Top 10 Student Loan Mistakes to Avoid

a chalkboard that has "student loan debt" written on it with three stacked books and a degree on top of the books.

It’s no secret: whether you’re an incoming college student or their lucky parents, tuition payment strategies are an important topic before school starts.  Student loans are becoming one of the largest types of debt in the nation. For most people, they are often necessary to receive a college education.

If you’re not careful, student debt can stack up. You’re still responsible for your debts even if you declare bankruptcy.

That’s why it’s important to know what you’re getting into before you start a student loan journey. Take a few minutes to familiarize yourself with these 11 common student loan mistakes before you take on more than you can handle.

1. Taking Out the Wrong Type of Loan

While filling out the FAFSA (Free Application for Federal Student Aid), you may only be eligible for some aid that may not be enough to cover the cost of an out of state or even in-state school tuition. You may need to start with other loans to help supplement FAFSA.

Every loan type comes with its own interest rates and requirements. See the details below:

  • Federal subsidized loans – These loans do not accrue interest until you graduate. However, these loans are based on financial need, so not everyone qualifies.
  • Unsubsidized Federal Student Loans – These loans have a fixed interest rate that accumulates while you’re in school. They may be the best option if you don’t qualify for a subsidized loan and if you have the ability to make payments on interest while you’re studying.
  • Private loans – Private loans offered by local financial institutions like credit unions and national banks offer loans that are based on credit history and can come with a variety of penalties fees.
  • Direct Plus or Parent Plus loans – These federal loans are taken out by parents and allow students to use their parent’s credit score for better interest rates. Although the parent is legally responsible for the debt, these loans can be deferred and may be forgiven in certain circumstances.

2. Choosing Loans With Bad Interest Rates

Both federal and private loans require you to pay off interest. However, the interest rates will vary by loan type and lender. Before taking out any loans, shop around and find the best interest rate available.

Federal loans begin to accrue interest on the date the loan is disbursed. If you have a Direct or Unsubsidized loan, you are responsible for making interest payments. However, if you have a Federal subsidized loan, the U.S. Department of Education makes your interest payments during the following periods:

  • While you are attending school as at least a half-time student
  • During the grace period after graduation
  • During a deferment period

Federal loans have a fixed interest rate, meaning that the rate does not change during the entire life of the loan. However, you should note that no payments will be made towards your loan amount until all outstanding interest payments are made.

Unlike most federal loans, private student loans have interest rates based on your credit score. If you have a high credit score, you will qualify for a lower rate. If you have a low credit score, you may be able to get a better interest rate if you take the loan out with a cosigner.

Some private loans have prepayment penalties, charging you a fee for paying off the loan early or making an extra payment. Look for the phrase “no prepayment penalty” before you sign.

If you are responsible for making interest payments, be sure to make your payments on time. Any unpaid interest will stack on top of your principle and will be capitalized, costing you more over time.

3. Not Understanding the Difference Between Variable and Fixed APRs

In addition to being based on your credit score, private student loans can have either a fixed or variable annual percentage rate, or APR. This rate includes the interest you will pay over the course of a year and any extra fees your loan process may incur.

There are two types of APRs: fixed and variable.

A fixed APR is a locked-in rate that will not change throughout the loan period. While a fixed APR will give you a predictable monthly payment, fixed rates usually start off much higher.

A variable APR is a rate that may change over the loan period. Lending companies base their interest off of a benchmark standard known as the London Interbank Offered Rate, or LIBOR. This standard measure is the interest rate a bank would charge another bank to lend money to.

As LIBOR changes, lenders may adjust your variable interest rate to match. This means that although you may begin by paying a small interest, you may see an increase over time, costing you more out of pocket.

Take some time to shop around for the best offers. If you can’t find a loan that meets the criteria you’ve set for yourself, it may be worth evaluating exactly what that loan is for, and whether or not you can change your educational standards.

4. Taking Out More Student Loans Than You Absolutely Need

It’s important to only borrow money that you absolutely need. While it can be tempting to take out an extra $3,000 to help pay for day-to-day costs like food and transportation, loans can come at a steep price that can push you deep into debt before you even graduate.

Learn More: The $1.5 Trillion Student Loan Debt Crisis

Some loans require you to make interest payments while you’re in school, so the amount of debt you take on may impact the payment amount or payment schedule. Missing your payments can affect your credit score and increase the amount you pay towards the end of your loan period. It’s better to pay off as much of the principal as you can while you’re in school.

5. Missing Payments

Like any other debt, missing a payment towards your student loans can have a detrimental effect on your credit. Missing one may cost you:

  • Late fees
  • A higher total amount
  • A lower credit score

Federal loans allow a six month grace period after graduation before borrowers have to start paying. If you are unable to make your payments, there are ways for you to hold off on having to make payments on federal loans, including:

  • Deferring payments
  • Forbearance
  • Public Service or Teacher Loan Forgiveness programs

Unlike federal aid, private lenders have no obligation to provide grace periods or alternative payment options. If a private loan goes unpaid past the statute of limitations in your state, your private loan lender may charge off your debt. Missing these payments can have a severe negative impact on your credit history.

When you set up your college budget, make sure you have the correct amount going towards your monthly loan payments. If you don’t have a source of income while you’re in school, it might be worth your while to look into a part-time job.

If you feel like you can’t make your payments, it’s best to be proactive before it’s too late. Reach out to our expert debt coaches to learn how you can get help managing your current financial responsibilities.

A person with a speech bubble above them that says student loan thinking about how to avoid them

6. Choosing the Wrong Payment Plan

Federal Student Loans

Students who take out federal student loans are automatically enrolled into the standard federal loan repayment plan. This plan is structured to have fixed, equal payments over a period of 10 years.

However, you do have the option to find a plan that better fits your needs. If you qualify, you have the opportunity to change to one of the following payment plans for free:

  • The Graduated Repayment Plan starts with low payments that gradually increase over time based on the idea that you’ll be making more money as time goes on.
  • The Extended Repayment Plan allows you to spread payments out over a 25 year period. However, the amount you pay in the end will be much higher than the amount paid within a small loan period.
  • The Pay As You Earn Plan uses 10% of your discretionary income for loan payments. The amount will be recalculated annually to account for changing life costs and will be changed into annual tax fees after 20 years.
  • The Income-Based Repayment Plan uses 10-15% of your discretionary income for loan payments.
  • The Income Contingent Repayment Plan takes either 20% of your discretionary income or the amount you’d pay on a 12 year fixed plan, whichever is less.
  • The Income Sensitive Repayment Plan is based on your income and a repayment period of 15 years.

Private Student Loans

Private loans typically only offer one plan. Before taking out any loans, make sure you completely understand the stipulations of repaying your debt. Some lenders may require you to make interest-only payments in school, while others may allow you to wait to make interest-only payments until you graduate.

Your monthly payments will be based on your credit history, loan size, and length of your loan. The longer it takes to repay your loan, the less you may pay each month. However, the longer you take to repay, the more you may end up paying in interest.

Like federal loans, some private loan companies offer deferments and forbearance. However, this may not be possible for every case.

If you feel as if you can’t make your monthly obligations, talk to your private lenders as soon as possible about alternative repayment plans. While there is no guarantee that they will help, taking pre-emptive steps could keep you from falling any deeper into debt that you have to be.

Use student loan calculators to find out what your monthly payment should be and what the loan will cost you over time.

7. Missing Application Deadlines

Applying for a student loan takes time. It’s important that you do your research early and begin the process as soon as you can.

Start by determining the financial aid and tuition deadlines of your college. This deadline may vary school by school and may be provided as early as an entire school year in advance. Be sure to follow up with financial deadlines as soon as they are available from your school.

Most loans, including federal student loans, require you to fill out your FAFSA form before determining if you meet the criteria. The FAFSA application enrollment period traditionally opens on October 1st and ends on June 30th every year.

If you’re considering taking out private loans, you should begin your application process as soon as possible. Some private loans and scholarships allow you to apply as early as a year in advance.

Every private loan company has its own approval process and can last anywhere from a few minutes to several months. Find out well before your college’s deadlines how long your private lender’s approval process lasts, and how long it may take for loan reimbursement.

Regardless of what loans you take out, plan on applying for your FAFSA as soon as the application period begins in October to know exactly where you stand in federal student aid, and whether or not you need to look for private help.

8. Not Understanding Co-Signer Responsibilities

Some private loans require co-signers. By putting their name on a loan, co-signers help lower interest rates but increase their liability.

Many parents co-sign student loans without fully understanding the weight of their responsibility. If left unchecked, this could cause issues with who’s responsible for payments during school or after graduation.  

Just like other loans, student loan co-signers are equally responsible for paying back the amount borrowed. This means that if the student is unable to make payments, the co-signer must cover every month or risk damaging their credit.

Fortunately, federal loans do not require co-signers. If possible, you should focus on taking out Federal subsidized and unsubsidized loans before turning to potentially pricy private loans.

9. Ignoring Student Loans’ Effect on Credit Scores

You might have heard that student loans do not count toward your credit score. This is not true. All student loans can raise or lower your credit rating. It’s important to know the effects student loans can in order to maintain a good credit score throughout and after college.

Positive Effects on Credit

On-time student loan payments are reported to the credit bureaus and will help build your credit score. Based on how your credit score breaks down, taking on student loans can have a positive impact.

For example, 35% of your credit score is based on on-time debt payments. The more student loan payments you make on time, the better.

Also, 15% of your credit score is based on the length of credit history. Because most loans take 10 or more years to pay off, having such loans will positively affect your credit score.

Negative Effects on Credit

Your debt-to-income ratio should be approximately 36%. Student loans can cause you to exceed that ratio right off the bat. This means your credit rating won’t be as high, and it may affect your ability to get other kinds of loans or credit.

If you’re late on payments, your score will drop. Defaulting, or not paying will have a similar effect.

10. Refinancing Hastily

If you’ve taken out a variety of student loans, they may each have their own monthly payment due date. Refinancing student loans, or taking out one loan to pay off multiple debts, is common for those who have taken loans out from too many places. Here are some pros and cons to consider before you take out multiple loans:

Refinancing Pros

  • A new, lower interest rate will help you save money
  • You can choose your new lending company
  • Multiple monthly payments will be consolidated into one
  • Co-signers can help get lower interest rates

Refinancing Cons

  • There are no alternative payment plans
  • You will no longer qualify for deferment or service-based loan forgiveness
  • You must have an excellent credit rating (usually a score of 660 or above) to refinance
  • A new, higher interest rate may result in you paying more money over time

Remember, refinancing is not a fix-all for student loan debt. If you qualify for refinancing, you still have to make loan payments on time or your credit will continue to suffer.

11. Not Making Extra Payments

Paying your student loans off as fast as possible will save you in interest fees. Every chance you have to make higher, or extra, payments will allow you to get out of debt faster.

Take a look at your budget to see how much extra cash you set aside each month. If you can, use some of your pocket money to make extra payments.

Create your Budget!

Do Your Research

It pays to do your research before taking on student loan debt. Understanding exactly what you’re getting into will help you plan for a financial future completely within your control.

If you need help handling your debts, reach out to one of our expert coaches. We can help you set up a financial plan that fits your needs and get you to graduation with as little debt as possible.

Get Started. It’s Free.

Article written by
Melinda Opperman
Melinda Opperman is an exceptional educator who lives and breathes the creation and implementation of innovative ways to motivate and educate community members and students about financial literacy. Melinda joined in 2003 and has over two decades of experience in the industry.

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