student loans

What to do when you can't pay student loan

a graduation cap and a pile of money
Highlights
  • Defaulting on a student loan is a bad idea with serious consequences.
  • You can choose a different repayment plan, including two income-based plans.
  • Deferment and forbearance are two other alternatives to defaulting.

The jobless economy is taking a toll on a growing number of college grads who are behind on their student loans. Nearly 7 percent of student loans for fiscal year 2007 are expected to default, involving more than 231,000 borrowers, according to the U.S. Department of Education.

Default is the worst outcome, resulting in a blemished credit score at least, as well as garnished wages and possibly getting sued for the full loan amount. Fortunately, grads facing economic troubles have much better options. Here's what to do if your dollars won't cover your student loan debt.

Avoid default on student loans
  • Let the lender know.
  • Ask about payment plans.
  • Investigate payment postponement options.
  • Research loan cancellation and forgiveness.
  • Dig out of default.

Let the lender know

"Students who are in trouble absolutely have to talk with their lender first," says Michael Gaer, creator of Collegefinancing.com and president of Gaer Financial Group, based in Hackensack, N.J. "They can't just walk away from it because it's going to affect their credit score. It's going to affect their entire lives."

Gaer says that students who apply the silent treatment to their creditors will immediately fall into delinquency and later into default, usually after missing two to three payments.

Those who tell their lenders upfront that paying is difficult will have an array of options, especially with federal loans. While each private lender has its own rules and punitive measures for borrowers, those who disburse federal loans are required to offer borrowers deferment options and the ability to change their payment plans once a year.

Ask about payment plans

A simple way to lower your monthly payments without hurting your credit score is to change payment plans, says Sam Wilson of Texas Guaranteed Student Loan Corp., a nonprofit student loan disbursement agency.

"Ten years is the standard repayment period on a student loan," says Wilson. "But that doesn't mean that they have to make equal payments every month for all 10 years. Most students don't know that there are several payment plan options."

The federal government currently offers four basic types of repayment plans.

Current repayment plans:
  • The standard plan lets students pay the same fixed amount each month ($50 per month minimum).
  • An extended plan stretches payments across 12 years to 25 years (available only for borrowers with loans totaling more than $30,000).
  • A graduated plan requires lower payments in the first few years, and then the payments are increased every two years until the loan term is up.
  • An income-contingent plan assigns payment amounts based on a percentage of the graduate's annual income (anywhere from 4 percent to 25 percent).

If a borrower who opts for the last payment option never earns enough to fully repay the loan, whatever principal that is left after 25 years' worth of payments is forgiven.

The feds will roll out a fifth option starting July 1 -- the income-based repayment plan.

Income-based repayment caps monthly payments at 15 percent of a borrower's discretionary income, says Patricia Nash Christel, spokeswoman for Sallie Mae. This is defined as any earnings above 150 percent of the poverty line, she says.

Currently, the poverty level for a single person is about $11,000, she says. So at 150 percent, the income floor is about $16,000. "That would mean that payments would be 15 percent of any income over $16,000," she says.

In this case, Christel says that individual borrowers who earn $16,000 or less per year will have no payments until they start earning more.

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Like the income-contingent plan, the income-based repayment option requires grads to make regular payments (excluding deferment and forbearance periods) for 25 years, after which any leftover principal is canceled.

A final option is to opt for a temporary interest-only repayment plan. Unlike the aforementioned repayment options, interest-only plans are available only for a specific amount of time to be negotiated between borrower and lender.

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