Student Loan Myths Debunked

April Fool’s has come and gone, but the financial “pranks” of education debt have the potential to stretch over years of April 1sts. The student loan crisis is a trillion-dollar problem in the United States, and a lack of basic knowledge is one of many contributing factors. Review the myths below before you embark on the path to higher education. What you learn will prevent you from suffering from years of foolish consequences.

• Myth #1: Lenders cannot charge more than X% of my income per month during repayment. This myth is true for some loans, false for others. For example, suppose you apply for two loans during college:
  • Loan A: Federal Direct Subsidized: $10,000
  • Loan B: Private loan: $25,000

Loan A is backed by the federal government and may qualify for an income-sensitive repayment plan, limiting your monthly burden to 10 percent of your income. (Learn more about the different types of federal repayment plans here.)

Loan B is funded by a private company, which, like a credit card lender, has the ability to adjust interest rates and charge high monthly payments based on loan balance, regardless of your income. Many private lenders offer reduced payment options for qualified applicants, but like so many new grads learn, the law does not limit their ability to gouge borrowers at will.

• Myth #2: Income-sensitive repayment will protect me from overwhelming debt. Many borrowers believe income-sensitive payments make student loans more affordable. While they may provide temporary budget relief, you’ll pay more interest on your private and federal loans over time. According to the U.S. Department of Education:

“Income-driven repayment plans usually lower your federal student loan payments. However, whenever you make lower payments or extend your repayment period, you will likely pay more in interest over time — sometimes significantly more. In addition, under current Internal Revenue Service (IRS) rules, you may be required to pay income tax on any amount that’s forgiven if you still have a remaining balance at the end of your repayment period.”

• Myth #3: All federal student loans have the same fixed interest rate. False. Federal loans vary by type and borrower (e.g., student vs. parent) and while all interest rates are fixed, they aren’t identical. For example, the current rate for a Direct Subsidized undergraduate loan is 4.29%, while the rate for a Direct Plus loan for graduate students or parents is 6.84%, drastically increasing the interest due over time.
• Myth #4: I can’t afford school without student loans. True, higher education comes with a steep price-tag. According to a College Board survey, the average price of tuition for the 2014-2015 school year was $31,231 for private universities, $9,139 for in-state students attending public universities, and $22,958 for out-of-state students. These numbers don’t include room and board, books, food, utilities, transportation and other living expenses. The average family isn’t equipped to handle 100% of these costs, and many believe student loans are the only answer. Don’t jump to loans right away. Consider alternative funding in the forms of:
  • Scholarships
  • Grants
  • Work-study
  • Part-time employment
  • Online resources, e.g., free books
  • Reduced tuition for core classes through your local community colleges

The resources don’t end there. Download our free e-book, the Student’s Guide to Credit to learn more about loan-free financing.

• Myth #5: Education debt won’t affect my credit that Millions of student borrowers are learning the hard truth about this myth. Graduating with mortgage-sized student loans is sure to affect your finances, especially with an entry-level salary. Let’s break it down in terms of how credit scores are calculated. The Five Factors include:
  • Payment history (35 percent). The ability to pay your bills has a significant effect on your credit score. Overwhelming loans can hinder your post-grad budget before your career is established.
  • Debt utilization (30 percent). Student loans are considered installment debt, which means they don’t impact credit utilization (amount owed vs. total credit limit) in the same way as consumer credit cards. On the other hand, student loans will affect your debt-to-income ratio, a key factor that qualifies you for home loans, auto-financing etc. Learn more about the differences here.
  • Credit length (15 percent), new accounts (10 percent), and diversification (10 percent). Limiting your ability to secure new loans is a major risk of student lending. If your loans exceed your income, lenders aren’t likely to offer funding for housing, cars, personal expenses and more. This consequence can damage your credit score by up to 35 percent.

The bottom line: Don’t begin your education with a lack of financial knowledge. Utilize our e-book and other available resources to pursue a degree deliberately and safely.