How to Approach Student Loans the Right Way

What is the difference between a loan and credit? If you are financially astute, you know the answer is “not much.” Sure, there are varying terms, conditions, repayment amounts, timelines, etc., but whether it’s a loan or a line of consumer credit, you are borrowing money you don’t have.

So, why are student loans considered a necessary burden when credit card debt is considered frivolous? A college education is seen as a valuable resource for future success; therefore, paying thousands of dollars to achieve your goal is “necessary.” If done correctly, funding a college degree is a worthwhile endeavor. On the other hand, using reckless tactics to subsidize education is like using your Visa to pay for tuition.

Of course, lenders hope you don’t draw the comparisons between the two. After all, student loans represented a $1 trillion debt crisis by the end of 2012, a number that has economists worried for our nation’s future stability. Within the same vein, we’re worried about your stability when it comes to paying for college. Don’t get swallowed by debt for the sake of a degree. Just as you would with a credit card, avoid these mistakes with student loans.

Mistake #1: Using loans as an open-ended bank account.

Funding a college education used to be simple math:

Tuition + room and board + supplies=Money needed for college

Money needed for college-federal student aid- scholarship and grant awards=Out-of-pocket expenses

Easy, right? It should be, but the harsh truth is that federal loans rarely cover the full cost of tuition and living expenses. To cope with those out-of-pocket expenses, many students turn to private loans to fill the gap. Private student loans can be a dangerous method of college funding. Many come with high, variable interest rates (dependent on your credit score), unrealistic repayment terms, and worst of all, no spending cap in sight. That’s right—the sky’s the limit. Think carefully before pursuing this option. Often, using a private loan is no different from using your Visa to pay for tuition. Signing on for too much debt can lead to big credit repair issues after graduation. College is where learning begins; why tarnish your education with foolish decisions?

Mistake #2: Allowing interest and principal to spiral out of control.

Accruing interest is the worst part of borrowing money. It prevents you from paying down the principal more quickly, thereby keeping you in debt. Whether it’s a credit card or a student loan, allowing interest to prolong your financial burden is a credit repair no-no. It increases your credit utilization ratio, limits your savings, and affects your ability to borrow elsewhere when necessary. Consider the following example:

Jessica graduated from college in 2001 with a degree in communications. Although she has been steadily employed since graduation, she has chosen to pay only the minimum monthly amount on her $35,000 student loan. Thanks to a 6.5 percent interest rate, her loan has increased to over $71,000, more than twice the initial amount. If she had chosen to pay down the principal and interest, her loan would currently be less than $5,500.

It doesn’t take a mathematician to see the value of controlling interest. By contributing a mere $2,200 per year in interest payments, Jessica could have reduced her loan burden by more than $65,000. Take a lesson from her shortcomings and manage your loans wisely. The result could save you thousands.

Mistake #3: Failing to anticipate the effects on your budget.

The bubble of college is similar to the bubble of reckless spending, where one can easily say, “Charge it now, worry about it later.” As a freshman in college, you probably weren’t worried about repaying student loans in four years. As a senior, the stress was likely getting to you. The truth: Unless you have a family business or guaranteed source of income, you have no idea what your budget will look like after graduation. What you do have is hope for a good future, something that won’t help you repay your debts. With this in mind, it’s important to use student loans as scarcely as possible. Poor budgeting is the culprit of necessary credit repair. Don’t ruin your finances by spending carelessly.

Mistake #4: Relying solely on a lender’s advice.

College education is a business, plain and simple. Sure, there are non-profit universities, but that doesn’t mean your tuition is free. Federal and private lenders can help you pay for school, but they can’t help you determine what’s affordable. The statements, “Don’t worry, you’ll be able to pay back your loans,” and “This is such a good school; you won’t have any trouble finding a job!” are reassuring, but they don’t guarantee results. Skip the hard-sell and speak to an unbiased professional. Talk to an accountant or financial planner about your future. They’ll help you understand the effects of student borrowing based on your projected budget, repayment schedules, and other factors. The bottom line: Approach lender advice with a healthy dose of skepticism. Your happiness is not their primary concern.

Mistake #5: Failing to explore more affordable alternatives.

You wouldn’t finance a car without shopping around, so why finance an education without the same consideration? While it’s true that a high-profile university name is valuable on a résumé, the average employer cares more about your skills than your alma mater. When deciding where to attend school, make a list of their pros and cons, weighing the cost as heavily as the name. Research statistics like graduation rates, hiring rates, etc., to help you make your decision. If find comparable results, choose the route that will help you avoid mountains of student debt. A degree should never hurt your financial stability.