How to Avoid the Standard Repayment Plan Trap (and have money for the life you want)

It was supposed to be a sound investment in your future: You went to school to gain an advanced education that would lead to a lucrative career. But month after month, year after year, a substantial chunk of your pay goes to your school loans. It may feel like you’ll never get out of debt. The idea that you could actually start investing for other things—like a house of your own, or putting money away for your child's own education, or your retirement–that seems like a fairy tale.

Now, if this describes you, know this: You're not alone. The average new graduate finishes college with $37,172 in student loan debt. In the United States, there are more than 44 million borrowers with $1.3 trillion in student loan debt.

Then there's the most troubling statistic of all: 36% of millennial graduates say they regret going to college, and they wouldn't have gotten a degree, if they'd known how much it would cost them. The reason for this statistic is simple, the payment is too high compared to what happens on average in the life of a college graduate in that first 10 years after college.

There’s a reason it's so tough to get ahead. Most borrowers–including you–are probably in what's called "the Standard Repayment Plan" (SRP). It’s called “the Standard Repayment Plan” because it is the payment plan that every college graduate is put in after they leave school, hence “Standard.” So, if you haven’t changed a thing about your loans since leaving school then that is what you are in!

SRP sounds like reasonable. You make a payment each month until, after 10 years, the debt is paid in full. Some “official” websites tout it as a way to save money. One credit union in Oregon describes it as "the ideal" option, because it is scheduled to be paid off in 10 years, so you'll pay less in interest.

But there are two things most student loan borrowers don't understand.

First, lenders don't warn you that SRP monthly payments are often cripplingly high. The payment on the ten-year standard plan falls under, what is known in the industry, as the 1% rule. Meaning that if you borrowed $40,000 dollars in debt then your payment will be roughly 1% of that each month or $400 dollars. That is a big bill to swallow every month for ten years. Millennials are spending one-fifth of their salaries on loan payments. Couple that with the fact that 73% of all college graduates do not go into the field that they studied for which means the income for that $40,000 degree is not what was promised to the high schooler who signed for the loan. The preverbal bait and switch or buyer’s remorse.

People on SRP may find themselves stuck in jobs they don’t like, putting off a move to a new city to pursue new opportunities. Student debt is even delaying people from starting their families. According to a 2016 survey by Citizens Bank, of college graduates 35 and under, 40 percent say that student loans have limited the amount they can spend on rent or mortgage payments, while 50 percent say they've cut back on expenses such as clothing and shoes. Not to mention, speaking of new opportunities lost, there is also a 40% drop in entrepreneurship in the millennial generation directly due to student loans. They just can’t take that leap of faith on a new venture with this huge weight on their shoulders.

What makes SRP so expensive–and unjust–is the interest lenders are charging. I will go deep into this in another article but for now all you need to know is that student loan interest is calculated much different than any other type of interest. It is what’s called “Simplified Daily Interest.” It’s a fancy way of saying that if you don’t pay the loan compounds very rapidly, if you do pay it is very hard to pay down, and you can bet you are going to be paying way more than the face value of the loan. The easiest way to understand it is to compare it to mortgages. On a $100,000 mortgage at 7% interest (the average student loan today is 6.875%) amortized over 30 years is $239,508.90. More than double the face value of the debt and much much more than 7%, now imagine student loan interest is worse, but more on that later.

Now Typically, when lenders charge interest and fees on normal loans, they do so to cover the risks inherent in lending money and of course to get a return on their money, or a profit/incentive, so that everybody wins. But student loan lenders charge a ridiculous amount in interest and fees, when there’s absolutely no risk attached to student loans. Unlike other debts, filing bankruptcy does not relieve the borrower from paying back their student loans: They still have to pay them.

In fact, if a borrower stops making payments on a student loan, the loan gets turned over to a collection company, and the collection company is allowed to add an additional 18 percent in fees, in addition to the interest and fees already charged by the lender. The loan just keeps growing and compounding. What’s worse, the collection company can legally garnish up to 15 percent of your wages, or your entire tax return, or both, and even your social security checks when you retire or become disabled, until the loan is paid in full, or you die whichever comes first. So, you tell me, where is the risk in that?

This is a huge issue, because, according to a study by the Urban Institute, borrowers with the SRP are more likely to be delinquent on loans; they're also about twice as likely to default on their loans. According to the Wall Street Journal 40% of all student loan borrowers, or about 20 million of the 44 million, are either delinquent or in default.

The second problem is that, too often, borrowers don’t know they can opt for a different repayment plan. A 2016 survey by Credit Karma found that 40% of borrowers weren't even aware that they could refinance their loans.

There are actually several plans to choose from.

Some of the best options fall under the Income-Driven Repayment plans. I explain the Income-Driven Repayment Plan in greater detail here but, essentially, the amount you owe each month is based on your income. If you don’t make much, you don’t pay much. And you can get loan forgiveness after 10, 20 or 25 years.

I explain how student loan forgiveness works in this short video.

If you’re considering taking out a student loan, or you’re trying to pay back one you already, I can work with you, to help you get a plan that allows you to save money for all your goals—things like a home, a family, a retirement, or even just a vacation. Let's work together to get you life you envisioned when you began your education–rather than the one you felt stuck with, once the loans started coming due.