Is Student Loan Debt Really ‘Good Debt’?
By Devon Delfino
When you borrow money to pay for college, two words can help you make peace with your student loans: good debt.
When financial experts use the phrase, “good debt,” they’re usually talking about debt that has the potential to create value in the future. That’s in contrast to something like credit card debt, which really only leaves you with less money and can even keep you in debt if you only pay the minimum.
But even good debt can derail your finances if mishandled. Here’s how to ensure your student loans help you in the long run.
Keeping good debt from going bad
Even though there are variations along racial, gender and occupational lines, it’s still a valid claim: Bachelor’s degree recipients 25 and older earn about $2,260 more per month than high school graduates, and college graduates are less likely to be unemployed, according to the Bureau of Labor Statistics.
But as certified financial planner Kathryn Hauer points out, even good debt can go bad if you can’t afford your monthly payments. And larger payments become even more difficult to handle if you don’t stick to the script.
“If you don’t finish your degree and you’ve incurred debt, it’s highly unlikely that you’ll be able to pay that back,” Hauer says. “That debt can be a real burden then.”
She’s right: Falling behind on payments increases your risk of going into default, and nearly 17% of students who leave college without a degree end up in default, compared to 3% of college graduates. It’s even more likely if you go to a for-profit, less-than-four-year school, where the default rate for degree-less borrowers is nearly 30%.
Federal loans generally go into default after 270 days of nonpayment, while private loans could go into default the day after you miss a payment. That adds extra costs like late fees, accrued interest and collection costs to your loan bill. Plus, it’ll have a negative impact on your credit score, so you’ll have a harder time qualifying for things like a mortgage or a car loan in the future.
How student loans affect your credit
Federal student loans — which don’t require a credit check — are an easy way to establish your credit history. Most students who fill out the Free Application for Federal Student Aid, or FAFSA, qualify. And as long as you keep up with your payments, your loans will help you build credit, too. That’s because on-time payments are one of the main factors credit bureaus use to calculate your credit score.
A high credit score is important because it allows you to qualify for lower interest rates on everything from credit cards to auto loans in addition to helping you get approved for a lease on an apartment. That will save you money long-term.
How to avoid default
Your best line of defense is to limit the amount you take out in the first place. As a guideline, it’s best to only borrow the amount you expect to make during your first year out of college.
“Look at all your resources and don’t make borrowing or student loans one of the top sources of paying for your college education,” says certified financial planner Jason Reiman. “[Loans] should be the last resort.”
Once you have student debt, it’s all about managing your loans. To lower your federal loan payments, apply for an income-driven repayment plan. If you qualify, your payments will be capped to a percentage of your income and your loan term will be extended from 10 years to 20 or 25 years. Any balance that’s left over after that would be forgiven and taxed as income.
Private loans don’t have flexible payment plans, so you may have to go straight to deferment or forbearance if you fall behind. While that drives up the long-term cost of your loan, it prevents you from going into default.
By following these guidelines, you can rest easier and focus on more important things, like churning out your thesis or landing your dream internship.
Devon Delfino is a staff writer at NerdWallet, a personal finance website. Email: ddelfino@nerdwallet.com. Twitter: @devondelfino.
Originally published at www.nerdwallet.com on November 18, 2016.
