Lifeboat Drill Active Debt Management Mark Kantrowitz Publisher of Fastweb and FinAid September 6-7, 2010

Student Loans are Complicated  Federal education loans have fixed interest rates, while private student loans have variable interest rates  Government pays interest on subsidized loans during deferments (Perkins 5%, Subsidized Stafford 4.5%  3.4%)  Borrower is responsible for interest on unsubsidized loans but may defer it by capitalizing it (Unsubsidized Stafford 6.8%, Grad PLUS 7.9%, Parent PLUS 7.9%)

Borrowing Private Instead of Federal  More than a quarter of private student loan borrowers (26.7%) did not borrow federal loans in even though federal loans are less expensive Three-fifths (60.2%) did not apply for federal aid  More than a third of private student loan borrowers (38.1%) borrowed Stafford loans in but less than the maximum available Stafford loan limits  91.7% of the parents of dependent students who borrowed private did not borrow Parent PLUS

Students Misunderstand Loans  Most students treat loan limits as targets  Misunderstand variable rates, interpreting LIBOR + 6% or PRIME + 6% as a 6% fixed loan Do not understand why the interest rate increased  Do not understand capitalization of interest  Do not understand that years of nonpayment will cause big increases in the loan balance  Do not understand how interest works  Don’t want to think about how they will repay their student loans until after graduation

Quiz  What is the total amount repaid on a $10,000 loan with a 10-year term at 10% interest? A.$1,000 B.$11,000 C.$15,858 D.$18,100 E.$20,000 F.$32,479

Debt Grows with Capitalized Interest Forbearance Duration Capitalized Interest Increase in Loan Balance Increase in Life- of-Loan Interest 3 months$1711.7%$236 (6.2%) 6 months$3453.4%$476 (12.5%) 1 year$7027.0%$967 (25.4%) 3 years$2, %$3,115 (81.8%) 6 years$5, %$6,933 (182.0%) 9 years$8, %$11,613 (304.8%) 12 years$12, %$17,348 (455.4%) Increases in loan costs from capitalized interest on a $10,000 Stafford loan with a 6.8% interest rate and a 10-year loan term

Leaving Money on the Table  Two-fifths (40.9%) of undergraduate students do not apply for federal student aid About a quarter (26.8%) would qualify for a Pell Grant 2.3 million would have qualified for the Pell Grant 1.1 million would have qualified for a full Pell Grant  Nearly half of students (46.9%) who submit the Free Application for Federal Student Aid (FAFSA) qualify for a Pell Grant

Growth in Cumulative Debt  65.6% of Bachelor’s degree recipients graduate with an average of $23,186 in education debt  Of Bachelor’s degree recipients applying for federal student aid, 86.3% graduate with an average of $24,651 in education debt  86.9% of Pell Grant recipients graduate with debt ($24,671), compared with 50.2% of non- recipients ($21,266)  Pell Grant recipients are 73% more likely to graduate with debt, and the debt is $3,405 higher

Growth in Excessive Debt  Borrowing more than $10,000 for each year in college is excessive  8.3% of Bachelor’s degree recipients (12.8% of those with debt) borrowed more than $40,000  10.3% of Associate’s degree recipients (21.8% of those with debt) borrowed more than $20,000  Students who enroll at more expensive colleges, such as for-profit and non-profit colleges, are more likely to borrow excessively, as are independent, minority and low income students

Counseling that Works  Personalize it with their loan amounts Actual monthly payments Total interest paid and total payments over the life of the loan, especially if total interest exceeds the amount borrowed  Use rules of thumb that involve simple comparisons, not math Good: “Do not borrow more than your expected starting salary for your entire education” or “Do not borrow more than $10,000 for each year of college” Bad: “Debt-service-to-income ratio should be < 12%”

Example Repayment Plans Repayment Plan Monthly Loan Payment Total Interest Total Payments Standard – 10 Years$288$9,524$34,524 Extended – 12 years$254$11,639$36,639 Extended – 15 years$222$14,946$39,946 Extended – 20 years$191$20,802$45,802 Extended – 25 years$174$27,054$52,054 Extended – 30 years$163$33,674$58,674 Assumes $25,000 unsubsidized Stafford loan at 6.8% interest and ignores balance-based setting of extended repayment term.

Tips for Student Borrowers  Minimize debt. Live like a student while you are in school so you don’t have to live like a student after you graduate.  Borrow federal first, as federal loans are cheaper, more available and have better repayment terms. You do not need to be poor to qualify for federal loans.  It is cheaper to save than to borrow. Saving $100 a month for ten years before college will save you $200 a month for ten years on student loan payments after college.

Reduce Need for Student Loans  Every dollar in grants is a dollar less borrowed. Search for scholarships on free web sites like Fastweb.com. Complete all the optional questions to get about double the number of matches. Apply for financial aid even if you think you won’t qualify or didn’t qualify last year. Enough changes that you might qualify. The FAFSA is also required for the unsubsidized Stafford and PLUS loans, which don’t depend on need.  Use tuition installment plans instead of loans  Use Hope Scholarship tax credit, AmeriCorps

Tips for Repaying Student Loans  Accelerate repayment of the highest cost debt first, which is usually private student loans and credit cards. The most expensive debt has the highest interest rate, not necessarily the largest monthly payment.  Stick with the shortest repayment period you can afford and avoid capitalization of interest  Use the $2,500 student loan interest deduction  Sign up for auto-debit for a 0.25% or 0.50% interest rate reduction

Impact of Extended Repayment Loan Term Reduction in Size of Monthly Loan Payment Increase in Total Life-of-Loan Interest Extended Repayment – 12 years12%22% (factor of 1.22) Extended Repayment – 15 years23%57% (factor of 1.57) Extended Repayment – 20 years34%118% (factor of 2.18) Extended Repayment – 25 years40%184% (factor of 2.84) Extended Repayment – 30 years43%254% (factor of 3.54) Impact of extended repayment on monthly loan payment and total interest paid as compared with standard 10-year repayment

Debt Grows with Capitalized Interest Forbearance Duration Capitalized Interest Increase in Loan Balance Increase in Life- of-Loan Interest 3 months$1711.7%$236 (6.2%) 6 months$3453.4%$476 (12.5%) 1 year$7027.0%$967 (25.4%) 3 years$2, %$3,115 (81.8%) 6 years$5, %$6,933 (182.0%) 9 years$8, %$11,613 (304.8%) 12 years$12, %$17,348 (455.4%) Increases in loan costs from capitalized interest on a $10,000 Stafford loan with a 6.8% interest rate and a 10-year loan term

Many Miss First Loan Payment  One quarter to one third of borrowers are late on the very first payment on their student loans Most student loans have a six month grace period before repayment begins and students often move after graduation, losing track of bills Borrowers who consolidate their loans are more likely to pay on time, with less than one fifth missing the first payment, probably because the first payment is due soon after consolidation  Many need a statement or bill as a reminder  Many do not use auto-debit, despite discounts

Budgeting Tips for High Debt Students  Review your spending to identify ways to save money and avoid defaulting on your loans  Start with a descriptive budget, where you track and categorize all spending for a month Distinguish mandatory spending (need) from discretionary spending (want) and compare total mandatory spending with total income Identify spending on food, clothing, shelter, health, transportation, taxes, student loans, entertainment Eliminate discretionary spending and substitute lower cost options (e.g., live with parents to save on rent, cut gym membership, sell extra belongings on eBay)

End of FFELP, Start of 100% DL  Since July 1, 2010, all new federal education loans are made through the Direct Loan program  Existing FFELP portfolios are decreasing as borrowers repay their loans  Many lenders are trying to reinvent themselves Introducing new purely private loan products, increasing the competition Smaller lenders selling loan portfolios  Tuition increases and stagnant federal loan limits remain a key driver of private loan growth

Income-Based Repayment (IBR)  Loan payments capped at percentage of discretionary income (new plan July 1, 2009) Discretionary income is defined as income (AGI) minus 150% of the Poverty Line for the family size Currently 15% of discretionary income, but decreasing to 10% of discretionary income in July 2014 for new borrowers only $0 payment if income < 150% of the poverty line  Remaining debt and interest forgiven after 25 years in repayment (20 years for new borrowers on/after July 1, 2014)

Public Service Loan Forgiveness  Public service loan forgiveness accelerates the forgiveness for income-based repayment to 10 years and makes it tax-free Only federal student loans are eligible. Parent PLUS loans and private student loans are not eligible. Borrower must be employed full-time in a public service job, such as police, fire, EMT, government, military, public education, public health, social work, public interest law, public librarians and 501(c)(3) Will yield a financial benefit if debt exceeds income Must move loans to the Direct Loan program at loanconsolidation.ed.gov loanconsolidation.ed.gov

Credit CARD Act of 2009  New requirements to get a credit card, effective February 22, 2010 Students under age 21 will need a cosigner age 21+ Students who can demonstrate an independent source of funds sufficient to repay the debt will not need a cosigner  Sallie Mae survey showed that 84% of college students have a credit card (average 4.6 cards) Average balance $3,173 (median $1,645) 17% pay in full each month, 30% charge tuition Average debt $4,138 (median $2,495) at graduation

Gainful Employment  For-profit colleges and vocational programs are required to prepare students for “gainful employment in a recognized occupation”  The US Department of Education is proposing to define gainful employment in terms of affordable debt restrictions Three strikes rule –Loan repayment rate ≥ 35% –Debt-service-to-income ratio ≤ 12% –Debt-service-to-discretionary income ratio ≤ 30% Preferred thresholds of 45%, 8% and 20%

Repeal of Exception to Discharge?  Congress is proposing to repeal the exception to discharge for private student loans  Currently both federal and private student loans cannot be discharged in bankruptcy unless the borrower can demonstrate “undue hardship” in an adversary proceeding  Less than 1% of borrowers with federal student loans who file for bankruptcy get their student loans discharged  Sallie Mae supports repeal, but without nonprofit exception and with 5-7 year “good faith effort”

Resources  FinAid.org (  Student Loan Borrower Assistance Project (  Federal Student Loan Consolidation (loanconsolidation.ed.gov)loanconsolidation.ed.gov  US Department of Education’s Debt Collection Service (  FSA Ombudsman (

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