Student loans are complicated. And, unfortunately, most freshly-minted freshmen sign those promissory notes without having a clue about student loans (let alone know what a promissory note is).
Before you sign on the dotted line, take time to understand your student loan options. And be sure you’re making the best choices. While you’re at it, avoid these 10 common student loan mistakes.
1. Assuming You Need Them
Yes, about 60% of students borrow annually to cover their college costs, according to the Chronicle of Higher Education. But that means that 40% don’t.
Contrary to popular belief, you do not have to have student loans to get through college. There are plenty of ways to get around them:
- Choose a cheaper school, and pay in cash
- Opt for a school with a great scholarship for you
- Go to a work-based school for free
- Work while attending school part-time
- Put off school for a year to save up
As you’re making your college choice, don’t just assume student loans — especially tens of thousands of dollars worth — are a necessary evil. In some cases, you might be OK taking out some loans. But you don’t have to use them to get a decent degree.
2. Not Exhausting Other Options First
Before you even apply for student loans, you should be shooting for every single grant or scholarship you can possibly get. This means spending time trolling the Web, talking to your local librarian (they usually have access to scholarship databases), and looking for schools that offer great scholarship programs. Remember, the more free money you get, the less student loan money you’ll need!
And while you’re at it, be sure you understand education-related tax credits, which could put money back in the bank for you (or your parents), making school more affordable.
3. Taking Everything You’re Offered
When you get your federal student loan offer (after filing your FAFSA), you’ll see how much the government is offering you in loans. If you’ve (unwisely) chosen a very expensive school that you really can’t afford, you may actually need the full amount to cover tuition.
But if you’re like most college students — especially those at state schools — you don’t really need that whole amount to cover tuition, or even room and board. Unfortunately, many of these same students take the full student loan amount — either because they want to use loans to fund their frat parties or because they don’t know they can accept less than they’re offered.
Carefully evaluate your actual needs, and only take the amount that you must have to pay tuition for that year. If you need student loan money to cover books, car insurance and other expenses, consider getting a part-time job.
4. Not Figuring Out Monthly Payments
One way to keep from taking out more than you need in student loans is to take a few minutes to figure out your monthly payments. Many college graduates are shocked to find out how big a chunk student loan payments will take out of their shiny new post-college paychecks.
This calculator can help you determine how much that federal student loan will cost you later on, based on today’s student loan interest rates and how much you borrow.
5. Not Keeping Track of Your Debt
We get it. You’re a student. You deal with a lot of paperwork, and you’re probably not all that organized. This makes keeping track of student loan paperwork difficult. But tossing those papers in the recycling bin can be devastating later on. If you can’t find your student loan providers, how do you know where to send payments?
(If you do lose your paperwork, the National Student Loan Data System can help you find out who services each of your federal student loans.)
Also, you need to keep track of the actual amount of your debt. It’s easy to lose tabs on how much you’re borrowing, in total, since you’re just taking out loans once a year for a four-to-six year education track. Make a spreadsheet of how much you borrow each year, and probable monthly payments that you’ll shell out eventually. That, alone, should keep your borrowing in check.
6. Skipping Out on Interest Payments
Unless you qualify for a subsidized student loan (which is based on income), your loans will start accruing interest immediately. The biggest problem here is that your interest will capitalize, which means the outstanding interest is added to the loan’s principal. This means you’re now paying interest on an even bigger principal amount. Let’s let the numbers illustrate:
Let’s say you take out a $5,000 loan for your first of four years of college. The loan is in deferment for 54 months — four years of school plus the standard six-month grace period. On a loan with a 6.8% interest rate that capitalizes annually, your new loan balance when you enter repayment is a whopping $6,722.65!
Because you let that $1,722 in interest capitalize, you’ll now pay around $78 per month on that loan (in a 10-year repayment plan), as opposed to $57 per month otherwise. If you let the loan capitalize and then make minimum payments, you’ll pay a total of $9,283, as opposed to the $6,904 you would have paid otherwise.
What does all this mean? You can — and should — make interest payments while you’re still in school. Even on hefty student loans, monthly interest isn’t too much to tackle. And even if you can only pay part of the interest, you’ll save a fortune in the long run.
7. Turning to Private Loans
Private student loans have a place for some students, but most shouldn’t turn to them first. Federal student loans typically have lower interest rates and much more flexible payment terms. If you do need to take out private student loans, shop around for the best interest rate and terms, and take out the absolute least amount possible.
8. Asking Your Parents to Co-Sign
Some parents automatically assume they need to co-sign on student loans, and this may be the case on private loans. But most students can take out federal loans on their own. And your parents shouldn’t co-sign unless they’re really OK making your student loan payments if you run into financial problems later on.
Having a parent as a co-signer looks good on the surface, but it effectively makes your parents secondarily responsible for your student loans. This means if you fail to make payments, their credit suffers. It also means your parents would be responsible for paying your loans if something should happen to you.
9. Not Updating Your Information With Your Loan Servicer
Student loan servicers are used to their debtors changing address frequently, and they’re good at tracking people down. But if your student loan servicer doesn’t have your current address, you could miss important information about your loans — like when, who, and how much to pay.
So what happens if you accidentally forget to update your address and miss payments because of it? Your student loan servicer will report those late payments to the credit bureaus, which will seriously ding your credit score.
10. Choosing the Wrong Payment Plan
Once you enter repayment on your student loans, you can choose a variety of repayment plans (assuming your loans are backed by the federal government). These plans give you some flexibility in your actual payment, which can be helpful if you can’t find a job or aren’t making much money.
The standard repayment plan has your loans repaid within 10 years, which is good. You want to choose this one if at all possible — even if you have to give up lattes and nights on the town to make your student loan payments. With the standard plan, you’ll pay much less interest over the life of your loan.
Other options – like extended repayment and income-based repayment – are tempting because of their lower monthly payments. But be sure to calculate how long it’ll take to pay off your loan under these plans, and how much interest you’ll pay over time.
And be extra careful with income-based plans. Sometimes with these plans, the minimum payment doesn’t even cover all your student loan interest. In that case, your interest will be capitalized, and you’ll run into the same problem with a growing balance that you saw in the above example.
[Editor’s note: You can see how your student loans are affecting your credit by monitoring your credit scores, which you can do for free through Credit.com. It’s also a good idea to make sure your student loans and other debts are being reporting accurately by checking your credit reports regularly, which you can do for free once a year through AnnualCreditReport.com.]
More on Student Loans:
- How Student Loans Can Impact Your Credit
- How to Pay for College Without Building a Mountain of Debt
- Strategies for Paying Off Student Loan Debt