How Paying Off Student Loans Works

College graduation is a special milestone, but it can also leave you wondering how you're going to pay off thousands of dollars in student loans.

More of us are going to college than ever. In 2007, 18.2 million people in the United States were enrolled in a postsecondary degree program, a 30 percent increase from just 20 years before [source: National Center for Education Statistics]. Millions more are getting postsecondary vocational training. Besides traditional straight-from-high-school students, adults are going back to school to enhance or change their careers. One reason for the increasing popularity in postsecondary education may be the escalating number of jobs requiring a college degree, projected to grow by significantly between 2008 and 2018 [source: Bureau of Labor Statistics].

Meanwhile, education isn't getting any cheaper. In fact, the National Center for Education Statistics (NCES) reports that the cost has increased steadily over the last three decades. In the 1980-81 academic year, full-time college undergraduates paid an average of about $3,100 for tuition, fees, room and board, and meals. In 2007-08, that average was about five times as much, more than $16,200. According to the Consumer Price Index Inflation Calculator, that $3,100 from 1980 had the same buying power as about $8,000 in 2008, or half the cost of that undergraduate degree [source: Bureau of Labor Statistics].


So how are we paying for it? Academic and needs-based scholarships are available, as are federal, local and institutional grants. However, these "free money" options are limited in size and quantity, leaving most of us to cover part or all of our college expenses.

College savings programs can help us prepare in advance, and work-study programs can let us earn while we learn. For many of us, though, student loans make up the difference. In fact, two-thirds of the collegiate class of 2008 each owed an average of $23,200 in student loans upon graduation [source: The Project on Student Debt].


Paying off Different Types of Loans

There are many different types of loans available when you're planning how to pay for college. Believe it or not, the way you pay them back may depend on what type of loan you have.

Whether you're the student or the parent, you may have taken out a home equity loan or home equity line of credit (HELOC) to cover college expenses. During repayment, most home equity loans work like mortgages. Your key concerns should be whether you can make your payments on time, stay ahead of the market value on your property and prevent foreclosure. If you have a HELOC, the mortgage lender may have other options when the borrowing period ends, such as moving the debt to a traditional loan.


You might have unsecured loans instead of, or in addition to, equity loans. If you have a private student loan, check your loan paperwork for limits, interest rates and repayment terms. If you have a federal student loan, your interest rates and repayment terms depend on the type of loan, the date the loan was made and your selected repayment plan.

Federal Perkins Loans give you up to 10 years to pay, and you'll owe your school directly for that amount. Also with the Perkins, you don't have to pay while you're enrolled at least half-time, and you'll have a nine-month grace period before repayment when your enrollment ends.

Federal Stafford Loans and Parent Loans to Undergraduate Students (PLUS) are paid back to whomever you borrowed from. You owe the federal government directly if you borrowed using its Direct Loan Program. You owe the bank or lending institution managing your loan if you borrowed using the Federal Family Education Loan (FFEL) Program. Repayment for PLUS loans starts after only 60 days, but you don't have to pay your Stafford Loans while you're enrolled at least half-time. Stafford Loan repayment starts after a six-month grace period when your enrollment ends.

You can choose one of the following repayment plans for your federal student loans:

  • Standard Repayment is a fixed amount each month, with payments of at least $50 and up to 10 years to repay the loan in full.
  • Extended Repayment is a fixed or graduated monthly payment with up to 25 years to repay the loan in full. To qualify for this repayment option, you must owe more than $30,000 in loans under the same program (Direct Loan or Federal Family Education Loan).
  • Graduated Repayment lets you start out with a lower monthly payment, and increase that payment amount every two years. You'll have up to 10 years to repay the loan in full.
  • Income Based Repayment (IBR) sets the required monthly payment to a maximum based on your income and family size. You'll have up to 25 years to pay the loan, and the possibility of canceling the remaining balance of the loan after that time if you meet certain requirements.

If you plan to pay off your loan early, make sure you won't be punished by the lender. In many cases, you can pay off the loan early to avoid interest that would otherwise accrue each month. Some loans, though, might require you to pay all or part of that interest, or some other repayment fee.


Consolidation and Loan Forgiveness Programs

Four or five years of teaching is one possible way to have your student loan debt forgiven.

If you're paying off a student loan over 10 or more years, chances are your life will change a lot over that time. You might buy a house or a car, get married, have children or some combination of all of these. As things change, you can adjust your repayment options to alternatives that better meet your lifestyle.

Student loan consolidation lets you pull several loans together into one loan. This can help you take advantage of a lower interest rate, and it can often lower your minimum monthly payment. You can consolidate your federal loans with the government's Direct Consolidation Loan program or with an institution lending under the Federal Family Education Loan (FFEL) program.


You can't consolidate private loans with a federal loan. You could, however, take out a private consolidation loan to pull everything together. You could even use a home equity loan to combine them. To keep your interest rates as low as possible, though, you should probably consolidate your federal loans separately. Shop around to find the best interest rates and repayment terms.

Another reason to consolidate your loans, or move your current loan into a new loan, is to change your loan terms. Besides taking advantage of a better interest rate or lower payments, you can also change your repayment options, such as requirements for deferment or penalties for missed payments. Again, shop around to find the best loan terms.

Consolidation can lower your cash payments, but what about other ways to pay off your balance? The federal student loan program offers loan forgiveness options depending on the types of loans and your current financial situation. For example, you could cancel all or part of your federal loans by teaching full time for a few years in a low-income school or covering material in a certain subject area [source: U.S. Department of Education]. You might also qualify for loan forgiveness if you work in a public service job such as the Peace Corps or a non-profit health services group [source: U.S. Department of Education]. Research private organizations and your state and local government to find similar loan payoff options in exchange for your service.


Deferment and Forbearance

Though a difficult financial situation may make those student loan payments seem scary, you may be able to defer your payments until you're better able to pay them off.

When you can't make your student loan payments, and forgiveness programs aren't an option, you may have an opportunity to postpone payments until a time when you're better able to make your payments. These options can keep you from missing payments and going in default, which could impact your credit rating and subject you to debt collection actions such as wage garnishing.

Most loans targeted to covering your college expenses allow you some type of deferment while you're enrolled in school at least half-time. Unless the loan interest is subsidized, such as for some Stafford Loans, it's still added to your loan balance each month throughout the deferment. To prevent your balance from going up, you might choose a payment plan during your deferment that lets you pay the loan interest while leaving the principal balance the same.


At the end of your deferment, you'll have a grace period before you have to start paying back the loan. Private loans may have grace periods of as little as 15 days, while federal loans allow you six or nine months before your first payment. If you re-enroll later, such as to finish a degree program or start graduate school, you can defer your loans again. Deferment requirements will probably be the same as when you were enrolled before, and you'll probably have the same grace period afterward.

For some loans, you might also qualify for deferment while you're in military service or going through an economic hardship. Check the terms of your loan to see if your loan qualifies for this type of deferment. Also, contact your lender to see if they have any additional deferment options for you that aren't stated in the terms of your loan.

When deferment isn't available, you can ask for a forbearance to help you through a rough financial situation, like being laid off from your job. Forbearance lets you delay payments on your loan without penalty while you get back on your feet again. Forbearance periods vary in length, lasting anywhere from a few months to three years. When you apply for forbearance, you may need to explain your circumstances in your request, and you must continue your payments until the application is approved. Interest will accrue during your forbearance, so your balance will be larger when your payments resume.


Good Debt or Bad Debt?

Financial experts vary in their assessment of student loans when compared to other debt.

Bob Schumann, a financial planner, says student loan debt is good. Schumann's reasoning is that you can deduct the loan interest, the loan rates stay low and the debt "paves the way for you to make more money throughout your lifetime" [source: Anderson].


Mary Hunt, founder and publisher of the popular Cheapskate Monthly newsletter, argues that the debt is unsecured with "no escape route." Hunt reminds borrowers that there's no guarantee that the education will result in a job, and you're obligated to pay the debt regardless of the results.

Whether or not the debt is good or bad, student loan debt does affect your credit. A high credit rating allows you to borrow more at lower interest rates. To keep your credit rating high, make your scheduled payments on your student loans and look for deferment or forbearance options if you have trouble making payments.

School loan debt is also a risky business for the university itself. Students who default on their loans to for-profit institutions put those schools at risk of being shut out of the federal loan and grant programs. In 2007, 21 percent of students who started repayment to for-profit schools defaulted on their loans, while only 10 percent of students in four-year public schools defaulted on their loans. With 70 percent of their revenue coming from grants and loans, for-profit schools could suffer a financial blow if their enrolled students are denied financial aid because of their graduates' defaults [source: Marketplace].


Lots More Information

Related HowStuffWorks Articles

  • Anderson, Jessica L. "Climb Out of Debt Faster." Kiplinger. Dec. 1, 2006. (Jan. 3, 2010)
  • Hunt, Mary. "Mary Hunt's Debt-Proof Living: The Complete Guide to Living Financially Free." p. 298. Broadman & Holman Publishers. 1999.
  • J.P. Morgan Chase & Co. "Chase Select Private Student Loans - FAQ." July 31, 2009. (Jan. 3, 2010)
  • Marketplace. "Student loan defaults may hurt schools." American Public Media. Dec. 14, 2009. (Jan. 3, 2010)
  • Project on Student Debt, The. "Student Debt and the Class of 2008." December 2009. (Jan. 2, 2010)
  • Sallie Mae. "Sallie Mae Smart Option Student Loan." (Jan. 3, 2010)
  • Student Lending Corp. "Private Student Loans FAQ." (Jan. 3, 2010)
  • U.S. Department of Education. "Federal Family Education Loan (FFEL) Program." Nov. 23, 2009. (Jan. 3, 2009)
  • U.S. Department of Education, Federal Student Aid (FSA). "Cancellation/Deferment Options for Teachers." Nov. 30, 2009. (Jan. 3, 2010)
  • U.S. Department of Education, Federal Student Aid (FSA). "Facing Loan Default." (Jan. 3, 2010)
  • U.S. Department of Education, Federal Student Aid (FSA). "Funding Education Beyond High School: The Guide to Federal Student Aid." 2009-10. (Jan. 3, 2010)
  • ;Loan Forgiveness for Public Service Employees." February 2009. (Jan. 3, 2010)
  • U.S. Department of Education, Federal Student Aid (FSA). "Repayment Information." June 11, 2009. (Jan. 3, 2010)
  • U.S. Department of Education, Federal Student Aid (FSA). "Repayment Plans and Calculators." June 11, 2009. (Jan. 3, 2010)
  • U.S. Department of Education, National Center for Education Statistics (NCES). "Digest of Education Statistics." Tables 104, 188 and 198. 2008. (Jan. 2, 2010)
  • U.S. Department of Education, National Center for Education Statistics (NCES). "Fast Facts: What are the trends in the cost of college education?" 2009. (Jan. 2, 2010)
  • U.S. Department of Labor, Bureau of Labor Statistics. "Occupational Outlook Handbook, 2010-11 Edition." Dec. 17, 2009. (Jan. 2, 2010)
  • Wei, Christina Chang; Berkner, Lutz; He, Shirley; Lew, Stephen; Cominole, Melissa; Siegal, Peter; Griffith, James. "2007-08 National Postsecondary Student Aid Study (NPSAS:08): Student Financial Aid Estimates for 2007-09, First Look." April 2009. (Jan. 2, 2010)