Three Classic Mistakes to Avoid

Debt is a major issue for literally millions of Americans. However, when you find yourself overextended, the fact that many others are in the same boat offers little in the way of consolation.

As your debt accumulates, there is a strong tendency to make three very common mistakes. While it is easy to understand why people make them, they must be avoided at all costs.

Mistake 1: Making Only the Minimum Payment

This is easily the most common of mistakes but minimum payments are a trap. Because of how cards work, the goal of the credit card company is to enlarge your debt so that interest rates yield more in the profits.

Making only the minimum payments ensures you will be in debt for the longest possible time. Paying the typical minimum level for a $500 debt at current interest rates of 15-20 percent will keep you in debt for more than a decade, even if you never charge another item.

Of course, by paying the minimum amount your are maintaining your credit score. It’s just that your debt will grow instead of decrease.

The folks at Learn Financial Planning recommend that you set your own personal minimum payment level that is at least triple the minimum payment and stick to it.

Mistake 2- Taking a Payday Loan

There is debt that is worse than credit card debt. It is the debt created by payday loans.

A payday loan is short-term loan, generally offered on a two-week basis (from one pay period to the next) and ranging between $100 and $500. The idea of a payday loan is to provide you the cash needed for immediate expenses and is a loan against your next paycheck.

Payday loans feature administration fees, processing fees, broker’s fees and even early repayment fees. Typically, the finance charge per $100 borrowed is $25.

While it is easy to accumulate credit card debt, payday loan debt is considered as much as eight times more punishing. While it easy to think this is a good way to deal with an immediate issue it is one you should never consider.

Mistake 3 – Falling for a Debt Settlement Scam

When your debt reaches the breaking point, debt consolidation and debt settlement can be the right step. The first step to take in such a situation is to admit you have an issue and then contact your creditors to discuss possible mechanisms to work through your issue.

You may be able to make some simple progress with your company, perhaps even negotiate a lower interest rate. Simply stated, credit card companies do not benefit if you default.

However, you have probably heard on television or seen online an ad by some third party company that can help you eliminate your debt. While there are legitimate agencies that do provide such services, many other entities are simply hoping to take advantage of your plight. If you are not careful, you may soon find one of these companies is bleeding you worse than your credit card company.

A legitimate debt settlement company will consolidate your loans and negotiate with your creditors on your behalf. The basic structure involves you making one monthly payment based on the total amount owed. As funds are collected, payments are negotiated with each creditor separately, a step that can reduce your debt total by as much as 50%.

There will be a fee associated with the process but legitimate firms will set up a reasonable plan that will help you make modest progress immediately and significant progress long term.

Avoid Compounding Your Mistakes

It is easy to accrue debt in a multitude of formats. If you do not do due diligence, that debt can double or quadruple in the matter of months.

Avoid borrowing and purchasing with plastic. When you do borrow or purchase, pay the amounts off quickly, do not fall into the trap of making only the minimum required payment.

Doing so puts you on a downward spiral into the world of payday loans and debt settlement scammers.

On Wednesday, under the College Cost Reduction and Access Act of 2007, the repayment of college loans will become a whole lot more manageable for lower income wage earners.

New Options

The new Federal Student Loan Forgiveness Law is set to help student repayment in two significant ways:

• Lowering the monthly student loan payment on federal student loans (Income Based Repayment or IBR); and

• Canceling remaining loan debt after 10 years for those who have entered public service (Loan Forgiveness for Public Service).

Income Based Repayment (IBR)

Income based repayment (IBR) offers enormous potential reductions in the monthly payments for high debt/low income borrowers. Designed for those with “partial financial hardship,” IBR limits annual educational debt payments to 15% of a borrower’s discretionary income. For the purposes of the law, discretionary income is defined as adjusted gross income minus 150% of the poverty level for the borrower’s family size.

Under the IBR plan, the loans eligible for consideration include: all Federal Direct Loans (FDL) and federally guaranteed loans (FFEL) including subsidized and unsubsidized Federal Stafford loans; Federal Grad PLUS loans (but not Parent PLUS loans); and Federal Direct Consolidation loans. Federal Perkins Loans are only eligible when part of a Federal Direct Consolidation Loan.

The Detroit Free Press offers the following as an example of the potential savings:

Take a college grad who has $40,000 in federal student loans and an adjusted gross income of $30,000 each year.

If we use this example, the grad would pay $171.94 a month using the new plan — compared with $460.32 with a standard 10-year repayment plan or $277.63 a month for an extended 25-year repayment plan.

As a person receives annual salary increases, the monthly payment would rise only according to the percentage of salary increase. In the case of a married couple, each would be eligible for the program and the eligibility would be dependent on each individual’s situation, not the combined income of the two individuals.

The new IBR option goes into effect July 1, 2009. Members of the Class of 2009 become eligible within two months of graduation.

Loan Forgiveness for Public Service Employees

In addition to repayment reduction under the law, students entering public service are also eligible for loan forgiveness. Upon entering full-time public service, once a borrower makes 120 qualifying loan payments on a Federal Direct loan (including Federal Direct Consolidation loans), the unpaid balance remaining including the accumulated interest on the loan is forgiven. The worker must remain in public service for the entire ten year period and the 120 payments timeframe but there is no limit to the amount to be forgiven.

The time period for public service is retroactive to October 1, 2007 meaning those borrowers who have already elected public service may begin counting the ten year period at that point. Some restrictions occur for those who had already consolidated their loans and those restrictions may move the eligible period forward to July 1, 2008.

In the case of loan forgiveness, only Federal Direct loans (including Federal Direct Consolidation loans) are eligible. Payments made on federal loans in the Guaranteed (or FFEL) program are not eligible for the loan forgiveness aspect (only eligible for IBR).

A Major Step Forward

The new law represents an enormous positive development for those students who have accumulated significant federal college debt yet have limited income. To learn more about the program and examine the calculation process visit:

• Georgetown Professor Phil Shrag’s law review article detailing IBR and Loan Forgiveness for Public Service Employees (pdf).
• The IBR monthly repayment calculator.
• Federal direct consolidation loan information and applications.

What We Can Learn From Suze Orman

The other night I had television on, just on, background noise. At some point in the evening the Suze Orman Show came on. I paid relatively little attention until one of her guest callers asked her opinion on student loans: Her daughter was in the process of choosing colleges. She was down to a choice between a private, four-year college and a state university. Did Suze think the value of the private college matched the increased expense or should she encourage her daughter to choose the more affordable state university? And would the education at the state university offer comparable value?

Two separate college issues were addressed in that call:

• Value between types of colleges
• Expense of high tuition costs

Lesson One from Suze: The additional cost associated with the four-year college would most likely have to be financed via private student loans. According to her, an absolute no-no.

Lesson Two from Suze: She attended a state university and look where she is right now.

Private Student Loans: The Bottom Line Revealed

Private student loans, or alternative student loans, have generated colossal business for lenders—really the meat and potatoes—in the last few years. The startling statistics (College Board): Since 2001 private student loan borrowing has increased 27 percent annually and is fattened enough to monopolize 20 percent of the student loan market. Just a decade ago, private student loans constituted a mere sliver–7 percent–of the same market. Regionally the behavior may be even worse; one source reports that private student loan borrowing among Maryland students has increased by 600 percent since 2000.

As I speak there are some alarmists extolling the evils of the private student loan market—bloated beyond belief, they say, could cause another market debacle not unlike the recent mortgage fiasco. But how did the alternative student loan market get so heady? The advertising message is: don’t worry if your federal student loans don’t cover the cost of your education; with a private loan you can carry enough credit to cover everything, in some cases even add on auxiliary expenses such as textbooks, transportation, and computers.

No Limits and Interest Rates as High as Your Worst Credit Card

Suze’s message was, of course, right: private student loan interest rates are all over the place and lenders may hike them at will, much like those attached to credit cards. Also, most have no limit. Borrow as much as you’d like—no problem…. Lenders sell them as easy, as quick and simple as opening a checking account. You can be approved and paid overnight, so the perception is that these loans are no big deal. It’s usually thousands and thousands of dollars worth of a deal.

Private Loan Gluttons

Some in the education industry have commented that the gluttony in private loans is due in large part to the leaner Pell Grants. Hmmmm. Pell Grants certainly fail to cover the same costs they did when they were first established, but the statistics I’ve seen suggest that it may not be the Pell Grant crowd gobbling up the private loans—it’s middle to upper income students! A sample of student loan data (ECMC Group) from 1992-3 and then again in 1999-2000, reveals absolutely no increase in the number of low-income students borrowing with student loans. BUT—here’s the dope: middle income borrowing increased “from 32 to 45 percent” and upper income borrowing “from 15 to 31 percent.”¹

Where’s the Steering Wheel for this Fancy Sports Car?

Stories emerge that illustrate how ignorant college borrowers really are when choosing private loans. The sad reality is that for many college grads there is little latitude following graduation for traditional rites of passage, such as hiking across Europe or volunteering with the Peace Corps. Those times are gone. Better find a damn good job because loan repayment is knocking on your door and it’s a pretty big payment for a pretty long time–and it doesn’t come with a high performance engine or a steering wheel.

Cultural Barriers to Incurring Debt, ECMC Group Foundation, March 2003, accessed September 6, 2007, http://www.ecmcfoundation.org/documents/CulturalBarriersExecSummary.pdf.

Up to Our Necks in Debt

Paying back student loans is a daunting task, and if you recently graduated in 2006 you are facing this reality very soon. Student loans usually have a 6 month grace period before payments begin, and it has been about 6 months since graduation. Today’s college graduates have more debt than previous generations, but they also have more options, knowledge, and tools at their disposal.

USAToday’s Six Week Series on Debt

For example, check this out. USAToday and ABC News is currently in week two of a six week series called “Young and in Debt,” which tackles the increasing debt load that recent college grads are faced with. The series pairs ‘twentysomethings’ with members of the Financial Planning Association who can give sound lending advice. Already, the site (youngdebt.usatoday.com) is chock-full of useful tools and resources to help grads weigh their lending and repayment options.

One useful tool is an interactive state-by-state map, illustrating the average debt of graduating seniors at 4-year colleges in 2006. A few highlights?

• Debt of Michigan graduates from public colleges: $18,526 and private colleges: $21,020
• Debt of Florida graduates from public colleges: $16,402 and private colleges: $21,282
• Debt of Iowa graduates from public colleges: $23,198 and private colleges: $22,184

Check the map for more info on the rest of the states.

Other tools include a debt-consolidation calculator, to help you decide if that option is for you, and what it will take to pay off lines of credit, depending on your interest rate and payments.

Take Advantage of Financial Planning Experts

The site also hosts an interview with USAToday’s personal finance columnist, Sandra Block, which tackles questions like “What should borrowers do if they can’t afford their monthly loan payments?” and “What are some ways to reduce the interest rate on my loans?” The beauty of the internet is that expert advice that may have once been costly to acquire is now freely distributed, if you know how to find it. Take advantage of the experience of expert financial planners, by submitting your own questions to a certified financial planner.

Follow the entire six week series on USA Today for more valuable information on loans, debt, repayment, and how to plan for a smart financial future.

Going the Criminal Route to Pay for School

A piece in the October 16, 2006 online edition of the Pittsburgh Post-Gazette relates the story of a woman who forged a bankruptcy court judge’s signature in order to obtain federal student loans to continue her university studies. Seems she needed to prove she had arranged re-payment of her debts in order to get the loans and in order to do that, she needed the judge’s signature. Since her case was still pending at the time the signature was needed, she took matters into her own hands.

She got caught and is now charged with a felony carrying a maximum sentence of 5 years in prison and a $250,000 fine. She’s thrown herself on the mercy of the court and among other blatherings, stated she “didn’t want to owe the school money.”

Ok, so the lady has 4 kids and is separated from her husband. Still, she’s not so very different from the millions of other college students trying to make it through school. Yes, college is expensive and all we hear lately is how much tuition has increased while aid has decreased. However, this sense of entitlement is sickening.

Funny how we don’t want the government to tell us to buckle up or reduce the fat in our McDonald’s fries but the minute we need something, who do we run to? And if it’s not enough? Well, some of us just curse the government and some of us commit fraudulent acts.

Anybody and everybody who has the inclination can go to college in the United States. There are enough scholarship, grant and loan programs to see us through. Ok, so maybe we’ll owe $25,000 by the time we’ve graduated or maybe we’ll have to get a second job or get a job. Perhaps we’ll have to work full-time and go to school part-time maybe we’ll have to work one semester and go to school the next semester but anyone can go to school without resorting to fraud!

It will indeed be a tragedy if they throw the book at this lady and give her anywhere near the maximum. Even convicting her of a felony will greatly reduce the vocational choices she’ll have and getting saddled with a tenth of a $250,000 fine will cost her more than the student loan she didn’t want to bother with in the first place. That doesn’t even take into account the fact that she is facing a prison sentence.

I just read a great article from the Metro Times. It is entitled, “In Too Deep”, and covers a plentiful range of perspectives on the current generation’s college debt situation.

Should I start with some facts and statistics to bore you?

No!

I will address the problems and give solutions that are being enacted or solutions that should be enacted.

Problem #1:

College students are mounting more debt every year while the average tuition increases every year far beyond the rate of inflation.

Solutions:

1.) Write letters to local congressmen for legislation to halt the increase of tuition of public colleges and universities, provide more grants, give more funding, etc.

2.) Don’t go to college.

We all know performing solution 2 is straightforward. Solution 1 needs some answers. I’m not here taking sides on any one political party, but the ‘non-partisan’ group, the Project on Student Debt, stated in a press release regarding student loan assistance:

“While President Bush and his allies in Congress have given lip service to the importance of a college education, they have cut $12 billion from the student loan program, turning a blind eye to rising tuition and interest rates.”

I don’t think any American likes to hear this type of thing. I’m sure there are more important budget issues than education. Yeah, right.

Since I just brought up the importance of education, let us see if a ‘college education’ is worth the money for certain popular professions that usually require a degree.

Problem #2:

Careers such as social workers and teachers do not pay enough to comfortably pay off student loan debt over time.

Solutions:

1.) Pressure the federal and state governments to raise salaries for these jobs which are primarily funded by the state.

2.) Ask employers that these jobs not require a degree.

3.) Educate future college students that these careers will not comfortably pay off student loans.

This problem is the most obvious one in need. How would anyone go into a career where they will be confronted with debt that is hardly manageable?

Teacher salary is low, and we all know it. Why is this? That’s a whole other topic. My hunch is that it could be the establishment powers wanting to keep education quality low to keep the middle class from gaining too much power. I could be wrong. I must also note that if everyone REALLY cared about the children, voters would not be voting for the same people who keep teacher salaries low!!! Anyway, enough of the politics.

Problem #3:

College students are getting into student loan and credit card debt where they do not think of the real consequences.

Solutions:

1.) As the article states:

Debt consolidation consultant Dvorkin would like to see a mandatory fiscal education class at the high school level, covering everything from the working of credit cards to student loans.

2.) I really don’t think there is a better solution than number 1.

In the article, a student mentions that credit cards were, “being given to me like candy”. Oh, please stop with the innocent child defense. People get scamed, ripped off, and robbed every day. I do agree that credit card companies are rampant on college campuses. I do not believe it is their fault for mounting debt.

The irresponsibility of today’s generation with debt is not only a personal problem, but a national economic problem. So, actions must be taken such as teaching high schoolers the effects of student loan and credit card debt, along with enacting laws that make credit card companies state realistic debt scenarios before a student signs up. Here’s a nice example:

…a bill proposed by Sen. Christopher Dodd (D-Conn.) would require credit card companies to disclose in plain English how long it would take to pay off the total debt when making only minimum payments.

We may, after all, be in for some progress.

An AP article details the medical doctor supply in Idaho.

About 90 percent of Idaho qualifies as a “health professional shortage area,” according to federal guidelines.

That’s a lot of demand. To remedy this problem the state Office of Rural Health awards $220,000 per year to medical facilities, some of which go to clinicians for student loan repayment.

The lure of bonus money to relieve student loan debt is often not enough to get someone to move to a small town and become a family doctor.

Dr. Rob Wolfe said part of his inspiration to work in a rural area was attending the funeral of his grandfather, who worked as a doctor in a Wisconsin farming town.

“There were thousands of people coming in and they said, ‘You don’t know what he did for me,’ and ‘He delivered me,’ and ‘He delivered my kids,”‘ Wolfe said. “It struck me that you can make a big impact on people’s lives.”

A nice resource to check out would be the National Health Service Corps, which provides up to $50,000 of loan assistance for doctors that work in qualified rural areas for two years.

A Chicago Tribune article warns of the problems associated with cosigning for student loans and credit ratings.

If you cosign for your child’s student loan, you are held accountable for the repayment of the loan. I know it’s a nice thing to do for your son or daughter, but there is a huge risk when repayment time begins.

Since Stafford and Perkins Loans can only offer limited funding, parents often take out additional loans to finance their child’s college education. This makes the parents liable for repaying the loan every month.

If the student goes into default, both the student and parent will have their credit rating affected. Oftentimes, parents are uninvolved with the financial actions and obligations of their child once they graduate or leave college.

Having bad credit from this unfortunate situation affects all other credit-based financial activity such as the interest rate on other types of loans and getting insurance. The credit score can be damaged for up to seven long years.

The best solution for parents wanting to help their children, while protecting the parents’ credit is recommended:

…after students exhaust federal Stafford student loans, which carry a 6.5 percent interest rate, parents finance remaining costs by borrowing through the federal PLUS loan program, which are loans with a 7.9 percent interest rate.

…if parents use PLUS loans, they draw up an official contract with their child, outlining specific terms under which the child will repay parents after graduation.

Pamela Yip writes in The Dallas Morning News about the challenges facing many student debt holders. It’s true that on average, students with a college degree earn much more over their lifetimes than high school diploma holders. On the other hand, there are situations where the job received is less rewarding than anticipated.

Many people take out student loans while they are young and first entering college. They may not see the actual risk of taking out a loan for such a large amount of money. These loans should be repaid promptly, and any default will cause personal and professional consequences.

Student loans are very different from other debts such as with a credit card. Students should financially plan like the adults they are to consider the negative effects of a college degree such as not getting the job they want, being underpaid, losing their job in a recession, and paycuts.

The article describes the uniqueness of a student loan with other consequences:

The Internal Revenue Service can seize your tax refund to pay your student loan. You can’t discharge your loan by filing for bankruptcy, and the federal government can garnishee your wages to pay the loan. That applies even in Texas, which has strict prohibitions against wage garnishment.

What’s more, professional licensing boards will deny you a license if you default on student loans.

If you think you’ll have trouble paying off your federally guaranteed student loan, contact your lender immediately to work something out. You don’t want to mess with Uncle Sam.