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Student Loan Repayments May Cost More Than The Amount Borrowed

Submitted by Jill Yoshikawa, Ed M, Partner of Creative Marbles Consultancy on November 9th, 2013

Changes to repayment rules for Federal student loans offers borrowers flexibility to manage their debts, as outlined in a recent New York Times article.  However, not only do the recent changes provide assistance for current borrowers, potential student loan borrowers can plan ahead. Our recommendations are outlined, alongside excerpts of the article in italics.

Rising default rates are a warning for potential borrowers to understand the risks of borrowing and explore all possible repayment plans, before assuming loans.

More than 600,000 federal student loan borrowers who began repaying their debts in 2010 defaulted on their loans by 2012, according to federal data.

New rules for borrowers in default can help relieve the pressure of loan payments.

Under federal law, those who are in default on federal student loans may “rehabilitate” them by making nine on-time payments in amounts that are “reasonable and affordable.” Rehabilitation lets the borrower get out of default and become eligible for further federal student aid.

Some private debt collectors under contract with the government, however, were failing to offer payments that former students could afford, instead offering payments based, for instance, on a percentage of the borrower’s total debt. Such payments increased the commissions paid to collection agencies, but were often unworkable for borrowers. The collectors, Ms. Abernathy said, “were not appropriately counseling borrowers on how to get out of default.”

Although the Federal government is the lender, a variety of private companies administer and collect loan payments.  Borrowers will be informed of the company servicing their loans and are responsible for knowing their options for repayment.

 In its final rules, the Education Department requires that borrowers who want to rehabilitate loans must first be offered a payment amount similar to what would be offered under the federal income-based repayment program. That option, meant to help borrowers who have high debt in relation to income, caps a borrower’s monthly payments at 15 percent of his or her monthly income.

Now, borrowers can get the income-based offer first, and move on to the more complex form if they reject the income-based offer for some reason.

In addition, some debt collectors had demanded minimum monthly payments without disclosing more affordable alternatives, even though federal student aid law does not require minimum payments. The rules specify that payments in rehabilitation must not be a required minimum amount.

The more borrowers know about their options the more s/he can advocate for a repayment schedule that is affordable.  Borrowers have time to learn their options, as the majority of the changes will be effective as of July 1, 2014.

The opportunity costs, like delaying purchasing a home or starting a family, given the cash needed to repay student loans are other potential disadvantages of borrowing student loans.  Potential borrowers would be prudent to think through all the advantages and disadvantages before signing a promissory note.

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