Paying Back Your Student Loan
When possible, fund your education with a grant or scholarship, which does not require you to pay money back. You should complete the Free Application for Federal Aid (FAFSA) to see what resources are available to you.
How do Loans Work?
You will pay interest on a loan. Interest is essentially the “rent” that lenders charge for using their money. It is the part of repaying the loan that frequently gives borrowers the most problems.
Interest charges on a loan make the debt that you must repay larger. Any time you have a debt, the interest charges will increase your balance over time.
View the Infographic (PDF)
Imagine that you have been awarded a $1,000 student loan and that the interest rate is 5% per year. This means that every year your $1,000 loan goes unpaid, you owe an additional 5% on the balance. If you don’t make any payments, after a year the loan balance increases by $50. If you don’t make a payment during the second year, your balance rises by another 5% not just on the $1,000, but also on the $50 interest charged during the first year. This interest-on-interest charge is called COMPOUND INTEREST.
If, on the other hand, you begin paying the loan after the first year, you reduce the amount that you owe in the future. So, if after the first year you make a $100 payment, then you will have paid off the $50 in interest and reduced your $1,000 mortgage loan balance by $50. Therefore, during the second year you will pay 5% interest on $950 rather than the full $1,000.
Making these payments on time is the best way to reduce your debt.
Let’s take a closer look at the effects of COMPOUND INTEREST and how you can avoid it by making regular payments.
David, Natasha, and Lee got a deferment, or a postponement, on the debt, but their debts were growing! Even if a lender agrees not to enforce the debt (an agreement called a “forbearance”), it is getting bigger. Lee especially was running into some problems. What would happen to Lee if he didn’t get around to making any payments after his forbearance was up? That’s called DEFAULTING on the loan, and has some serious consequences!
What Are the Consequences of Default?
The consequences, which can be severe, include the following:
- The entire unpaid balance on your loan and any interest you owe becomes immediately due (This is called “ACCELERATION“).
- You can no longer receive deferment or forbearance, and you lose eligibility for other benefits, such as the ability to choose a repayment plan.
- You will lose eligibility for additional federal student aid.
- The default will be reported to credit bureaus, damaging your credit rating and affecting your ability to buy a car or house or to get a credit card.
- Your tax refunds and federal benefit payments may be withheld and applied toward repayment of your defaulted loan (this is called “TREASURY OFFSET“).
- Your wages will be garnished. This means your employer may be required to withhold a portion of your pay and send it to your loan holder to repay your defaulted loan.
- Your loan holder can take you to court.
- You may not be able to purchase or sell assets such as real estate.
- You may be charged court costs, collection fees, attorney’s fees, and other costs associated with the collection process.
- It may take years to reestablish a good credit record.
- Your school may withhold your academic transcript until your defaulted student loan is satisfied. The academic transcript is the property of the school, and it is the school’s decision — not the U.S. Department of Education’s or your loan holder’s — whether to release the transcript to you.
Source: Federal Student Aid, an Office of the U.S. Department of Education