5 Reasons Your Student Loans Keep Growing
Friday, October 26, 2018, 6:00 AM | Leave Comment
The year is 2018, and student loans are becoming a massive problem for the American populace.
According to Student Loan Hero, the average graduating college student has $39,400 in debt, and across all of America there is 1.48 TRILLION dollars in student loan debt. And what’s worse, for many of us suffering from student debt, the loans keep growing even though we are consistently paying them back.
And with so many terms regarding student loans thrown about, such as “student loan rehabilitation” and “variable interest rates”, it can often feel like you need in-depth knowledge of student loan law to understand where things are going wrong.
If you or someone you know has loans that seem to keep growing, here are 5 reasons that might be why, and what you can do to get on top:
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Compounding Interest
This is the big one, and it’s one of the most important things to learn about finance: compound interest. It can grow your savings and wealth quickly, but also your debt. Interest is a percentage of funds paid to a borrower or lender. If you put $1000 into an investment account that pays 5% compounded annually, at the end of a year you would now have $1050. That extra $50 you earned is interest.
If you keep that $1050 in the account, now you are earning 5% on $1050 instead of $1000, meaning the interest you earned last year is compounding, because your interest money is now earning more interest money. So at year 2 of having the money in the account you would now have $1,102.50. This means that for each year you leave the money in the account, you will earn more money than the year before, the money you earned in interest is now compounding and earning interest of its own.
Now I know this is a lot of numbers and it’s hard to read, but this stuff is important, because it works if you OWE money. The longer you take to pay your student loans, and the smaller your monthly payments are, the more money you will have to pay due to interest.
Let’s say you have a $50,000 loan at 6.31% interest with a loan term of 10 years, and your monthly payment is $562.92. During that 10 years you will pay $67,599.71 in total, even though your original loan was only for $50,000! You paid almost $18,000 more than your loan was originally worth.
The money you pay extra becomes even bigger if you are making minimum payments or have a longer loan term. If you are not paying, then your debt grows even more because you are not paying off the interest that keeps accruing, and it will keep growing and growing.
The best way to fight this back is to start paying your loans as soon as possible, and pay consistently. Even if it’s just minimum payments, it’s way better than nothing. Making large payments will help as well, but make sure you truly can afford it first. The more consistently you pay your loans and the larger the payments you can make towards them, the less total interest you will end up paying.
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Forbearance
Now that the heftiest topic is out of the way, things will be a little easier to talk about. If you have student loans there’s a good chance you’ve heard of the term forbearance.
Forbearance is when your loan provider allows you a grace period where you won’t go into default by not paying your loans. For Federal loans the allowable forbearance period is 3 years, for private loans it can often be less. The idea is usually that “it’s better to go into forbearance than go into default” or even worse that “I’ll start paying my loans as soon as I graduate, get a job, and get my feet under me, and then start paying when I can afford to” mentality.
I myself fell victim to the latter trap when I graduated college, and a lot of college counselors recommend it over better solutions, like an income based repayment plan. The ugly reality is that while your loans are in forbearance they are still earning interest, and 3 years worth of compounding interest making no payments at all results in a LOT of extra money owed.
The best way to avoid this is start paying as soon as possible.
Now it is true you don’t want to go into default, but if it is at all possible for you to pay your loans, start paying as soon as you can. If you can’t afford the payments there are often options for income based repayment plans or other ways to make your minimum payment lower.
While usually not ideal these options are far better than not paying in most cases. If you do an income based repayment plan or something similar, learn what you are signing up for.
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Consolidating Loans or Student Loan “Rehabilitation”
These two can be real nasty. Consolidating your student loans in theory sounds like a good idea. You are rolling all your separate loans into one larger loan, so now you have only one payment and one interest rate. Student Loan Rehabilitation, on the other hand, is usually a program to help people pay on a defaulted loan.
The problems with both programs is there are often hefty fees hidden in the fine print. For Student Loan Rehabilitation programs, collection fees can be as high as 16%! If you have $10,000 in loans you might pay $11,600 just by the mere act of joining this program!
That’s a lot of extra money, and the lenders bury those fees in a contract that even a student loan law expert would have trouble reading.
The other issue is sometimes the interest rates of these programs can be even higher than those of the original loan providers. Usually you want to stay away from these entirely, and if you are considering a program like this or are already in one, make SURE you read the fine print and know what you’re on the hook for.
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Going Back to School to Avoid Paying Loans
Many people think that they can buy themselves time and avoid paying their loans, or maybe qualify for loan forgiveness by going back to school. In reality loan forgiveness is usually bunk and rarely works, and they are just digging themselves further in the hole and racking up more tuition debt by returning to college.
Not that there isn’t a time and a place to go back to school, but it’s important to consider how much more money you will be spending on further education, and on how likely it is that your new post-graduation career will pay as good as you think it will. If you want to go back to school it’s best to pay your way through it. If you must finance your further education with debt, make sure you are entering a degree that is high paying and in high demand, such as a nurse or an x-ray tech.
Don’t go back to school for a generic business degree because you think it will give you better prospects than your anthropology degree. It might give you better prospects, but financially is that really worth another $20,000 in debt?
In a lot of jobs, just having the first degree will be enough to get you where you must go. If you want to go back to school, think it through and know how much your spending, and have a realistic view of what your prospects will be like with the second degree. There are many instances in which it will be worth it if it can get you a promotion at your current job, or help you enter a higher paying field.
It may also just be that you want to follow your passion and change careers. There’s nothing wrong with that, and it’s a wonderful thing! Just make sure you’re realistic about it and have a plan so you don’t land yourself in financial hot water by going back to school, and don’t go back to school to avoid your loans.
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Students Don’t Understand Their Loans
This is probably a central theme for a lot of debt related problems: signing contracts you don’t understand. I’ve been guilty of this, as most Americans have at some point.
I went into college straight from high school, I didn’t even take a summer. I knew nothing about money and my parents did all of my loan stuff for me. I eventually graduated and realized I knew nothing about how much my college had cost, what I owed, my interest rates, and what my options were for repayment.
This is a gritty reality for thousands if not millions of Americans.
They don’t understand their loans. I realized that it was important for me to become financially literate, and now I understand my loans and a lot of other aspects of finance. But many people never do learn about these things, and in all cases you would be better off if you learn what you’re agreeing to.
The good news is you can start now, and if you’re reading this article you’re probably already on your way! One important aspect of understanding student loans is simply understanding compound interest.
Another is paying attention to terms like “variable interest rates” when you’re applying for loans. Federal loans have fixed interest, but a lot of private loans have variable interest, which means that while they often start with low rates, the interest rate can fluctuate with market changes. You may wake up one day and realize a market change turned your 3% interest rate into a 6% interest rate, meaning you will now pay way more money in interest.
It’s important to pay attention to these things and learn as much as you can, whether you are looking at getting a loan or even if you already have one that you don’t know all the details of. Knowledge is power, and the more you know about your finances the easier it will be for you to get ahead.
These are 5 common reasons your student loans might keep growing. I know the situation might seem dismal, but there is hope! The mere fact that you are taking the time to read articles like this and learn means you are taking giant step in the right direction, towards being student loan free!
Getting rid of student loans is a marathon, not a race, and the most important thing is being consistent in your payments and learning what you need to know to come out on top! Good luck out there.
Bibliography:
“For Some, Student Debt is Doubling, Tripling, even Quadrupling”. cnbc.com.
https://www.cnbc.com/2018/05/05/for-some-student-loan-debt-is-doubling-tripling-and-even-quadrupling.html
“Five Reasons Why Student Debt Is Skyrocketing” . truthout.org.
https://truthout.org/articles/five-reasons-why-student-debt-is-skyrocketing/
“Four Reasons Your Student Loan Payments Could Skyrocket (And What You Can Do About It). Student Loan Hero.
https://studentloanhero.com/featured/why-did-my-student-loan-payment-go-up/
“A Look At the Shocking Student Loan Debt Statistics of 2018”. Student Loan Hero.
https://studentloanhero.com/student-loan-debt-statistics/
“The Power of Compounding Interest” . LendKey.
https://www.lendkey.com/blog/the-power-of-compounding-interest-2/
“The Powerful Effects of Compound Interest” Student Loan Guy.
https://www.studentloansguy.com/compound-interest/
