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May is the month of Pomp and Circumstance. Of graduation parties, caps thrown in the air and dreams thrown even higher. It’s also the month where many seeds of financial destruction are sown.

Student loan borrowers who are graduating have six months to figure out how to start paying back their loans — or how to avoid paying back their loans. Decisions made during this time are critical, and can really dictate many other choices during the young adult years: when to buy a car, a home, or even start a family. That’s why it’s important to think about these things even before your cap hits the ground on graduation night.

First, a quick refresher on the problem. The national student loan default rate is 11.8% for the three most recent years of graduates. But that understates the problem. Borrowers can be delinquent (late on payments) without being in default — and the student loan delinquency rate is 17%, according to the Federal Reserve Bank of St. Louis. But even THAT number understates the problem dramatically.

About 45% of recent graduates aren’t repaying their loans at all — they re-enrolled in school, and are in deferment, or they are in forbearance, for example. So, among borrowers who are actually supposed to be paying their loans, the delinquency rate is actually 27.3%. One in four have fallen behind, and at the very least, are seeing their credit scores plummet.

Don’t miss the significance of that last number. Much is made of borrowers who can’t repay their loans at all, but for every borrower who goes into default, two more are merely delinquent. Maybe you are lucky enough to not fear default…but your odds of becoming at least delinquent are shockingly high.

So we asked student loan expert Mark Kantrowitz to help us develop a checklist for soon-to-be former students that can help them avoid adding to those disastrous numbers.

1. Don’t Miss Payment No. 1

There are plenty of reasons for high late payment rates, but this one is surprisingly simple to avoid.

“About a quarter of borrowers who miss a payment are late with the very first payment,” Kantrowitz said. “Most student loans come with a six-month grace period after the student graduates before repayment begins. That’s a lot of time during which a college graduate can forget about their student loans.”

It’s easy to become distracted by finding a job, an apartment, buying a car, and suddenly, the six months is gone. Making matters worse, address changes mean loan servicer notices could get lost in the mail. Remember, “I never got a bill,” is no excuse. Proactively engage with your lender to make sure that first payment is on time.

2. Automate Your Payments

One great way to avoid problem No. 1 is to sign up for automated payments with your lender. Many servicers also give borrowers a small interest rate break for doing so. Set automated payments up early, and you’ll have less to worry about come the Fall. Sure, it can feel strange to give a lender direct access to your checking account, but unless you are a bill-paying ninja, it’s probably worth the peace of mind.

3. Select Conservative Payment Terms

Many borrowers will find themselves with options that seem to ease the immediate pain of repayment — by lowering monthly payments. These can sound seductive, but they trade a little pain today for a lot of pain tomorrow. For example, borrowers may have the option to spread payments out over 10, 20 or 30 years. Those who choose 30-year payments will cut their monthly payments nearly by half, but will pay more than triple the interest. Let’s examine a $35,000 federal student loan balance with a 6.8% interest rate. Using 10-year terms, borrowers would pay $402 per month, for a total of $48,333 over 10 years. Borrowers who pick a 30-year term would pay $228 per month, but a total of $82,146, or $47,145 in interest compared to $13,333!

“Students often choose the repayment plan with the lowest monthly payment, thinking that it ‘saves’ them money,” Kantrowitz said. “Instead, they should choose the repayment plan with the highest monthly payment they can afford.”

If the 10-month term creates monthly payments that are just too steep, borrowers can pick 20-year terms initially to ease the pain a bit…but make a promise to make extra payments as their income grows.

4. Don’t Choose Income-Based Repayment Because it ‘Feels Cheaper’

With income-based repayment, monthly loan terms are set based on a borrower’s income. This can be a great alternative to delinquency or default, but it should be a last resort, not a first choice. See the math above. Yes, income-based plans hold out the promise of loan forgiveness … but only after decades of payments.

“Most borrowers should stick with a standard 10-year repayment plan. Anything longer than that, and they will still be repaying their own student loans when their children enroll in college,” Kantrowitz said.

5. Don’t ‘Snowball’ by Consolidating

Many borrowers graduate with multiple student loans, and the attraction of pooling them together to make a single payment is understandable, but usually misguided. Consolidation only makes sense if it lowers the total cost of borrowing (by lowering the interest rate), and that’s often hard to accomplish. Simply merging federal loans gives borrowers a rate that averages across the loans. The one method that does work is waiting a few years so the borrower’s credit score improves, enabling refinancing the debt with a better interest rate.

Another mistake borrowers make when they consolidate is that they rob themselves of the chance to apply extra payments to the loan with the highest rate first, which is always the best method. Some borrowers are attracted to the so-called “snowball” method, which suggests paying down the loan with the lowest balance to score a quick win. That might make a borrower feel good, but financially, it’s not the best way to save money.

6. Don’t Ignore ‘Interest Capitalization’

Those are big words, but here’s a simple rule of thumb: You pay for both borrowing money and borrowing time. Adding time to repayment is basically the same thing as borrowing more money, so if you obtain a loan deferment or forbearance, you might avoid payments for a while, but you will not avoid added interest. In rare cases (with subsidized loans in deferment), the federal government will pay the extra interest for you. But you can’t avoid the added cost of stretching out loan terms. In most cases, added interest will be “capitalized,” meaning it increases the outstanding total balance of the loan. Again, postponing pain today merely increases pain tomorrow.

Remember, defaulting on a loan seriously damages your credit score, and because student loans are rarely discharged in bankruptcy, the debt can beat down on you for decades. (You can see how your student loans are currently impacting your credit scores for free on Credit.com.)

There are some options for people who are behind on payments to get back on track, though, even if forgiveness isn’t an option. To get out of default, you can combine eligible loans with a federal Direct Consolidation Loan, or you can go through the government’s default rehabilitation program. If you make nine consecutive on-time payments (the payments can be extremely low), your account goes back into good standing, and the default is removed from your credit report.

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Image: Michael Krinke

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