How to reduce student debt

Answer these five key questions to help consolidate loans and reduce monthly payments.

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Nick graduated from medical school with $160,000 in student loan debt—and he panicked. “Six months after finishing med school, I was hit with the first monthly payment of $2,500. I had no idea where the loans were held and no concept of how they were set up,” he recalls. Thankfully, his brother, who graduated from business school, stepped in to help. But even he found that it wasn’t easy to figure out how the loans were structured and what the different payment options were.

Student loan debt has become a struggle for many students. According to the Consumer Credit Agency, there is currently $1.2 trillion in student debt in the United States—surpassing even credit card debt.1

According to the College Board, the average debt for students who have borrowed for college is between $24,000 and $30,000. Some graduate students have debt that exceeds $200,000. No wonder many young people feel like they can’t move forward in life, to buy a house, start a family, or save for retirement.

For most young people, the truth is that there are simple strategies to reduce student debt so graduates can begin creating the lives they want. To understand your options—whether you’re a student or a parent who’s helping your child navigate the student loan process—it’s important to have a plan to make the most of the different ways to pay back and consolidate debt, and reduce interest payments. Start by asking yourself these five key questions.

1. Do you qualify for a government loan forgiveness program?

This should be the first step in analyzing and taking control of student debt. Find out whether you can take advantage of one of these programs:

  • Income-based repayment plans are available on all federal student loans, allowing borrowers to pay just up to 10% of their discretionary income toward their entire outstanding federal direct student loan balance—no matter how much debt is owed. It’s ideal for those with low incomes and high outstanding debt. To calculate discretionary income, visit studentaid.ed.gov.
  • Public service loan forgiveness plans are intended to encourage young people to work in the public service and nonprofit sectors. The borrowers pay 10% of their discretionary income toward the total outstanding balance of all their federal direct student loans, just like the income-based plan, and it’s calculated the same way. The difference is that after only 10 years the remaining balance is forgiven. While anyone who works full time for a public service or nonprofit company qualifies, it’s especially advantageous for those with student loans that will not be paid off in 10 years or more. For more details visit studentaid.ed.gov.

2. Which loans benefit from being refinanced?

Don’t automatically assume that federal loans have the lowest rate. Right now, private lenders are courting college graduates with low refinancing rates in hopes of turning them into long-term customers. What’s more, an employed graduate is a better credit prospect than a college freshman and therefore usually qualifies for a lower interest rate from a private lender.

One way that private lenders can offer lower rates is through consolidating all outstanding loans into a single loan offering a new rate. Based on your credit rating, that rate may be a more favorable one and could actually save a substantial amount of money over time. Analyze each loan to see whether it has a higher rate than the one being offered by the private lender. Loans most likely to benefit from refinancing are Grad PLUS and Parent PLUS loans that bear relatively high interest rates, ranging from 6% to 9% depending on the year the loan was received.

If you meet the requirements listed below, you may be a candidate for private student loan refinancing and consolidation. Of course, some lenders may have stricter or looser criteria.

  • A minimum credit FICO score of 640
  • A 45% maximum monthly debt-to-income ratio
  • A minimum monthly gross income of $2,000
  • A college degree or certificate of enrollment if still in school

Once a lender offers a rate based on individual criteria, you can use this calculator to figure out how much can be saved. Many financial institutions, but not all, allow you to consolidate and refinance both government and private student loans into one loan, making it easier to keep track and manage the debt. While consolidating government and private loans can help get a lower interest rate, keep in mind that the flexible and sometimes cheaper repayment plans offered by the government may be lost.

Also, some financial institutions will allow a parent to cosign a student loan, thereby potentially reducing the interest rate on a consolidated student loan.

3. What if federal loan rates are lower than the one offered?

If your federal loans have lower rates than the rate offered by a private lender, you may want to consolidate these through a government-sponsored program. The resulting rate will be a weighted average of the prior loan rates (rounded to the nearest one-eighth of a percentage point). You can also lower monthly payments by lengthening the loan’s term. While it’s true you will pay more in interest over time, the monthly savings can be used to pay off higher-interest loans more quickly.

Remember, only federal loans can be consolidated through the government-sponsored program. You can explore your options at studentloans.gov.

Need help choosing between a government and a private program?
Direct Federal Loan Consolidation Private Loan Refinancing
Are federal loans eligible? YES NOT ALWAYS
Are private loans eligible? NO YES
Is a credit check required? NO YES
Is a lower interest rate possible? NO YES
Can I extend the terms of my loan(s)? YES YES
Will I save money? NO YES
Will I get one bill? YES YES

4. Why is flexibility so important?

When refinancing, you will be working with this lender for the next five to 20 years, so it’s important to make sure it’s a good fit. Choose a lender that offers a range of options that help optimize monthly payments, lifetime costs, and speed to pay off.

Here’s what to look for:

  • Low, competitive rates
  • A choice of variable and fixed rate loans
  • No prepayment penalties
  • Ability to compare plans online
  • Online preapproval
  • No application or processing fees
  • Automatic payment plan
  • Cosigner release
  • Payment leniency
  • Unemployment protection
  • Access to live customer support

5. Is it possible to defer payments for a short time?

Under certain circumstances, students are able to postpone paying their federal direct student loans until a later date. Depending on the type of loan, the federal government may pay the interest on the loan during a period of deferment.

Also, if you intend to go to graduate school after college, private lenders typically won’t allow a deferment, whereas you can get a deferment on federal loans like a Perkins or subsidized loan. So it’s important to weigh the pros and cons of consolidating/refinancing direct subsidized loans.

Get started on the right foot.

The faster graduates move from being debtors to becoming savers and investors, the brighter their futures will be. It may make sense to pay the minimum on student debt and start putting money away in a tax-deductible 401(k), especially if their company offers a match.

“If possible, try to pay off debt while saving and investing at the same time,” says John Sweeney, executive vice president of retirement and investing strategies at Fidelity. “If you can borrow at a low rate and earn money at a higher rate, you’ll come out ahead over the long term.”

It’s also a good idea to live frugally for a couple of years after starting a career, instead of inflating your lifestyle.

Learn more

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1. Source: ConsumerCredit.com.
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
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