Did you know that if you take out a $30,000 student loan during college, you could end up having to pay back a balance larger than that?
College graduations are just wrapping up, which means in 6 months, those who are entering the work force are about to meet their worst enemy: student loans. And for many, they may be surprised that their balance is higher than they originally planned. This week, I'm featuring a guest post from Drew Cloud, Founder of the Student Loan Report, that explains how your balance can increase and the insanely good move you should do to make sure it doesn't. Parents, this is a must read for you, too. Check it out and afterwards, head over to his site and learn more about how you can better manage and save on your student loans.
For many college and graduate students, borrowing money to pay for higher education means that after they leave school, they will be stuck with a substantial amount of debt. In most cases, borrowers will be paying back both principal and interest on their loans. That is because for most types of student loans — other than subsidized federal student loans — interest will start to accrue as soon as they are disbursed. After the six-month grace period between graduation (or when you leave school) and the first student loan payment, the interest is capitalized. This means that it is added to the principal balance, and the interest starts to accrue on the new, larger balance.
For many borrowers, this can be an unwelcome surprise, as they find out that the $40,000 that they borrowed to pay for college has ballooned significantly due to the addition of interest while they were in school. Many young high schoolers, as well as their parents, do not understand this situation going into college. Here is a bit more information.
There are two primary types of student loans: federal and private student loans. Most federal student loans are unsubsidized, which means that the government does not pay interest on the loans while a student is in school, during the grace period, or during periods of deferments or forbearance. Instead, the student is responsible for paying interest during these times. If a student chooses to not pay interest, it will accumulate on the loan. With subsidized student loans, the Department of Education pays interest on the loan while a student is in school at least half-time, during the six-month grace period, and during periods of deferment.
Private student loans are never subsidized, and interest will accrue as soon as the payment is disbursed. As with unsubsidized federal student loans, borrowers will be responsible for paying interest on private student loans during the grace period and any periods of forbearance and deferment (if available). To learn more about these differences, read the private student loan guide that is up on my site, The Student Loan Report.
Most students choose to skip making payments on their student loans while they are in school. After all, most students are not employed during college — or if they are, they are not employed full-time or are not making much money. But by making a small loan payment during college can make a world of difference after graduation. Just paying the interest on a loan can mean having a much smaller debt at graduation.
[RELATED: How to Cut Your Student Loan Payment in Half]
Paying the interest while you are in school will save you money. If you are paying the monthly interest while you are in school, you will be paying a much smaller amount than if you wait until it capitalizes and is added to the principal of your loan. For example, a $50 per month interest payment may seem difficult while you are in college — but imagine if that same $50 per month were multiple by 4 years ($2,400), and then added to the total amount of your loan. Then, instead of paying interest on the amount of money that you took out to pay for college, you would be paying interest on that amount plus $2,400. This would increase the amount that you will pay overall.
Making monthly interest payments while you are in college will also get you on track for paying back your student loans. If you can sacrifice and scrape together enough money to pay your interest each month while you are in college, you will find it much easier to make larger payments once you are out of school. You will already have a dedicated spot in your budget for student loan payments — and you will ultimately be paying off much less money than you would be if you hadn’t been making those monthly interest payments.
If you aren’t lucky enough to graduate debt-free, making monthly interest payments simply makes good financial sense as a way to minimize your student loan debt at graduation. Making a relatively small interest payment each month can make a substantial difference in your overall amount of student loan debt. It may require you to forego a night out or spending less on leisure activities — but by living like a college student now, you can avoid having to live like a college student after you graduate.
Would love for you to share: What money-saving moves did you make in college that helped you set yourself up for a better financial future?