The 6 Worst Student Loan Mistakes You Can Make

Reviewed by Katie MillerReviewed by Katie Miller

For many borrowers, a loan is their only option for financing a higher education. That being said, there are a few substantial mistakes you can make at every step of the borrowing process—before you get the money, while you have the money, and after you start paying the money back. These major student loan faux pas include making sure you aren’t falsifying any information on your application, choosing the wrong repayment plan for you, and missing loan payments, among others.

Key Takeaways

• Don’t lie on your student loan application.
• Don’t use your student loan money for anything but educational expenses.
• Don’t choose a repayment plan with a small monthly payments and/or long repayment term, unless that’s the right fit for you.
• Don’t skip loan payments, even if you fully intend to “make them up” the next month.
• Avoid defaulting on your loan at all costs; contact your lender if it’s looking like you won’t be able to make your repayment.

1. Falsifying Your Application

Lying on your student loan application is the first misstep you can make. If you misrepresent anything, such as your income, there’s a high possibility that you’ll get caught, as some schools audit all financial aid applications.

Not only will you lose your loan and incur fines of up to $20,000, but you may also be charged with fraud and sentenced to prison. You may be able to receive your education for free while incarcerated, but securing a well-paying job is typically more difficult if you have a criminal record.

2. Spending Money on Wants, Not Needs

Using student loan money to pay for an education that will be with you forever is good debt. Using student loan money to purchase the latest smartphone, which will be obsolete a decade before you’re done paying off said loan, is bad debt. A small, occasional splurge is unlikely to set you back much, but mortgaging your future to pay for the fleeting pleasures of today is poor money management.

If you receive a higher loan amount than what you actually need to survive, save the excess cash in the highest-interest savings account you can find, and use it to begin paying back your loans when you graduate. Alternatively, see if you can apply the funds toward interest payments on the loan, even while you’re still in school.

3. Choosing the Wrong Repayment Plan

It’s tempting to choose the repayment plan that demands the smallest monthly sum. The Income-Based Repayment (IBR) or Pay as You Earn (PAYE) plans sound great—who wouldn’t want to have 25 years, rather than a decade, to settle a debt? Yet these plans also ultimately cost you more in the long run. Payment plans with lower monthly payments also have the longest repayment terms, which increases the total interest you will pay over the life of the loan.

To help you pay as little in interest as possible, you should opt to pay the highest amount you can afford each month. So how much is that? One rule of thumb is that your monthly student loan payment should be no more than 10% of your expected salary. Start by calculating your monthly loan payments (including interest) on a 10-year repayment schedule using your expected salary—which tends to be the standard option.

If your loan payments will be higher than 10% of your income—which may be difficult to afford on most entry-level salaries—then it’s worth considering a longer, less expensive program. But promise yourself that you’ll take another look if or when your financial situation improves.

4. Overlooking Refinancing

Speaking of taking another look, if there’s been a significant drop in interest rates, it’d be a mistake to ignore a potential opportunity to refinance your loan. You could be missing out on saving hundreds, if not thousands, of dollars on your student debt. Of course, interest rates and loan terms can vary considerably among lenders. Be sure to compare and crunch the numbers carefully to make sure you are, in fact, getting a better deal.

If you have multiple federal student loans, you may be able to consolidate those into a single payment at a lower rate.

However, if you have a federal student loan, bear in mind that, by refinancing, you are exchanging it for a private loan. That means you are exiting the federal loan program and its income-based repayment plans and loan forgiveness options, in addition to losing out on certain financial protections.

Even if you can’t refinance the entire loan, it’s not against the law to make an extra payment from time to time or to pay more than the minimum amount each month. Even an occasional bonus can add up, shortening the life span of your loan. Just make sure that your student loan servicer applies the additional payment or amount to your principal balance, thus reducing the interest, instead of just applying it to the next month’s payment.

Some loan servicing companies may also offer an interest rate reduction for signing up for autopay. Make sure you consider all of your options for lowering your rate.

Note

Federal student loan rates are determined by federal law, not the United States Department of Education. These standardized rates are typically much lower than private student loan rates.

5. Missing Payments

Many students have skipped one month’s student loan payment with the intent of doubling up on their payments the next month. That’s a big mistake.

Every missed or late payment is a black mark on your credit report and will ding your credit score, whether you make up that payment or not. (For federal student loans, delinquencies of 90 days or more are reported to the three major credit bureaus). This ding can stay on your credit history for years, affecting your ability to take out other loans.

If your monthly payment is more than you can handle, talk to your lender to find a solution before you start skipping your monthly payments.

6. Defaulting on Your Loan

Failing to make payments on your loan for more than 270 days will send your loan into default and your financial life into a tailspin. Don’t dodge your lender. They will find you, and the penalties for nonpayment are steep. Unlike credit card companies, the federal government (the loan guarantor on most student loans) has the ability to keep your income tax refund to pay back the loan, plus any collection costs.

Again, before you get into dire straits, contact your lender or loan servicer. If your problems stem from unexpected misfortune, such as being laid off, you might be able to work out a deferment or forbearance arrangement to buy yourself some breathing room. But simply failing to make your monthly payments is the worst student loan mistake you can make.

How Risky Is It to Lie on Your FAFSA?

It’s incredibly risky to lie on your Free Application for Federal Student Aid (FAFSA). Even if you somehow slip past a financial aid auditor, chances are that at some point, lying on your student loan application will cost you more in fees and potential legal troubles down the line.

Can I Skip My Student Loan Payment?

Skipping a student loan payment isn’t the best idea. Skipped payments show up on your credit report and will lower your credit score. If you’re struggling to afford your monthly loan payments, reach out to your lender and try to find a repayment plan that better suits your financial situation.

Can You Use Student Loan Money for Clothes?

Some student loans designate how the money must be used. Typically this is limited to books, tuition, and possibly room and board. If you receive additional student loan money and buying clothes is more of a necessity than a luxury for you, you may be able to use it to purchase a few essentials. But for anything beyond the basics needed to keep you clothed, it’s better to wait and save up.

The Bottom Line

A student loan is often the first large sum of money that a young adult must manage. Avoiding detrimental money mistakes when securing funding for your college education is crucial to graduating with only good debt, and as little of it as possible.

Read the original article on Investopedia.