can help motivate them to work on improving their score. Checking credit scores often can also inform them if certain credit-related behaviors need to be adjusted.
Resources for Parents
Students who don’t budget are more likely to misuse credit, since they will be more prone to overspending, and then use credit to make up the difference when it comes time to pay the bills. Budgeting requires self-discipline and patience – when those skills are learned and practiced, the student’s use of credit will be more appropriate. Additionally, students who get in the habit of budgeting won’t feel as much pressure to use credit as a way to shortcut the savings process and immediately buy the things they want.
The Parent’s Role
Budgeting skills are hard for some students to learn, and they can easily give up on the whole idea if they become too frustrated by a lack of success or the work that is necessary. Parents can help their students by keeping them motivated, as well as assisting them in developing a budget.
If students are receiving financial support, parents can set the expectation that a budgeting needs to happen. Parents can also use their own life experiences (either good or bad) to model what effective budgeting does or doesn’t look like.
The Zero-Sum Budget
This budget is simple – students take the amount of money they earn each month and decide ahead of time how they are going to spend it. The goal is to determine how every dollar will be spent or saved, and then have “zero” left over. Students start by identifying their fixed expenses (bills), and then they create categories for their other expenses and track spending. Each month an updated budget is formulated.
This type of budget is best for working students who don’t live on campus and have to pay bills. Here’s what an example of what a simple Zero-Sum Budget looks like:
Note: Students who don’t get a regular income can simply split up funds from each paycheck (or other type of income) into the proper categories based on their budget. For instance, if they get a $200 paycheck, they know that they will have $100 for bills and other necessities, $40 for spending, and $60 to save until the next paycheck.
Resources for Parents
Step by Step Guide to Creating an Effective Budget
This process starts by identifying regular income that is mostly consistent every month. Irregular income (when a student isn’t sure what they will earn or when) can be handled in two ways. Students can average out their income over the last three months and use that figure, or they can determine the minimum that will be earned, and then decide what they will do with any extra income that is earned (for instance, they could choose to save half and spend the other half).
This step takes a bit of time, but it’s a big part of creating an effective budget. If cash is used, keeping receipts will be necessary, but if a debit card is primarily used, online banking tools can be used to determine current spending habits. Students should examine all of their spendings over an entire month.
Students can divide up all of their expenses into two categories: “needs” and “wants,” and then further divide them up from there. For instance, rent would be considered a “need,” and Netflix would be a “want.”
Alternatively, expenses can be divided into “fixed” and “variable.” This system identifies the items that a person has control over, and those that they don’t. For instance, the electric bill is a fixed expense (even if it varies slightly from month to month), and food spending is considered a variable cost. Sub-categories should also be created until each expense is assigned to a category.
Those with a fixed or semi-fixed income and considerable living expenses should consider the Zero-Sum Budget, while those with low living expenses and an inconsistent income should consider the Proportional Budget.
There are many free tools for creating the actual budge; one such tool is Google Sheets. Students who aren’t practiced at budgeting shouldn’t try and make their budgets too complex at first. The first couple months can be a broad overview of where money is going, and then get more complex as time goes by.
Note: If the expenses that were identified earlier add up to more than the student’s expected income, adjustments need to be made. Students can use their current spending habits to start off, and then each month make gradual changes. They should be careful about not changing too much too quickly, as this can cause them to get discouraged and give up budgeting altogether.
This step is where a budget usually breaks down. If expenses aren’t tracked, then there’s no way to limit spending and stick to the budget. There are several ways to make this step easier:
- Only Track Several Problem Categories: For example, students can choose to track food and clothes spending and ignore gas spending for the time being.
- Use the Envelope System: This system requires students to take out cash at the beginning of the month for specific expense items (such as food or entertainment). Envelopes are created for each expense category, and the appropriate amounts of cash are deposited into each. The envelopes are carried in a student’s purse or wallet, and cash is exclusively used for those types of purchases. When the cash runs out, no more can be spent in that category until the next month.
- Use Online Software with a Mobile App to Help Track Spending: Mint and LearnVest are two examples of this type of software. Students’ online banking might also have helpful tools.
There are many different systems that people use, but students should choose the system (or combine several systems) that will help them remember to pay bills on time with the correct amounts.
- The Calendar System: This system uses a calendar to identify the date on which each bill is due and how much needs to be paid. A digital calendar could also be used which would allow for built-in reminders.
- The Whiteboard System: This requires students to write down a list of all their bills with the amount and due date, which lets them plan what paychecks will be used for which bills. A spreadsheet can also be used in place of a whiteboard.
There will always be adjustments that need to be made. Overall, it’s better to have a broad or inaccurate budget, then no budget at all. Learning to budget takes time and a willingness to “try again the next month” if the budget didn’t work this month.
Introduction to Investing and Retirement
Why Students Should Start Investing Now
If students in college start investing a small amount of money and continue that habit after they graduate, their investment has the maximum amount of time to grow. The power of habitual saving is a powerful tool that students should utilize as soon as possible. Saving for retirement also allows students to harness the power of compound interest, rather than having debt work against them.
For example, consider two investors. Investor #1 is a 30-year-old who initially invests $500 and contributes $150 a month until he is 65 years old with a 7% interest rate. Investor #2 is a 20-year-old college student who invests $500 and contributes $25 a month for 10 years, and then $150 a month until she is 65 years old with a 7% interest rate.
Resources for Parents
- Practical Money Skills: This is a quality curriculum used to teach college students about saving and investing. This lesson plan uses a Teacher’s Guide paired with student activities.
- U.S. Security and Exchange Commission: This resource provides tips for teaching students about saving and investing.
The Dangers of Identity Theft and Scams
While the majority of credit card fraud (the theft and use of credit card information) is discovered immediately by credit card companies, other forms of identity theft can be harder to spot. Scammers and identity thieves can use students’ personal information to take out loans, get jobs, or even get medical care. Many consumers aren’t aware that their identity has been stolen until they are turned down for a loan or credit card. During the period of time that it takes to dispute and resolve fraudulent activity on a credit report, consumers have to live with a lower credit score than they deserve.
How to Protect Against Identity Theft
There are many important steps students should take; the following are a few recommended by the Federal Trade Commission.
- Personal Information: Only the necessary documents with personal information should be carried in a purse or wallet. For instance, it’s not a good idea to haul a social security card around. Documents with personal information should be shredded, and electronic devices should be completely erased before they are sold or disposed of.
- Social Security Numbers (SSN): SSN’s shouldn’t be shared unless absolutely necessary. If asked to share their SSN, students can ask whether that information is optional, and what the consequences are if the number isn’t provided.
- Device Security: Keeping anti-virus software up-to-date is a major step to avoiding identity theft. Students should also be careful about entering personal information on an unsecured website while using a public wireless network.
How to Spot a Scam
The FTC has a database of recent and common scams that students can view if they ever have a questionable interaction. Scammers usually have one of the two following goals: getting personal information, or convincing the student to send money.
The Office of the Minnesota Attorney General lists red-flags that are summarized below:
Part 2: How to Use Credit Properly
Students are targeted by credit card companies who would like to take advantage of some students’ relative inexperience and impulsivity. For example, most student cards come with high interest rates and lots of fees. Students who run up high balances could be paying them off for many years to come. That’s why it’s important for parents to take an active role in helping their students use credit cards properly.
How to Choose a Student Credit Card
Students should look for cards with the following qualities:
- Low Credit Limit: To minimize the impact of frivolous spending or impulse buying, students should choose a credit card with a low credit limit. Once good habits have been established, students can always request a credit limit increase if necessary.
- Low Fees: Cards that don’t charge annual fees or raise the APR after late payments are optimal for students.
- Low Interest Rates: Not all credit card companies will treat students the same – parents should help their students shop for reasonable interest rate. However, if a student doesn’t have established credit yet, and a parent isn’t cosigning, then the rates will be somewhat high compared to an older adult with good credit.
Note: When shopping around for a credit card with a good rate, students and parents should be careful – this practice could result in hard inquiries being created which may damage students’ credit scores. Whether shopping online or over the phone, make sure to verify whether a hard or soft inquiry is being used to extend an interest rate offer. Many times, companies will use a soft credit check to initially give shoppers a general idea of what their rate would be if they were to apply for a credit card, and the hard inquiry doesn’t take place until the person actually applies for the account. If a student’s social security number is provided, a hard inquiry will generally be created.
For students with little or no credit history, a secured credit card might be the best choice. While this type of card does require a deposit, it is a good way (and sometimes the only good way) to build credit for those who have none. Parents and students can use this guide that was created to help consumers choose the best secured credit card.
Students who have some established credit (or have parents that are willing to cosign) and want a credit card that comes with rewards can use this guide to find the best card for their situation: Best Credit Card for College Students.
What Credit Cards Should Be Used for
How Not to Use Credit Cards
Credit Card Habits Students Should Develop
Resources for Parents
Student Loans are the largest source of debt most students will take on until they purchase a home. 68% of college seniors graduate college with student loan debt that averages $30,100, and they can be paying off loans all the way up into their 40s – the average number of years it takes to repay student loans is 21 years. To put it in perspective, most students make these decisions before they are allowed to purchase alcohol. That’s why students need education about the cost of student loans and assistance from their parents in understanding the consequences. Since most students have never had to live on their own and struggle to make ends meet, they might not fully grasp the impact of having to shell out an extra $300 a month (or more) towards student loan repayment.
Minimize Student Loans
The best way to minimize student loans is to maximize other types of student aid, such as grants or scholarships. Students can use a scholarship search platform to find those that will be most relevant. They should also complete the FAFSA to take advantage of any federal grants or work-study programs for which they qualify.
Students should also consider working during college as much as possible to minimize the amount and number of loans that needed to be taken out. Every dollar that is earned and put towards a student’s college education isn’t just one that they don’t have to pay back later; it’s also a dollar for which they won’t be charged interest for years to come.
The third thing students can do to minimize student loans is to live on a reasonable budget. Remember that a lower standard of living now will allow for a higher standard of living later. Rather than driving a new car and using student loans to support a fun-filled, carefree lifestyle, students can spend less and keep costs low. This will allow for more of their money to dedicated to tuition, books, and necessary expenses, which means that fewer loans will need to be secured.
Choose Student Loans Carefully
Generally speaking, students should utilize Federal Student Loans before taking out private loans. For starters, Federal Student Loans usually have a lower interest rate unless the student has nearly perfect credit or a cosigner with that quality of credit. Students should be aware that most ultra-low rates offered by private lenders aren’t fixed rates – meaning that they can be raised in the future. Another factor to consider is that Federal Student Loans come with flexible repayment terms and even options for loan forgiveness. Subsidized Loans are especially attractive since they cover the cost of interest while in college or a period of deferment.
If students have no other choice, they should shop around before taking out private student loans. Students can use a search tool like Credible or SimpleTuition.com to compare rates. Also note that interest rates aren’t the only factor to consider – it’s also important to compare origination fees, repayment terms, and the grace period before payments become due.
Borrow the Correct Amount
There are two pitfalls to avoid when taking out student loans – borrowing too much creates unnecessary debt and facilitates unnecessary spending, while borrowing too little could encourage students to put expenses on credit cards. Putting extra college costs on credit cards is a poor tactic as they have much higher interest rates than most student loans (credit card interest also isn’t deductible from Federal Income Taxes like student loan interest is).
Before deciding the amount of money to borrow, students should sit down with parents or other advisors (such as counselors from the student aid department at their college) to help determine exactly what amount is necessary to borrow, and then stick to a budget that keeps expenses within the necessary margins.
Resources for Parents
- Bridges: This resource (titled “Know More, No Less”) focuses on helping students figure out exactly how much to borrow by empowering them to estimate their expenses.
- Next Gen Personal Finance: This lesson plan takes an honest at student loan’s role in paying for college. It encourages students to keep their student loans as low as possible by examining the potential impact of large loan amounts on their future plans.
Car Dealerships are especially savvy at locking inexperienced students into loans with super high interest rates on cars that are too expensive for them to afford. If a student buys a car they can’t afford, and it gets repossessed, it can do a lot of damage to their credit. That’s why parents should help their students to approach the car buying process carefully – especially if loans are involved. The following are some tips to help students who are considering the idea of using credit to purchase a vehicle.
Avoid “Buy Here, Pay Here” Dealerships
CARFAX recommends steering clear of this type of dealership, and an article in the LA Times sheds light on the process that many “Buy Here, Pay Here” dealerships use to take advantage of unwary buyers. They make the most money when people buy cars, and then get them repossessed shortly after. The car is simply resold, and the process starts all over again.
These dealerships can be especially attractive to students with poor or little credit history, since anyone can be approved. They prey on the desperate and unsuspecting, which is how they get away with dubious practices like charging double the market value for a used car and locking buyers into astronomical interest rates (they can be as high as 20 to 30 percent).
Shop Around for Interest Rates
Banks and Credit Unions typically offer the best rates. Some may refuse to loan money to students without a substantial credit history, and others may charge a higher interest rate. Either way, students shouldn’t get discouraged and should keep shopping until they are certain that they can’t find a better deal anywhere else.
While applying for multiple credit cards is a good way to hurt your credit score, shopping for interest rates on a car loan usually won’t hurt your credit score. The reason is that all of the credit checks are treated as a single hard inquiry as long as they are for the same type of loan, and they were within a certain time frame, typically 14 days.
While dealerships have the ability to help buyers get loans from multiple banks and credit unions, it’s usually wise to do the shopping ahead of time and get pre-approved for a certain amount. This approach prioritizes how much money you can afford to pay a month and how much total money you are comfortable borrowing. Skipping the pre-approval process can entice students to fall in love with a car, and then figure out a way to pay for it. Getting pre-approved for a certain amount encourages students to hold out for the right car at the right price.
Know the Value of the Vehicle
If a student buys a car above market value, it could put them in quite a bind if they need to sell it at a later date. Students should use a site like NADA to establish the value of the vehicle in question and refuse to pay significantly more than what it’s listed at.
Include an Experienced Car-Buyer in the Process
Since salespeople are experts at pressuring and convincing buyers to purchase a car for more than it’s worth, students should consider asking someone who has experience with this process (like a relative or older friend) to help them negotiate and make a decision.
Don’t Make a Rushed Purchase
A common tactic that salespeople use, is to pressure buyers into making a decision on the spot. They might say things like, “We have another customer who is coming in later today that wants to purchase this car.” They also might say something like, “This offer is way lower than market value, so we can’t guarantee that it will be available if you come back later.”
Always shop around – students should never purchase the first car they look at without looking elsewhere first. Leaving the dealership or seller’s location is a good strategy for buyers that are feeling any sort of pressure. They can then return a few hours later (or the next day) and make a final decision. This allows time for them to process everything involved, and it lets any pressure tactics wear off.
Refusing to make a rushed decision can help students avoid getting saddled with a large amount of debt, and potentially losing quite a bit of money if the vehicle needs to be sold at a later date.
The more a salesperson turns up the pressure, the more important it is to leave without committing. If it’s a good offer, the seller should be confident that the student will return and purchase the vehicle – no pressure tactics needed.
Be Wary of Private Parties with Incredible Deals
As with anything, if it sounds too good to be true, it probably is. Cars from purchased from private parties don’t come with any guarantees, so it’s important to get the vehicle inspected by a trusted mechanic before the sale is made. Cars with serious mechanical issues can be sold by simply lowering the price to make it very attractive, and then leaving out key details (like the fact that a new transmission will be needed in the next couple months). Some sellers also roll back the odometer to make it appear that a car’s mileage is tens of thousands less than it really is. A Carfax report can be used to verify key details.
- Edmunds: This article shares the “Secrets of a Professional Negotiator.” It contains helpful tips for negotiating with salespeople at dealerships.
- Edmunds: This brief guide lists “10 Steps to Buying a Used Car.”
- Federal Trade Commission: This resource advises consumers about what to watch out for when “Buying a Used Car.”
- Practical Money Skills: This lesson plan instructs students about the entire car-buying process. The curriculum utilizes a Teacher’s Guide and student activities.
Students should completely avoid payday loans since the interest charge associated with this type of loan is ridiculously expensive. For example, a $100 payday loan with a two-week term could cost $15 – that’s an Annual Percentage Rate (APR) of 400 percent. To put it in perspective, typical credit cards come with APRs of 12 to 30 percent. For more information, read this guide provided by the Consumer Financial Protection Bureau.
Part 3: Getting Out of Debt
Despite parents’ best efforts, the older students get, the less actual control parents have over their students’ finances. Students can get in over their head with debt very quickly. For example, students who lose their job may rely on a credit card to pay their bills which can lead to a lot of debt very quickly. 25% of college students worry that their credit card debt is “out of control.”
Because of those factors, parents should be prepared to assist students by helping them to develop a “plan of action” to get out of debt. While students may wait until their situation is dire, they often turn to their parents for advice when they get overwhelmed by their financial situation. While a “parental bail-out” (paying their bills for them) isn’t always the best option and precedent to set, helping them to develop a plan to stabilize their situation and get out of debt can be a life-saver for students.
Step by Step Guide for Students Struggling with Massive Debt
Step 1: Create a Barebones Budget
Creating a barebones budget will allow students to eliminate all the unnecessary expenses from their spending habits. This will let them focus on getting their debt under control, and keep them from making it worse.
Step 2: Choose a Strategy
Students can use this debt calculator to get a handle on how long it will take to pay off loans, and to help them to decide on a strategy. There are several tactics that students can use to start getting out of debt:
- Debt Snowball and Debt Snowflake: These methods require students to list out all debts, and then put extra money toward the debt with the smallest balance until it is paid off (while only making the minimum payments on the other debts). Students then take the amount of the payment they were making and add it to the minimum payment of the next smallest debt. This process continues until the debts are all paid off. Since both of these strategies prioritize paying off the first debt as quickly as possible, students are motivated, and momentum is built as they journey towards debt freedom.
- Debt Avalanche: This method prioritizes paying off debts with the highest interest rate, and moving down the list to until the student is paying off the debt with the lowest interest rate. This is accomplished by putting extra money towards the target debt, and only making minimum payments on the others. This will lead to the student’s total debt being repaid the quickest, but the first debt may take considerably longer if it has a higher balance than the rest.
- Balance Transfer Credit Cards: If a student runs up a large debt on a credit card with a high interest rate, it may be worthwhile to consider transferring that debt to a lower-interest card. This might not make sense for every student, but it’s worth the time it takes to verify whether he or she would qualify.
Step 3: Consider a Side-Hustle
While this might not be an option for everyone, most students have more time than they think to earn some extra cash. Students with a spending problem should consider investing the time and energy that is spent shopping or going out in an activity that brings in money rather those that spend it. Even an extra $100 a week could make a huge difference in the time it takes to pay down debt. Whether it’s picking up extra shifts or driving for a ride-sharing service, opportunities to earn extra money are out there if a person looks hard enough.
Step 4: Follow Through
No matter what strategy is chosen or what approach is used, the hardest part of any plan is following through. When a student has to skip going out with their friends for three weeks in a row, it starts to get tough, and they may feel like giving up. Parents and students alike should do their best to create an accountability system that encourages follow-through. Students should attempt to include others and ask for help. Trying to get out of debt alone isn’t easy – they need encouragement and support.
Repaying Student Loans
As was noted earlier, the average borrower with student loans takes 21 years to pay them off. If students don’t want to be saddled with debt into their 40s, they should take steps to quickly pay off their student loans. The sooner the loans are gone; the less interest is paid. Financial goals like buying a house or saving for retirement may not be easily attainable until student loans are paid off.
Understanding Deferment and Forbearance
Federal Student Loans come with a side-benefit that allows students to pause monthly payments for a period of time. This can help limit the damage to student’s credit if they find themselves in a hard situation like sudden unemployment since it may keep loans from entering default.
Deferment is usually available to borrowers when they are:
- Enrolled at least half-time in college or career school
- Unemployed and or unable to find full-time employment (for up to 3 years)
- On active duty military service
The main benefit of subsidized loans is that the government pays the interest during any period of deferment. Students who don’t have subsidized loans will still be required to pay interest during this time. If the student isn’t able to pay the interest, it will be capitalized and added to the principle of the loan (which results in higher payments later and more interest paid overall).
Forbearance allows those that don’t qualify for deferment to stop making payments or reduce them for up to 12 months. Interest will still need to be paid, or it will be capitalized – whether or not the loan is subsidized.
For more information about deferment and forbearance, read the explanation provided by the Federal Student Aid website.
Repayment Options for Federal Student Loans
If students are struggling to make payments, it may help to choose a different repayment plan. Students are automatically enrolled in a standard plan that pays off the loans in 10 years. There’s also a “graduated” option that starts payments off small, and they increase as time goes by. The Extended Repayment Plan stretches payments out for up to 25 years.
There are several different plans that base the minimum payment on the borrower’s income (and that of his or her spouse). The monthly amount due ranges from 10 to 15 percent of their “discretionary income.” Additionally, the balance of the loan is forgiven after 20 or 25 years. The three plans in this category are:
- Revised Pay As You Earn Repayment Plan (REPAYE)
- Pay As You Earn Repayment Plan (PAYE)
- Income-Based Repayment Plan (IBR)
The Income-Contingent Repayment Plan (ICR) is based on 20 percent of the borrower’s discretionary income or the amount that he or she would pay on a 12-year repayment plan that has a fixed payment (adjusted according to income). The lower of the two options determines the payment amount. This plan is eligible for loan forgiveness after 25 years. The last option is the Income-Sensitive Repayment Plan which bases the monthly payment on the borrower’s annual income with a repayment period of up to 15 years.
Resources & Help for Parents and Teachers
Practical Money Skills: College Lessons
- Lesson 1: The Art of Budgeting
- Lesson 2: Living on Your Own
- Lesson 3: Buying a Home
- Lesson 4: About Credit
- Lesson 5: Credit Cards
- Lesson 6: Cars and Loans
- Lesson 7: Consumer Awareness
- Lesson 8: Saving and Investing
- Lesson 9: In Trouble
- Lesson 10: About Consumer Privacy
Oklahoma Money Matters: Your Money Matters
- This is a general course in managing money for college students.
- It doesn’t go into depth on any single subject, but provides a good overview of topics that college students should think about.
Bridges: Know More, No Less
- This is a lesson plan that helps students identify the financial requirements to achieve their collegiate goals.
- It also helps students to minimize student loans by developing an awareness of non-loan paying options and by describing what borrowing options are available.
Next Gen Personal Finance: Paying for College
- This lesson plan leads students through an honest, non-biased evaluation of whether college loans are a worthwhile investment.
- It motivates students to minimize student loans by examining the impact of student loans on their finances after college.