The following guest post comes to you from Drew Cloud, Founder and owner of The Student Loan Report
When it comes to repaying your student loans, separating fact from fiction can sometimes be a little difficult. Some can make you think twice about paying your loans as quickly as possible. It’s time to dispel some of these student loan repayment myths once and for all.
Student Loans Don’t Affect Your Credit Score.
Student loans can have a positive and negative effect on your credit score. As you repay your loans, your debt-to-income ratio will get smaller and that means your credit score may improve (so long as you aren’t accruing debt elsewhere).
While your on-time student loan payments might not be as relevant as any prior car loans when you are applying to purchase a new car, for example, they still establish a track record that you can reliably make payments on-time every month.
If you miss student loan payments, your credit score could drop which could lead to financial disaster. Even worse, if you default on your student loans, that event will penalize your credit score further and remain on your credit report for up to 10 years.
Income-Based Repayment Plans Save Money
This repayment myth depends on your financial situation. Federal income-based repayment plans will result in a lower monthly payment because your payments are capped at 10% of your adjusted monthly income. If you qualify for the Public Service Loan Forgiveness program, any remaining balance will be forgiven after 120 monthly payments (10 years).
You might not save money if it takes more than ten years to repay your loans. While your monthly payments are smaller, you will pay more in cumulative interest because of the longer repayment term. This can still be cheaper than missing monthly payments and being charged late fees and having a damaged credit score that can deny you access to future credit requests like a home mortgage or auto loans.
Federal Loans Are Automatically Forgiven When You Work For Select Employers
Some graduates think that the Public Service Loan Forgiveness program automatically forgives your federal loans when you begin working for an eligible government agency or non-profit organization. You need to work for an eligible employer and make your monthly student loan payment for 120 months (10 years) before your remaining balance is forgiven.
If you don’t qualify for the PSLF program, any remaining student loan balance can be forgiven after 20 years of payments when you enroll in an income-based repayment plan. With any federal student loan forgiveness plan, the payments do not need to be consecutive. But, you will have a larger amount forgiven if you can make ten years or 20 years of consecutive payments.
Interest Won’t Accrue When You Defer or File Forbearance
If you need to defer your student loans or request a forbearance, interest will still accrue. Interest won’t accrue on subsidized federal student loans. You won’t be responsible for making the monthly principal payment. Under certain conditions with a forbearance, you can be required to pay the accrued interest each month.
You can continue making the monthly interest payment so the total accrued amount will not capitalize when the loans enter repayment status. If you allow the accrued interest to capitalize, that amount will roll into the principal and you will essentially “pay interest on interest” and increase the total cost of your loan.
You Cannot Refinance Private and Federal Loans Together
With certain private lenders, you can consolidate your private and federal student loans together. You might consider this option if you only want a single monthly payment or can qualify for a lower interest rate. Keep in mind that you will forfeit your federal loan forgiveness benefits like income-based repayments that cap your monthly payment at 10% of your income or the Public Service Loan Forgiveness (PSLF) option.
If you don’t plan on using these forgiveness options, the money you can save by privately refinancing all your student loans is a worthy trade-off. And, many banks that consolidate student loans will not charge you an application, origination, or early payment fee. You will only have to pay monthly interest based on your new interest rate.
There Are Fees to Refinance or Consolidate My Student Loans
Never apply with a lender that will charge a fee to refinance or consolidate your student loans. Private refinancing loans and federal consolidation loans do not charge prepayment penalties if you repay the entire balance early. Your federal interest rate will round up to the nearest one-eighth of one percent and increase your interest charges slightly, but, that is the only cost increase you will see with either loan. And, it’s even possible to get a lower interest rate when you privately refinance.
Once your loans enter repayment status, making the full monthly payment each month will gradually build your credit score. Unless you miss a monthly payment, you should never have to pay any additional fees if you choose to consolidate, refinance, or make extra payments. Finally, if you have a question about your student loans, ask your lender or servicer for a straight answer.