Lowdown on loans: loans can be a practical, low cost way to pay for college—just be prepared to make payments far into the future

Careers and Colleges, Nov-Dec, 2002 by Denise Rossitto

Waiting tables and working summers for a surveying firm gave David Hilmer a nice nest egg for college at the University of Wisconsin, Madison. Although the money he saved was a good start, it was not enough. "After about a year and a half, I was scrambling--thinking how I was going to cover my dorm expenses and tuition," he recalls. Now 37 and the director of business development at Little Tornadoes, a Web consulting company in New York City, Hilmer says that student loans (a federal Perkins, Stafford, and a university loan) enabled him to graduate.

With the high cost of a college education today, it is no wonder many students rely on loans to help them make ends meet. The American Council on Education (ACE) reports that student borrowing has increased substantially since 1992 when Congress created loans available to all students regardless of income. Plus, when you consider that more than 40 percent of all financial aid is in the form of loans, many students don't have a choice. (Note: Most of these loans are guaranteed by the federal government.)

Planning ahead now and understanding your options when it comes time to repay loans can help you make smart decisions about borrowing. Here are some simple guidelines that apply to the major federal loan programs--the Perkins, the Stafford, the PLUS, and independent bank loans. (For more information on specific programs, see page 6.)

Set a Limit

Keep in mind that every dollar you borrow must be repaid, with interest, which can really add up over a 10-year (or longer) repayment term.

"It's easy while you're in school to think a $200-a-month payment is not a big deal," says Hilmer, "but those payments can take a big chunk out of your monthly income, and you're going to need to pay your other bills." Although Hilmer credits the Perkins and Stafford loans for making it possible for him to get through college, he says he would borrow less if given the chance to do it over again.

To get some idea of how much is too much, you need to estimate how much you'll be able to pay back once you graduate. That involves estimating your future costs and salary. In effect, you're imagining a future budget.

Start by estimating how much money you will be earning when you graduate. The Occupational Outlook Handbook published by the U.S. Department of Labor (available in most libraries and online at www.bls.gov) can give you some idea of salaries for a wide range of careers. Then you need to estimate monthly expenses--rent, utilities, food, clothes, car payments, and auto and apartment insurance. By subtracting your estimated expenses from your estimated salary, you can predict how much you can afford in monthly loan payments.

Avoid Default at All Costs

If you do wind up borrowing more than you can afford, you run the risk of defaulting, or failing to pay back your loan according to agreed-upon terms. These terms are specified in a promissory note, a legal document that binds you to make regular payments.

Default usually results after you miss payments for 180 days. Many defaulted loans are sent to collection agencies that may charge you costly late fees, take money from your wages, and add on collection costs. Worst of all, a defaulted loan can haunt you in the future because it will be recorded as part of your credit history for seven years. Lenders refer to your credit history when you apply for any major loan. If they see a defaulted loan on your record, they may deny you a mortgage, car loan, credit card, or personal loan.

Most lenders provide students with charts or booklets to help track repayments--see our handy "15-Minute Loan Manager" chart on this page. Keep in mind: If ever you can't make a monthly installment, immediately contact your lender or servicer (the company that owns your loan) to discuss the problem.

Take Advantage of Deferments

Knowing your repayment options can help you avoid default. With many student loans, you don't have to begin repayment until six months after you leave college. This is called a grace period After the grace period, a deferment or forbearance may help you make ends meet by suspending your repayment schedule.

Deferment is a period when a borrower who meets certain criteria may temporarily stop loan payments. And depending on the type of loan you have, the federal government may pay the interest on it during your deferment period. If you are a new borrower, you might be eligible for a deferment if you are still enrolled in school half-time or full-time; unemployed; studying in an approved graduate fellowship or rehabilitation program for the disabled; or experiencing economic hardship.

Forbearance is the term used for a temporary adjustment to your loan repayment schedule in cases of financial hardship. Anyone with student loans may be in forbearance for six months at a time, for up to a total of three years. Remember, though, that since interest accrues during forbearance periods, it will be capitalized (added) to the principle balance of your loan. (For more on loan repayment options, visit www.CareersAndColleges.com.)