You've Got The Diploma. Now, About That Loan...

For Mark Lubelsky of Bethpage, N.Y., landing a job after graduating from law school in 1992 was tough. But a year and a half ago, he started working for a small Long Island law firm, and now the 27-year-old enjoys his days in court developing a speciality in workers' rights.

As satisfied as he is with his career track, Lubelsky is in a bind. He borrowed more than $80,000 to attend Boston University School of Law and can't afford to pay his loans on his $35,000-a-year salary. If he made the standard payments, he would owe $1,100 a month--more than half his take-home wages. Instead, he's barely getting by, sending $500 a month to a private lender and delaying repayment of his federal loans for the additional year he's permitted. Meanwhile, interest is compounding, and his indebtedness has grown into six figures. "In hindsight, it was a big mistake to borrow that much," he says.

Managing student loans has become a financial planning puzzle--not just for heavily indebted recent graduates like Lubelsky but also for borrowers further along in their careers. The problem is intensifying because as tuition costs rise, students are taking on more debt. In 1992, the federal government increased loan limits and made unsubsidized federal loans more widely available. Thus, from 1993 to 1994, borrowing in the federal program jumped 42%, to $21.1 billion, says the College Board, a non-profit educational association. There has also been plenty of business for private lenders, such as Knight College Resource Group. It saw a 45% increase in the number of its AchieverLoans in 1994 and predicts the number of students turning to private lenders will increase 20% a year over the next four. That means more students with more debt than they can handle, says Kalman Chany, author of The Princeton Review Student Access Guide to Paying for College (Random House, $16).

There is a silver lining: First the federal government and now some private lenders are making it easier to work out more favorable repayment terms. Last year, the Education Dept. created the Federal Direct Consolidation Loan Program (800 455-5889) that allows borrowers to combine loans from various sources and choose from a wide array of payback options, including a plan based on your income with terms as long as 25 years.

Of course, it's best--if at all possible--to stick to the standard schedule when your pay-up time arrives. Budget carefully, maintain a frugal lifestyle, and as you climb the career ladder, student debt will become little more than an administrative headache, says Mickey Levitan of Washington, D.C., who dispatched $25,000 in business school loans in eight years while working at the Save The Children Federation.

THREE CARROTS. As an incentive to stay on track, Student Loan Marketing Assn., the federally chartered corporation known as Sallie Mae that administers about a third of all guaranteed student loans, has created a rewards program. Make your first 48 payments on time, and Sallie Mae (800 524-9100) reduces the interest charge by 2 percentage points. By paying the first 24 installments on the low-interest, government-backed Stafford loans, you get the origination fee of at least $250 credited to your account. Plus, if you use automatic electronic transfers from your bank, your rate goes down a quarter-point. These add up to an $852 savings on a $10,000 loan over 10 years.

If loans are such a burden that you are racking up expensive credit-card debt or failing to participate in your company's 401(k) plan, you should negotiate for lower payments--even though that will add to the interest that accrues over the loan life, advises Ross Levin, president of Accredited Investors, a Minneapolis financial planning firm. The least expensive way to lower the monthly allotment is to make graduated payments. Sallie Mae's Select Step option requires you to pay off the loan in 10 years but lets you pay interest only in the first two to four years. This plan makes sense if your loans total between $4,000 and $7,500, says Betty Enve, head of Sallie Mae's consumer-service center.

People with a larger balance will probably need to extend the repayment period to keep the monthly amount manageable. With the Federal Direct Graduated Repayment Option, payments increase every two years over 12 to 30 years, depending on the size of your loan. With Sallie Mae's Smart Loan consolidation plan, the length of the loan is determined by the balance owed. If you owe more than $60,000, you could elect to pay it back over 30 years. But this would add to your costs. Chany estimates if you stretched out $70,000 in loans over 30 years, you could end up paying about $115,000 in finance charges, vs. $50,500 after 15 years.

You certainly don't want to stretch payouts into your retirement or have them overlap your children's college costs. However, for maximum flexibility, "it makes sense to arrange for the lowest payment possible, with the intention of paying off the loan much more quickly when your cash flow situation allows it," Levin says. On a $10,000 loan at 8%, you would remit $121 a month under the standard 10-year schedule, for a total of $14,520. Extended to 15 years, the payment would drop to $96 a month but the total would rise to $17,204.

A new option, intended for graduates with low income relative to the size of their debt, became available from Sallie Mae this year and Federal Direct last year. These plans take your salary level into account. Sallie Mae lets you pay as little as 4% of your income as long as that covers the interest accrued each month. But the Federal Direct program will let you pay less than the interest that is accumulating, which means your debt will keep growing while you make payments--an option that should only be a last resort.

Before you consolidate, there are two caveats. If you plan on going back to school, check with your lender before you mix subsidized Stafford loans with unsubsidized loans. That may jeopardize your ability to stop interest from accumulating while you are in school. Also, the interest rate is usually the weighted average of your loans rounded up to the nearest whole number. If your average rate is 8.01%, you would be charged 9%, says Chany. In that case, you should leave out the highest-rate loan so your rate would be 8%. The Federal Direct rate is the same as for Stafford loans: a variable rate (now 7.43%) that can't exceed 8.25%.

RATE PLAYS. If you haven't consolidated your loans and can afford more than minimum payments, pay the smallest possible amount on the low-interest loans, while doubling up payments on the high-rate loans, says Mary K. Sullivan, a financial planner in Oakland, Calif. Polishing off loans one by one gives you motivation to keep going, she says.

Levin suggests homeowners dispense with student loans by using a home-equity line of credit. That way the interest usually would be tax-deductible. "But student loan debt often has lower interest rates than other types of debt," Levin says. So don't pay off an 8% student loan if you're carrying a $5,000 balance on an 18% credit card.

If you have very low-interest loans, you could hang on to them and invest some money. Sullivan advised one client with old 4% medical school loans not to pay them off early since she could earn more after tax by buying Treasuries and some stocks. Today's typical student borrower with 8% loans might try to pay them back faster. But even if you can't, with the new repayment options, at least you won't despair that you ever took out student loans at all.

Strategies for Paying Back Student Loans


Sallie Mae lets you send in interest only in the first two to four years and still pay off your loan within the standard 10 years. With the Education Dept.'s graduated repayment, your monthly nut increases every two years over 12 to 30 years.


This can substantially reduce your payments but will increase the amount of interest you'll ultimately fork over.


Sallie Mae's new income-sensitive repayment account allows borrowers to pay as little as 4% of their income as long as that covers the interest each month.


Make your first 48 payments on time and Sallie Mae reduces the interest rate 2 percentage points. If you authorize electronic transfers, you get an additional quarter-point rate decrease.


Interest on most student loans receives no tax preference. But home equity debt interest can usually be deducted.


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