Student loans are often viewed as a necessary investment in one's future, providing access to higher education and the potential for increased earning power. However, when not managed carefully, student loans can sometimes become a debt trap, leaving borrowers struggling with the burden of repayment for decades after graduation.
The Benefits and Risks of Student Loans
Student loans are often classified as "good" rather than "bad" debt because they serve as an investment in a borrower's future. For example, the median wage for those aged 25-34 with a college degree is over $60,000 annually. The median salary for those with only a high school degree is around $40,000 – quite a difference! Extrapolate these differences over a lifetime's earnings, and there's a significant difference. So, even though tuition has risen astronomically in recent decades, college is still a good bet – unless you fall into the student loan debt trap.
Federal student loans are unusual because anyone attending a qualified school is eligible. While an 18-year-old might need a good credit score or a co-signer to secure a car loan, financing a college education is simple – the federal government offers student loans to borrowers regardless of credit qualifications.
While this has lowered the barriers to getting a college education, it also presents a real challenge to young students, who may need more financial savvy to make long-term financial decisions. For example, students may choose to attend college when they're not truly ready, meaning they may take on debt and not finish their degree. This situation is a worst-case scenario – education debt without the increased earning potential that comes with a degree.
While there are limits to annual and overall borrowing with federal student loans, private student loans from banks, credit unions, and other lenders may have higher limits. If federal loans don't cover the cost, some students may require private loans. These loans also don't include the flexible repayment options of federal loans. But especially for those who plan to pursue relatively low-paying career fields, borrowing a high level of federal and private student loans could be risky.
The Student Loan Debt Trap
There are several ways to look at how student loans can "trap" people. On the one hand, a borrower could simply be unable to afford the monthly loan payments comfortably. Perhaps they're underemployed and couldn't find a job in their chosen field, overestimated earnings in their chosen field, or didn't finish their degree. Either way, the income they expected their loans to provide ultimately didn't materialize. On the other hand, a borrower may be able to afford their loan payment but at the expense of other milestones – like buying a home, having kids, saving for retirement, or starting a business.
The consequences of being trapped by student loan payments can be severe. Those who fall behind in payments could be charged fees and penalties, their credit may be damaged, and their wages could be garnished. And unlike other consumer loans, it's very difficult to have student loan debt discharged – even if they declare bankruptcy.
Those who sacrifice other milestones because of student debt may miss opportunities to build wealth, create financial stability, and achieve personal fulfillment – probably not what they had in mind for their post-college lifestyle.
Escaping the Trap
Federal student loans offer a variety of repayment, deferral, and forebearance programs designed to help borrowers with almost any financial situation, from going back to school for an advanced degree to losing a job.
While there have always been federal repayment options that are based on income, they have been viewed by many as cumbersome and difficult to manage. In 2023, the Saving on a Valuable Education (SAVE) Plan was launched to address many of these issues. However, the plan is currently delayed because of legal challenges. If it does ultimately launch, key benefits will include:
- Reduced Payments for Undergraduate Loans – Starting in June 2024, undergraduate loan borrowers will have their payments reduced from 10% to 5% of their discretionary income. If borrowers have both undergraduate and graduate loans, they'll pay a weighted average of between 10% and 5% based on the original balances of those loans.
- Possible $0 Monthly Payments – Monthly payment amounts are based on discretionary income, defined as the difference between adjusted gross income (income after tax deductions) and 225% of the federal poverty guidelines for a given family size. For example, a single borrower earning roughly $15 an hour might qualify for a $0 monthly payment.
- No Growth in Balance with Regular Payments – Maintaining regular payments ensures that the loan balance remains stable, without increases due to unpaid interest. Even if a required payment doesn't cover the interest on the student loan balance, the balance will stay the same – a significant difference from other repayment options.
- Early Loan Forgiveness for Lower Balances – While typical income-driven plans require at least 20 or 25 years of repayments before any loan balance is forgiven, the SAVE Plan introduces a tiered system. Borrowers with original balances under $12,000 will receive forgiveness after 120 payments. For every additional $1,000 borrowed, the forgiveness period is extended by a year, capping at 20 years for undergraduate and 25 years for graduate student loans.
Since the SAVE plan outlook is uncertain, if you're having trouble affording your federal student loan payments, visit studentaid.gov to learn about other income-driven repayment plans – they may offer significant improvements to your financial outlook. Further, for those who work for the government or in the nonprofit sector, Public Service Loan Forgiveness can offer valuable rewards, including forgiving a portion of your debt after ten years. This option is especially valuable for those with a very high federal student loan debt (for example, debt incurred for a graduate or professional degree) since there's no limit on the forgiven balance.
The options available for those with private student loans will depend on the specific lender's policies. Other than loan interest for servicemembers being limited to 6%, there aren't many protections in place for private student loan borrowers. In any event, if you're having trouble paying your payments, it's crucial to maintain an open line of communication with your lender. Explore all options they offer and work with them to minimize potential damage to your credit score.
The Takeaway
While dealing with the student loan debt trap can be challenging, understanding all repayment options is the first step toward financial freedom. Consider logging in or creating a free account on this website for detailed information on effectively managing student loan debt.
