The Good, the Bad, and the Ugly of Student Loans

Student loans are a great resource to help cover the costs of obtaining a degree. After all, investing time and money into a college education can really pay off. Median earnings for someone with a bachelor's degree, for example, are 70 percent higher than someone with just a high school diploma, according to recent studies by the U.S. Department of Labor Statistics. But as with any investment, you have to be smart about student loans.

Avoiding the Bad and the Ugly

Do Your Research

The most important thing to remember before taking out a student loan is that it is a financial contract that has to be paid back -- with interest -- even if you don't finish your degree. So be sure to limit the total amount of loans you borrow to only what you really require to complete your program of study. Another crucial thing to keep in mind is that these funds are intended for essential costs such as tuition, fees and books, and not as a lifestyle subsidy. It's also a good idea to research what you might expect as a starting salary in the field you plan to major in to make sure you will be able to reasonably afford the monthly loan payments once they come due. (For salary information, check out data from the U.S. Department of Labor). For federal loans, payments will commence six months after you graduate or leave school, so be prepared.

Pay on Time and in Full

Once you enter the repayment phase, make sure you make your payments on time and in full. An added benefit of on-time repayment is that it's a great way to boost your credit score. Student loans are treated like any other installment loan by credit rating agencies, so keeping your payments current will demonstrate fiscal responsibility and credit worthiness, which will come in handy when you want to borrow money for other life milestones such as buying a house or car. Missing payments or defaulting on your loan can result in serious consequences, such as wage and/or tax refund garnishment. If you are having trouble making your payments, contact your loan servicer(s) as soon as possible to explore options such as changing your payment plan, deferment or forbearance.

Consider Refinancing Carefully

If you are interested in refinancing your loan to take advantage of what might seem like a lower rate, keep in mind that you are essentially getting a new loan and starting the repayment clock over. If you refinance in the later stages of repayment, when most of the payment is going toward the principal, refinancing will mean that you are likely to pay more in interest charges unless you make extra payments on the principal. Also, if you refinance federal loans with any private loans you may have, you lose any benefits that may be offered through the federal loan program. Programs such as income-based repayment (which may be extended to many more borrowers by December 2015 under an executive action by President Obama) would not be an option if you refinanced both federal and private loans together.

Maximizing the Good

Pay in Full

Some people ask if they should pay off student loans in full. If you are fortunate enough to have the resources to do so (without doing harm to your overall financial health) and you want to avoid paying any interest, then it may make sense for you to do so. For some individuals, carrying a significant amount of debt is worrisome and they prefer to have the peace of mind that comes with having that obligation off their plate. Another example might be a couple planning to get married when only one has student loan debt. They might want to start their new life together without that burden. Again, it depends on the individual, their financial situation and their financial goals, so think carefully before making your decision.

Accelerate Payments

If you -- like most people -- are not in a position to pay off your loans in full, you can still save money in interest costs by making extra payments to pay down the outstanding principal. It's all about what you can comfortably afford to do. However, one thing you want to avoid is accelerating your student loan payments (which tend to have lower interest rates, particularly if you have federal loans) to the point that you won't have enough funds to pay off your credit card bill or other debt obligations every month. It's more important to make extra payments to your highest interest rate debt first as you continue to make your loan payment.

Consider Other Investments

If the interest rates on your federal loans are low, you may be wondering if it makes sense to save or invest instead of trying to accelerate payments or pay in full. Again, it really depends on your current financial situation. If you have no other debt and your student loan payment is reasonable, such as no more than 10 percent of your monthly income, then it might make sense to keep making the payments and invest any other disposable income. A great place to start is by taking full advantage of your employer's 401k or other retirement savings plan.

Acquiring student loan debt can be an intimidating, confusing process; however, in today's educational environment, it's often a necessity in order to finance a college education. With proper advance knowledge and research, student loans are a worthwhile option -- but if treated as a frivolous investment, the bad and ugly side of student loans will be what follows you after college, whether you complete your degree or not.

States With Highest Average Student Debt - TICAS - Class Of 2012