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Repayment
Repayment is the second half of a student loan. You're in the system, now you start the process of getting out. For many people repayment starts when they or someone else totals up the loans they have taken out and starts to compute the interest. It is common for people, especially undergraduates, to graduate without an immediate awareness of the debt they have undertaken. After an overview of consolidation issues, this section discusses a number of repayment issues and the opportunities they offer for NSLA research. We encourage you to support these efforts by opting in to participate in the NSLA Ally Database. Grace periodIf you are not continuing to other forms of education, then you usually have a short grace period. During this time, you typically would get a job, move, and get settled in. Some people are able to spend the time traveling or taken a much-deserved rest. ConsolidationUpon graduation, if not earlier, you will begin receiving solicitations from your existing lenders and from many companies that would like to become your lender, informing you of their consolidation service offerings. The intensity of the solicitations can create the impression that it is necessary to consolidate quickly; this is not the case. And the consolidator you like best might be ones that did not market you heavily. For the reasons discussed below, if you are going to consolidate at all, it is vital to choose well. There are a number of attractive elements of consolidation. First, consolidation combines all your loans according to type which are distributed across multiple lenders. This offers the convenience of writing a check to only the consolidation company, rather than to several companies. It also simplifies keeping track of different lender policies and requirements. Lenders are frequently bought out by or absorbed into other companies, so having the loans consolidated removes the need to keep track of these changes for several companies. Depending on the consolidation company, consolidation may give you access to certain policies that save you money. Some of the most common are receiving a reduction of your loan interest in exchange for allowing the bank to directly deduct the payment from your bank account, with no action on your part. The clearest downside here is the risk that when changing jobs, the mechanics of direct deposits can go awry, making it easy to create a temporary and unnoticed a lack of funds for the automatic withdrawal to occur. This can trigger to late payment penalties and other consequences. Another common provision - and arguably the most desirable one - is receiving a reduced interest rate after making a significant number of payments on time. A typical exchange is a 1% interest rate reduction after making 60 payments (5 years) on time. Lenders have an institutional interest in maximizing the value of these provisions as a marketing tool to attract your business, and also as a way of ensuring they receive payments on time. But because this offers a tremendously valuable savings to the borrower, they also have an institutional interest in ensuring you do not actually achieve the reduction. Like other cases in which the lender must act against its financial interest, it is important to read the fine print very closely and watch for what businessmen referred to euphemistically as "sharp dealings". Some practices lenders have used in this area include:
It is also worth noting that there is tension between the 25% reduction in interest for direct payment and the 1% reduction for a period of on-time payments. The borrower should very carefully consider the risk that when the mechanics of payment are given to someone else for (.25% gain), there is a possibility something outside the borrower's control could break the chain of payment (1% gain). A customer service rep at SALLIE MAE in an unguarded moment said that achieving the 1% reduction is very uncommon. She reported with confidence 10% to 15% of borrowers succeed. These are areas in which the NSLA intends to gather data that is currently unattainable: what are the best incentives in the market and what are the sharp practices. Please support this effort by opting in to participate in the NSLA Ally Database. Reduced payment plansCommon repayment plans are level payment; interest-only payment for several years followed by level payments; and income-sensitive repayment. Level payment is self explanatory. The total cost of loan principal and interest over the agreed term of the loan is divided equally across all months. Sometimes the last payment is the amount of one month plus whatever amount remains that is not big enough to be a full payment. Interest-only repayment is often available for 3, 5, or 7 years and then followed by level payments for the rest of the term. This plan keeps payments after graduation lower on the theory that your salary will go up over time. The key element for the borrower in these plans is to recognize the attraction of "lower monthly payments". Income-sensitive repayment is available to borrowers whose earnings are low in proportion to their debt payments. This plan allows the borrower to choose a percentage of income they are willing to pay - resulting in a payment that is less than the amount of interest the loan is accruing. That interest is usually capitalized, in other words, the interest you are not keeping up with each month is grouped in with the principal. The result is you pay interest upon the unpaid interest. In the mortgage industry, this practice recently has come under considerable criticism. There is great attraction in the idea of having the lowest possible payments for as long as possible. Given that this repayment plan generates the most revenue for the lender, it should not be surprising that it does not go to great lengths to draw the borrower's attention to the greatly increased amount of interest that will happen over the life of the entire loan. This is an area in which NSLA intends to conduct research: the use of different repayment plans and their marketing. Please support this effort by opting in to participate in the NSLA Ally Database. Extra paymentsRegardless of the payment plan you select, it is important to remember that the repayment term is not a requirement. Always select a loan consolidator that allows pre-payment without any penalty. Use the NSLA Repayment Savings Calculator to see the tremendous savings you can achieve by paying a little extra each month. In the mortgage industry, the conventional wisdom is that one should pay enough extra that over 12 months the effect is to make 13 payments. This as a rule will reduce the total interest paid across the life of the loan by 25% to 33%. However, if making extra payments on the loan is so burdensome that it causes you to rely on credit cards to make ends meet, it is not a good tradeoff. The interest rate on a credit card will almost always be higher than the rate on a student loan. Multi-party consolidationWhen pointing out the convenience of reducing the number of bills you pay each month, lenders highlight the idea that when both spouses have loans it would be much more convenient to combine the husband's and wife's loans, so they have only one payment per month. To the best of our knowledge, this is never a good deal for the borrowers. Combining the loans of two people creates something called in law "joint and several liability". Each person is responsible for the combined amount. Because it's impossible to evade a student loan once taken, the result is this: If on Monday the husband and wife consolidate his $100,000 loan and her $5,000 loan, and if a week later the husband is hit by a car, then the wife is responsible to pay the entire $105,000. This is true if he dies in the crash. This is true if he becomes a quadriplegic for the rest of his life and she is unable to work because they have four children. It is true even if the medical bills and her inability to work force them to declare bankruptcy. Consolidation, fees, and interest ratesBecause the law protects lender profit, it is not possible to refinance a consolidated student loan. If it were a mortgage and interest rates dropped, numerous lenders would appear offering the borrower refinancing at a lower interest rate. This is not a choice and it is important to choose your consolidator carefully. Do a lot of research and comparison shopping for a lender that offers the most borrower-favorable saving incentives. The timing of your consolidation often does not result in a better interest rate. The interest rate assigned to your consolidated loan is frequently determined by a formula that considers the interest rates of all your loans, assigns them a ratio, and creates a proportionate aggregated rate. Although this means your interest rate may not be able to take advantage of rates that have fallen since you took our the loans, the timing of your consolidation might be useful in the area of fees. Banks have a wide variety of practices when it comes to charging the borrower a fee for consolidation: some charge fees for the privilege of consolidating which can actually increase the total debt, others give a reduction in the amount of principal as an enticement. Shop around. These are additional areas in which NSLA intends to conduct research. Please support this effort by opting in to participate in the NSLA Ally Database. Consumer treatmentHere too, it is important to choose your consolidator after considerable research. Once attached to the lender, you are subject to their customer service. Everything from wait times on the phone to the demeanor of customer service reps, the readability of your statements, and user-friendliness of their website will fall somewhere between helpful and convenient or annoying and a hassle. It is difficult to assess some of these factors, but seeing a sample statement and probing the website are possible. Consider connecting with someone who has an account with the lender and sit with them for a few customer service calls. Or call yourself pretending to be a clueless customer and see what happens. At a minimum, take an informal survey of people you know and see who likes and dislikes their company. This is another area in which the NSLA Ally Database intends to gather data: comparative customer satisfaction among consolidation companies. Please support this effort by opting in to participate in the NSLA Ally Database. Considerations in repayment savingsA number of issues impact the borrower's ability to minimize the burden of repayment. Which no one contests the obligation to repay the principal borrowed and an amount of interest that covers the reasonable time value of money, there exists a policy issue of where the balance rests between burden on the borrower and profit for the lender. The rationale for allowing home owners to deduct all of their mortgage interest payments from their income tax is that home ownership is very important to the well-being of the nation. It seems apparent that higher education is similarly important, but student loans do not receive comparable treatment. They cannot be refinanced and the full amount of loan interest is not tax deductible. To the extent that some interest is tax deductible, the deduction is limited by an income ceiling and a formula. These are areas in which NSLA intends to conduct research: the importance of these issues to borrowers in repayment and their effect upon borrowers' purchasing patterns. Theoretical approaches to repayment savingsHere is a good place to again remind the user that NSLA does not provide financial or tax advice. Everything contained in this section is strictly conceptual. Careful consideration suggests that there may be several ways to soften the impact of loan repayment, particularly for borrowers whose debt and income exceed the thresholds for tax deduction eligibility. As discussed elsewhere on the NSLA website, the borrower can easily elect to make extra payments in order to shorten the loan term and reduce total interest paid. There are, however, two elements of the system that are structural and operate to limit repayment savings: tax relief and interest rate reduction. Both of these receive better treatment in the context of a real estate mortgage, and of course the availability of bankruptcy also differs. Whether the differing treatment is warranted is an issue for further research. One possibility to explore with a qualified financial professional is to leverage the real estate market. If a hypothetical borrower purchased real estate in a vigorous market, it could create the possibility of selling a rapidly appreciated property and using the proceeds to pay off the loan in a short timeframe. Similarly, a hypothetical borrower could consider securing additional financing against the appreciated property and using the funds to pay student loans, effectively converting the student loan to a secured loan, possibly enjoying reduced interest rates and full tax deductibility of mortgage interest. Even in a flat market, an owner might consider using a standard home equity loan to pay down a hypothetical loan. Another possibility to consider exploring with a qualified financial professional (not NSLA) is a purchase / lease back arrangement. If a hypothetical borrower had parents who possessed un-encumbered real estate purchased some time earlier, it might be possible to purchase the property on favorable terms, create a landlord tenant relationship with the seller, and leverage part of the real estate's value to pay off the student loans. This again offers the theoretical possibility of essentially converting a student loan into a secured loan, gaining improved interest rates and full tax deductibility of loan interest. Finally, a hypothetical borrower could explore with a qualified financial professional options to leverage a stream of teaser-rate credit cards to fund repayment of a high-interest loan at significantly reduced rates, by rolling over multiple balances as the teaser-rate expires. This is an area in which NSLA intends to conduct research: the extent to which these and other sophisticated financial planning techniques are used by highly indebted borrowers in the absence of re-consolidation and full interest deductibility. Please support this effort by opting in to participate in the NSLA Ally Database. Social implicationsSome existing research indicates that high levels of indebtedness among professionals have noticeable adverse effects upon the individual, the public, and the profession itself. These issues are readily apparent among physicians and attorneys. They also are present among dentists, chiropractors, nurses, veterinarians, professors, and even church leaders who attend seminary. The research suggests that high student loan debt incurred which receiving a professional degree constrains professionals who have an interest in performing public interest work. It also causes the professionals to seek higher-paying positions in metropolitan areas, which are already well served, leaving more remote areas under-served. This is another important area in which NSLA intends to conduct research through the NSLA Ally Database: the aggregate, cross-industry effect of high professional student loans upon choice and location of employer, availability of services to the public at affordable rates, and how these may result in ripple effects to consumers, insurance, and other socio-economic dynamics. Please support this effort by opting in to participate in the NSLA Ally Database. |
