“How to ace the student loan test”

Posted: 23 Sep 2010 01:05 AM PDT

Grabbing a job, any job, is one way many college graduates grind it out in this tough economy while waiting to make it in their chosen field.

But earning just any paycheck won't cut it when it comes to paying everyday bills -- and paying off thousands of dollars in student loans.

So what do you do? Can you delay those loan payments?

Grads who are having a tough time paying the bills need to know that there are options. But they need to review the rules of available programs to make sure they are not creating an even bigger problem down the line.

Student loan debt needn't drag you down

Jason Chapman has had a few jobs since he graduated from Michigan State University in December 2008. But he's getting nowhere digging out of college debt.

The jobs he's had for the past two years paid $10 an hour. In one, as a case manager for a health care agency, he made slightly more through commissions.

Chapman, 29, has made some money here and there, too, including $300 as his share of a prize for creating a song called "Trouble" for a contest by mtvU, a 24-hour television channel available on campuses.

Still, once he factored in rent, auto insurance and other expenses, Chapman said there was no way he could afford the $300 monthly payments on his student loans. So he took steps to hold them off.

"I definitely don't think I had a choice," said Chapman, who lives with his girlfriend in Bloomfield Hills and is looking for a job in which he can use his degree in journalism.

Problem? While Chapman has held off his payments, the interest keeps building on more than $25,000 in student loans -- and eventually he's going to be paying interest on top of interest.

A $25,000 debt could easily turn into more than $30,000 at the end of three years in forbearance, said Mark Kantrowitz, publisher of Fastweb.com and FinAid.org, Web sites that provide information about scholarships and student aid. Over the life of the loan, the cost could be nearly $42,000.

"A key problem with capitalized interest is that you pay interest on interest, so the increase in the principal balance ultimately costs you a lot more," Kantrowitz said.

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But many recent college graduates who find themselves underemployed or even jobless have to do something to keep from going into default on their loans.

Here are some strategies:

• If you owe far more in college debt than you're likely to see in an annual salary for many years, there is an income-based repayment plan that assures a borrower never has to spend more than 15% of discretionary income on loan payments. In 2014, the rule changes to 10%.

"People aren't aware of it as an option," Kantrowitz said.

Discretionary income is defined as the amount by which the grad's adjusted gross income exceeds 150% of the poverty line for the graduate's family size. This year, that's $10,830 for a one-person household.

The monthly loan payment is adjusted annually, based on changes in income and family size. For some grads, a monthly payment can drop by $200-$300 -- or even to zero in the case of a single grad with no children, a $10,000 annual income and $25,000 in debt from loans.

To see if you can qualify, try to figure out your own payments with the online calculator at www.studentaid.ed.gov. Or go to www.finaid.org.

Talk to your lender. Remember that you will need proof, such as income-tax returns, of financial hardship.

If you qualify, the income-based plan also could help college grads who pursue careers in public service, say a lawyer who opts to work as a public defender at a lower salary for several years.

In certain types of public service, the amount of student loans outstanding can be forgiven after 10 years and the amount is not taxable.

But Kantrowitz said that working a year or two in public service and then landing a high-paying job won't get you out of debt. Monthly payments, in fact, would be higher once you landed that dream job.

After 25 years of repayment under the income-based plan, the debt would be forgiven for any profession, but the amount forgiven would be taxable.

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This recent repayment option is available for Stafford, Grad PLUS and consolidation loans -- but not for Parent PLUS loans or consolidation loans that repaid Parent PLUS loans. Private student loans don't qualify.

Remember, though, if you're anticipating a higher-paying job soon in your chosen field and expect to be able to afford a standard repayment plan, you're likely to dish out even more money if you are on an income-based repayment plan.

• What if your income is affected by such things as the loss of a job or a medical problem?

Even if you graduated years ago, if you have money troubles, you might try to get a break on student loans through hardship or forbearance programs.

The economic hardship program has a three-year time limit and the forbearance program has a five-year limit. You also have to reapply each year.

During a hardship deferment, Kantrowitz noted, the government would pay the interest on subsidized federal Stafford loans, federal Perkins loans and a portion of a consolidation loan that paid off a subsidized federal Stafford loan.

A borrower would still be responsible for interest on an unsubsidized federal Stafford loan.

With a forbearance, the borrower remains responsible for all the interest -- which keeps building.

"If you're capitalizing the interest, you're essentially digging yourself into a deeper hole," Kantrowitz said.

So he said most college grads would want to do what they could to make payments -- even if only the interest -- during a deferment or forbearance.

Again, contact your lender. Private loans can offer forbearance typically for a one-year limit and may charge a fee.

Typically you'd want to use a forbearance or a deferment to address a short-term financial problem.

The best idea is to pay something toward those student loans with any job -- even if it's not a great job.

Contact SUSAN TOMPOR: 313-222-8876 or stompor@freepress.com.

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