Tracking your student loans and making timely payments

You may have multiple types of loans with different loan servicers. It’s your responsibility to keep track of them, provide changes of address as necessary, and pay them on time. All your federal student loans can be found through the National Student Loan Data System (www.nslds.ed.gov).

Signing up for automatic electronic payments can knock ¼ percent or more off of the interest rate on your student loans. And, autopayment on your loans will keep you current on those loans, benefit your credit score, and eliminate the chance of getting hit with late fees.

If you fall on hard times (for example, you get laid off from your job) and can’t make a payment, communicate with your loan servicer and request a deferment. While your deferment request may be turned down if your circumstances are deemed not severe enough, you may qualify for forbearance, during which interest continues accumulating on your loans but you stop making payments for up to one year. If you fail to get in touch and communicate with your loan servicer when you’re having problems making payments, your credit report will show that you are deliquent on your loans and your credit score will suffer greatly (see Chapters 1 and 4 for more about credit scores).

Prioritizing the payback of student loans

How fast you pay back student loans should be a function of a number of factors. First, if you plan on doing more schooling and possibly applying for any type of financial aid, it generally makes sense to pay the minimum possible on your loans; the more debt you have outstanding, the better positioned you will be to see your future education bills reduced. You can see your repayment options on the website, studentaid.ed.gov/sa/repay-loans/understand/plans#estimator.

You should be aware of another quirky feature of federal student loans if you’re contemplating working for certain nonprofit or public-sector employers. The Public Service Loan Forgiveness Program may help wipe out your remaining federal student debt after you’ve made ten years of repayments if you work for a qualifying employer such as the federal, state, or local government or a nonprofit organization covered under Section 501(c)(3) of the Internal Revenue Code, or if you’re serving in a full-time AmeriCorps or Peace Corps position. See studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service for more information.

When weighing which student loans to pay back faster, you should consider the interest rate on your loans. If you have extra cash and would like to pay back your loans faster, start with the ones with the highest interest rate. If the overall interest rates on your student loans are relatively low, don’t miss out on the tax benefits you can earn by funding a retirement savings account, especially if that retirement account offers you free matching money from your employer.

If you’re sure you are finished with your higher education and associated costs and are debating paying down your student loans faster than required versus investing your extra cash, do a comparison of the interest cost on your most costly loans versus the likely investment returns if you were to invest that money. (The rules governing the tax-deductible amount of your student-loan interest are covered in the next section.) If your student loan interest is 4 percent and you are reasonably confident that you can earn, say, 6 to 8 percent by investing your extra cash, you could go for the investment.

Using education tax breaks

Whether you are finished with your higher education or not, be sure you understand and maximize your use of the U.S. federal government tax benefits relating to those costs. Here’s a summary of key provisions you should know about:

• Student-loan interest deduction: You may take up to a $2,500 federal income-tax deduction for student-loan interest that you pay on IRS Form 1040 for college costs as long as your modified adjusted gross income (AGI) is less than or equal to $65,000 for single taxpayers or $135,000 for married couples filing jointly. (Note: Your deduction is phased out if your AGI is between $65,000 and $80,000 for single taxpayers or between $135,000 and $165,000 for married couples filing jointly.) Loans must be for qualified education expenses at an eligible higher educational institution such as a college, university, vocational or technical school, or other post-secondary educational institution eligible to participate in student-aid programs overseen by the U.S. Department of Education. The student using the loan must be enrolled at least half-time in a degree program.
• Tax-free investment earnings in special accounts: Money invested in so-called section 529 plans is sheltered from taxation and is not taxed upon withdrawal as long as the money is used to pay for eligible education expenses. Subject to eligibility requirements, 529 plans allow you to sock away $200,000+. Please be aware, however, that funding such accounts may harm your potential financial aid.
• Tax credits: The American Opportunity (AO) credit and Lifetime Learning (LL) credit provide tax relief to low- and moderate-income earners facing education costs. The AO credit may be up to $2,500 per student per year of undergraduate education, while the LL credit may be up to $2,000 per taxpayer. Each student may take only one of these credits per tax year, and they are subject to income limitations. And in a year in which a credit is taken, you may not withdraw money from a 529 plan or take a tax deduction for your college expenses.

A number of so-called miscellaneous education and career-related expenses are deductible on IRS Form 1040 Schedule A. These include

• Educational expenses: You may be able to deduct the cost of tuition, books, and travel to and from classes if your education is related to your career. Specifically, you can deduct these expenses if your course work improves your work skills. Courses required by law or your employer to maintain your position are deductible if you pay for them. Continuing education classes for professionals may also be tax deductible. Note: Educational expenses that lead to your moving into a new field or career aren’t deductible.
• Job searches and career counseling: After you obtain your first job, you may deduct legitimate costs related to finding another job within your field. You can even deduct the cost of courses and trips for new job interviews — even if you don’t change jobs. And if you hire a career counselor to help you, you can deduct that cost as well.

Weighing the costs and benefits of education expenditures

If you are considering more higher education, it is imperative to weigh what this education will actually enable you to do in the workforce. Simply spending more on education may not be the answer.

Americans spend a lot of money on obtaining traditional college degrees. Yet, a good number of students fail to graduate with the education and training that they need to secure good, available jobs. A survey of those (especially young adults) currently unemployed and underemployed supports these concerns. There are good quality job openings, but the young adults available to work lack the proper training and educational background to do those jobs.

Simply put, too much money is wasted on higher education that is failing to train young adults to qualify for the best available jobs.

Just as government programs encouraged and enabled excessive mortgage borrowing and contributed to a housing bubble in the late 2000s, the same is happening with higher education.

When considering an advanced or undergraduate degree, try as best you can to research the value of particular colleges and degree programs. There are numerous resources for doing this. Among those which I’ve reviewed and found useful are the following:

• Forbes’ “Best Value Colleges” ranking compares and ranks colleges and universities based upon costs, school quality, post-grad earnings, student debt loads, and graduation success. Visit www.forbes.com/value-colleges/list.
• Georgetown University’s Center on Education and the Workforce produces “The Economic Value of College Majors” using Census Data to analyze wages for 137 college majors, the majors most likely to lead to an advanced degree, and the economic benefit of earning an advanced degree by undergraduate major. See cew.georgetown.edu/cew-reports/valueofcollegemajors.
• PayScale, the large online salary and benfits information collector, ranks colleges and majors on a return-on-investment basis over 20 years. Visit www.payscale.com/college-roi.

Making the most of student loans, grants, and other financial aid

If you’re still in school or considering going back to school, a host of financial-aid programs, including a number of loan programs, allow you to borrow at reasonable interest rates. Most programs add a few percentage points to the current interest rates on three-month to one-year Treasury bills. Thus, current rates on educational loans for students are in the vicinity of rates charged on fixed-rate mortgages (parent loan rates are a little higher). The rates are also capped so the interest rate on your student loan can never exceed several percent more than the initial rate on the loan.

A number of loan programs, such as unsubsidized Stafford Loans and Parent Loans for Undergraduate Students (PLUS), are available even when your family is not deemed financially needy. Only subsidized Stafford Loans, on which the federal government pays the interest that accumulates while the student is still in school, are limited to students deemed financially needy.

Most loan programs limit the amount that you can borrow per year, as well as the total you can borrow for a student’s educational career. If you need more money than your limits allow, PLUS loans can fill the gap: Parents can borrow the full amount needed after other financial aid is factored in. The only obstacle is that you must go through a credit qualification process. Unlike privately funded college loans, you can’t qualify for a federal loan if you have negative credit (recent bankruptcy, more than three debts over three months past due, and so on). For more information from the federal government about these student-loan programs, call the Federal Student Aid Information Center at 800-433-3243 or visit its website at studentaid.ed.gov.

If you (or your parents) are homeowners, you may be able to borrow against the equity (market value less the outstanding mortgage loan) in your property. This option is useful because you can borrow against your home at a reasonable interest rate, and the interest is generally tax-deductible on up to $100,000 borrowed. Some company retirement plans — for example, 401(k)s — allow borrowing as well.

Parents are allowed to make penalty-free withdrawals from individual retirement accounts if the funds are used for college expenses. Although you won’t be charged an early-withdrawal penalty, the IRS (and most states) will treat the amount withdrawn as taxable income. On top of that, the financial-aid office will look at your beefed-up income and assume that you don’t need as much financial aid. Because of these negative ramifications, funding college costs in this fashion should only be done as an absolute last resort.

In addition to loans, a number of grant programs are available through schools, the government, and independent sources. You can apply for federal government grants via the Free Application for Federal Student Aid (FAFSA). Grants available through state government programs may require a separate application. Specific colleges and other private organizations (including employers, banks, credit unions, and community groups) also offer grants and scholarships.

One of the most important aspects of getting financial aid is choosing to apply, even if you’re not sure whether you qualify. Many scholarships and grants don’t require any extra work on your part — simply apply for financial aid through colleges. Other aid programs need seeking out — check directories and databases at your local library, your high-school counseling department, and college financial-aid offices. You can also contact local organizations, churches, employers, and so on. You have a better chance of getting scholarship money through these avenues.

Benefits for military people

Special student-loan benefits are available to those who serve in the U.S. military. If you have student loans and then join a branch of the U.S. military (except the Marines), up to one-third of the amount you borrowed or $1,500 per year of service, whichever is greater, may be forgiven. There’s a reimbursement limit of up to $10,000 for the Air Force and $65,000 for the Army and Navy.

Numerous educational assistance programs are available for those who serve while in college or go to college after serving. See www.military.com/education/money-for-school for details by branch of the military, as there are many programs and they vary by branch.

Kicking the credit-card habit

It’s fine to use your credit cards as a convenient payment method — and possibly to earn benefits and rewards — if you pay your bill in full each month and don’t spend more due to having the cards. I’ve used them my entire adult life and also have reward cards that provide me with free and discounted airline tickets and hotel stays.

However, with their wide acceptance by merchants and their ease of use, having credit cards can foster living beyond your means by extending credit. That’s why I recommend that you cut up all your credit cards and call the card issuers to cancel your accounts if you have a habit of accumulating debt on credit cards.

You can manage your finances and expenditures without having a credit card. Now, if you can trust yourself to be responsible, keep one credit card only for new purchases that you know you can absolutely pay in full each month. But if you decide to keep one widely accepted credit card instead of getting rid of them all, be careful. You may be tempted to let debt accumulate and roll over for a month or two, starting up the whole horrible process of running up your consumer debt again. Even better than keeping one credit card is getting a debit card (see the next section).

If you’re not going to take my advice to get rid of all your credit cards or secure a debit card (discussed in the next section), be sure to keep a lid on your credit card’s credit limit (the maximum balance allowed on your card). You don’t have to accept a higher limit just because your bank keeps raising your credit limit to reward you for being such a profitable customer. Call your credit-card service’s toll-free phone number and lower your credit limit to a level you’re comfortable with. Also ask your card-issuing bank not to automatically raise that limit in the future when you’re deemed eligible for an increase.

Discovering debit cards: Convenience without credit temptation

Just because you get rid of your credit cards doesn’t mean you have to always pay by check or cash. Enter the debit card, which offers you the convenience of making purchases with a piece of plastic without the temptation or ability to run up credit-card debt. A debit card looks just like a credit card with either the Visa or MasterCard logo. Debit cards have the following characteristics, which are different from credit cards:

• Deduction from your checking account: As with checks, debit-card purchase amounts are deducted electronically from your checking account within days. By contrast, if you pay your credit-card bill in full and on time each month, your credit card gives you free use of the money you owe until it’s time to pay the bill.
• Potential for overdrawing your checking account: If you switch to a debit card and you keep your checking-account balance low and don’t ordinarily balance your checkbook, you may need to start balancing it. Otherwise, you may incur an overdraft (an attempt to withdraw more money than is available in your checking account) and unnecessary overdraft fees (fees charged when you overdraw your account). Overdraft protection may be worth considering, but beware of the temptation to use that as an ongoing, high-interest credit line on balances borrowed, similar to a credit card.
• Shorter window of time for making disputes: Credit cards make it easier for you to dispute charges for problematic merchandise through the issuing bank. Most banks allow you to dispute charges for up to 60 days after purchase and will credit the disputed amount to your account, pending resolution. Most debit cards offer a much shorter window, typically less than one week, for making disputes. (Despite widespread misperception, personal debit cards have identical fraud protection as personal credit cards.)

If you don’t already have a debit card, ask your current bank whether it offers Visa or MasterCard debit cards. If your bank doesn’t offer one, shop among the major banks in your area, which are likely to offer such debit cards. As debit cards come with checking accounts, do some comparison shopping between the different account features and fees. Check out Chapter 11 for more information about finding the right bank for you.

Also check out getting a Visa or MasterCard debit card with the asset-management accounts offered by investment firms. Asset-management accounts basically are accounts that combine your investments, such as stocks, bonds, and mutual funds, with a transaction account. One drawback of these accounts is that most of them require fairly hefty minimum initial investment amounts — typically $5,000 to $10,000. Among brokerages with competitive investment offerings and prices are TD Ameritrade (800-934-4448; www.tdameritrade.com) and Vanguard (800-992-8327; www.vanguard.com).

Lowering the interest rate on consumer debt

If you do have credit-card debt, you can slow its growth until you get it paid off by reducing the interest rate you’re paying. Here are some methods for doing that:

• Stop making new charges on cards that have outstanding balances while you’re paying down your credit-card balance(s). Many people don’t realize that interest starts to accumulate immediately when they carry a balance. You have no grace period, the 20 or so days you normally have to pay your balance in full without incurring interest charges, if you carry a credit-card balance from month to month.

• Apply for a lower-rate credit card. To qualify, you need a top-notch credit report and score (see Chapter 4), and not too much debt outstanding relative to your income. After you’re approved for a new, lower-interest-rate card, simply transfer your outstanding balance from your higher-rate card.

  See my website, www.erictyson.com, for an up-to-date list of good, low-rate cards.

As you shop for a low-interest-rate credit card, be sure to check out all the terms and conditions of each card. Start by reviewing the uniform rates and terms of disclosure, which detail the myriad fees and conditions (especially how much your interest rate could increase for missed or late payments). Also understand how the future interest rate is determined on cards that charge variable interest rates.

Negotiating better rates from your current credit card

Rather than transferring your current credit-card balance onto a lower-interest-rate card (as mentioned in the preceding section), you can try to negotiate a better deal from your current credit-card company. Start by calling the bank that issued your current, high-interest-rate credit card and inform the bank that you want to cancel your card because you found a competitor that offers no annual fee and a lower interest rate. Your bank may choose to match the terms of the competitor rather than lose you as a customer. If it doesn’t, get that application completed for a lower-rate card.

Be careful with this strategy, and consider just paying off or transferring the balance without actually canceling the higher-interest-rate credit card. Canceling the card, especially if it’s one you’ve had for a number of years, may lower your credit score, especially in the short term. Just be sure not to run up new charges on the card you’re transferring the balance from.

Tapping investments to reduce consumer debt

If you have savings and investment balances available to pay off consumer debt, like high-interest credit-card debt and auto loans, consider doing so. Pay off the loans with the highest interest rates first. Although your savings and investments may be earning decent returns, the interest you’re paying on your consumer debts is likely higher. Paying off consumer loans on a credit card at, say, 14 percent is like finding an investment with a guaranteed return of 14 percent — tax-free. You’d actually need to find an investment that yielded even more — around 21 percent if you’re in a moderate tax bracket — to net 14 percent after paying taxes in order to justify not paying off your 14 percent loans.

The higher your tax bracket (explained in Chapter 6), the higher the return you need on your investments to justify keeping high-interest consumer debt. This discussion refers to investments in nonretirement accounts. Unless your tax bracket drops because of an extended layoff from work or from going back to school, withdrawing money from retirement accounts is costly because of the requirement to pay current federal and state income taxes on the amount withdrawn, not to mention early withdrawal penalties.

When using your savings to pay down consumer debts, leave yourself enough cash to be in a position to withstand an unexpected large expense or temporary loss of income.

Paying down balances

If you’ve been reading this chapter from the beginning, you know that I discuss numerous strategies for zapping your consumer debt. Let’s take the discussion to a deeper level. How do you handle paying down multiple consumer-debt balances? It’s really pretty simple after you implement the advice I give up until this point in the chapter.

After meeting the minimum required monthly payment terms for each loan, I strongly advocate that you channel extra payments toward paying down those loans with the highest interest rates first. The financial benefit of doing so should be obvious. If you have one loan at a 20 percent annual interest cost and another at an 8 percent annual interest cost, you’ll be saving yourself a 12 percent annual interest cost by paying down the higher-cost loan faster.

I’m amazed at the wrong-headed advice I continue to see on this topic, especially on the Internet. One guru with no discernible training in the financial-planning/personal-finance field advises that you rank your debt payments by their total outstanding balances and that you channel extra payments to those with the lowest total balance owed. The “theory” behind this is that the psychological boost from paying down smaller debts completely will lead you to keep paying down your other debts.

In my real-world experience as a financial counselor, I’ve found folks to be intelligent and more responsive to the psychological rewards of saving money. And you best save money by paying down your highest-interest debts first.

Seeking counseling

If you’re seriously in debt, you may consider a credit counselor. The ads for these agencies are everywhere. Although some of these organizations do a decent job, many are effectively funded by the fees that creditors pay them. Before you hire a credit counseling agency, make sure you do your research on the company.

Put together a list of questions to ask to find a credit counseling agency that meets your needs. Here are some key questions you can ask:

• Do you offer debt-management programs? In a debt-management program (DMP), a counseling agency puts you on a repayment plan with your creditors and gets paid a monthly fee for handling the payments. You should avoid agencies offering DMPs because of conflicts of interest. An agency can’t offer objective advice about all your options for dealing with debt, including bankruptcy, if it has a financial incentive to put you on a DMP.

  This creates a bias in their counsel to place debt-laden folks seeking their advice on their debt-management programs wherein the consumer agrees to pay a certain amount per month to the agency, which in turn parcels out the money to the various creditors. Agencies typically recommend that debtors go on a repayment plan that has the consumer pay, say, 3 percent of each outstanding loan balance to the agency, which in turn pays the money to creditors.

  Although credit counseling agencies’ promotional materials and counselors highlight the drawbacks to bankruptcy, counselors are reluctant to discuss the negative impact of signing up for a debt payment plan.

• What are your fees, including setup and/or monthly fees? Get a specific price quote and contract in writing. Avoid any credit counseling service that charges a high upfront fee before it provides any services. And watch out if the service tells you to stop paying your bills; it may take your money and run while your credit gets ruined.
• Are you licensed to offer your services in my state? You should only work with an agency licensed to operate in your state.
• What are your counselors’ qualifications? Are they accredited or certified by an outside organization? If so, by whom? If not, how are they trained? Try to use an organization whose counselors are trained by a nonaffiliated party.
• What assurance do I have that information about me will be kept confidential and secure? This information includes your address, phone number, and financial information. Reputable agencies provide clearly written privacy policies.
• How are your employees compensated? Are they paid more if I sign up for certain services, if I pay a fee, or if I make a contribution to your organization? Employees who work on an incentive basis are less likely to have your best interests in mind than those who earn a straight salary that isn’t influenced by your choices.

Considering bankruptcy

When the amount of your high-interest consumer debt relative to your annual income exceeds 25 percent, filing bankruptcy may be your best option. Like any tool, it has its pros and cons.

Bankruptcy’s potential advantages include the following:

• Certain debts can be completely eliminated or discharged. Debts that typically can be discharged include credit card, medical, auto, utilities, and rent. Eliminating your debt also allows you to start working toward your financial goals, such as saving to purchase a home or toward retirement. Depending on the amount of outstanding debt you have relative to your income, you may need a decade or more to pay it all off.

  Debts that may not be canceled through bankruptcy generally include child support, alimony, student loans, taxes, and court-ordered damages (for example, drunk-driving settlements).

• Certain assets are protected by bankruptcy. In every state, you can retain certain property and assets when you file for bankruptcy. Most states allow you to protect a certain amount of home equity; some states allow you to keep your home regardless of its value. Additionally, you’re allowed to retain some other types and amounts of personal property and assets. For example, most states allow you to retain household furnishings, clothing, pensions, and money in retirement accounts. So don’t empty your retirement accounts or sell off personal possessions to pay debts unless you’re absolutely sure that you won’t be filing bankruptcy.

Filing bankruptcy, needless to say, has it downsides, including the following:

• It appears on your credit report for up to ten years. As a result, you’ll have difficulty obtaining credit, especially in the years immediately following your filing. (You may be able to obtain a secured credit card, which requires you to deposit money in a bank account equal to the credit limit on your credit card.) However, if you already have problems on your credit report (because of late payments or a failure to pay previous debts), damage has already been done. And without savings, you’re probably not going to be making major purchases (such as a home) in the next several years anyway.
• It incurs significant court filing and legal fees. These can easily exceed $1,000, especially in higher cost-of-living areas.
• It can cause emotional stress. Admitting that your personal income can’t keep pace with your debt obligations is a painful thing to do. Although filing bankruptcy clears the decks of debt and gives you a fresh financial start, feeling a profound sense of failure (and sometimes shame) is common.
• It becomes part of the public record. Another part of the emotional side of filing bankruptcy is that you must open your personal financial affairs to court scrutiny and court control during the several months it takes to administer a bankruptcy. A court-appointed bankruptcy trustee oversees your case and tries to recover as much of your property as possible to satisfy the creditors — those to whom you owe money.