5 top student loan mistakes and how to sidestep them

Key points

• It may seem like a no-brainer, but people often fail to get all the free money they can before they turn to borrowing.
• What’s a fixed rate versus a variable rate? Being clear on the difference could save you a lot of money.
• Just keeping your contact info up to date can go a long way toward ensuring you stay in good standing with your loans.

For many students, getting student loans to help pay for college is inevitable. But avoiding costly mistakes isn’t.

Over the years, we’ve seen borrowers make the same errors over and over again. And many of them are pretty simple to avoid as long as you know what they are.

Here are the top five most common mistakes people make with student loans that cost them money, and what to do instead.

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Mistake #1: Failing to exhaust all free funds before borrowing

Failing to focus on free money first will cost you dearly. Free money is cheaper than borrowed money. Scholarships, grants, fellowships and tuition waivers are examples of gift aid, which does not need to be repaid. A student loan, on the other hand, must be repaid, usually with interest.

A college’s net price is the difference between the cost of attendance and gift aid. If you don’t maximize free money, your net price will be higher and you may need to borrow more to cover the cost. Use the college’s net price calculator to get a personalized estimate of your net price, assuming you apply for financial aid.

To qualify for gift aid, apply for financial aid. You can’t get money if you don’t apply. In order to apply for need-based aid, file the Free Application for Federal Student Aid (FAFSA), which will provide you with grants, or free money that does not need to be repaid. FAFSA also determines whether you qualify for student employment (money that must be earned) and student loans (money that must be repaid, usually with interest). FAFSA is your opportunity to qualify for money from the federal and state government, and most colleges. A handful of colleges use a supplemental form called the CSS Profile.

To apply for merit-based aid, search for scholarships using free scholarship matching services, such as Fastweb and the College Board’s Big Future. Apply to every scholarship for which you are eligible.

Mistake #2: Borrowing too much money

If you borrow too much money, you will struggle to repay your student loans using the standard 10-year repayment plan. If your total student loan debt at graduation is greater than your annual starting salary, you will need an alternate repayment plan, such as extended repayment or income-driven repayment, to afford the monthly loan payments.

These repayment plans reduce the monthly student loan payment by increasing the repayment term from 10 years to 20, 25 or even 30 years. This means you could still be repaying your own student loans when your children enroll in college. It also means that you’ll be paying a lot more over the life of the loan.

Given the combination of loan fees, capitalization of interest and longer repayment terms, every dollar you borrow will cost about two dollars by the time you repay the debt. Borrow as little as you need, not as much as you can. Live like a student while you’re in school, so you don’t have to live like a student after you graduate.

Mistake #3: Confusing fixed and variable interest rates

Variable-rate loans often start off with lower interest rates than fixed-rate loans. This yields a lower payment initially, which you might feel is more affordable.

A variable interest rate might seem lower than a fixed interest rate, but it isn’t really lower. Variable interest rates can go up, increasing your costs. The monthly loan payment will increase and the interest you pay will increase. This can lead to a higher loan payment on a variable-rate loan than on a fixed-rate loan.

Fixed interest rates are more predictable, with an unchanging monthly loan payment throughout the loan term. You will know in advance how much student loan interest you can deduct each year on your federal income tax returns. Fixed interest rates also protect you from interest rate increases.

Variable interest rates are also riskier. In a rising-rate environment, variable interest rates have nowhere to go but up. There may be no limit on how high the variable interest rate can go. As interest rates rise, you may have to devote more money each month to repaying your student loans.

The risk of choosing a variable-rate loan is higher when the spread between fixed and variable interest rates is small. The risk of choosing a variable-rate loan is also higher over a longer repayment term, when changes in the interest rate are less predictable.

Tip: Variable interest rates for student loans are particularly risky, because they are offered by private student loans, which have fewer consumer protections than federal student loans. (Federal student loans have fixed interest rates.)

There aren’t any prepayment penalties on student loans, so you can choose to refinance a variable-rate loan into a fixed-rate loan at any time. But if you wait until interest rates rise to refinance, you may end up with a higher fixed interest rate than if you had chosen a fixed-rate loan in the beginning.

A variable rate might be better than a fixed rate when you expect to pay off the loan in full before it reaches maturity. You can save money by paying off the loan before interest rates rise too much. This can occur when you have assets sufficient to repay the debt, but don’t want to access the assets immediately. For example, you might have stock market investments that you expect to continue appreciating in value.

Mistake #4: Not updating contact information with your loan servicer

When you signed your student loan’s promissory note, you agreed to keep your contact information up to date. A typical promissory note, for example, includes a statement similar to the following one from Discover Student Loans: “You agree to notify us promptly after any change in your name, address or other contact information.”

You are still obligated to repay your student loans if you don’t get a loan statement or coupon book. If you don’t make a payment because you didn’t provide the lender or loan servicer with your current contact information, you will have only yourself to blame. It can take months for skip tracing to locate you. By then, you’ll be late with a payment or even in default.

Providing your lender with your current contact information also lets the lender contact you about important changes, such as a change in loan servicer or payment address, new repayment plans or loan forgiveness options.

Mistake #5: Choosing too long of a repayment term

Borrowers often choose the repayment plan with the longest repayment term available to them, because this usually results in the lowest monthly loan payment. But, this will cost you more interest over the life of the loan.

Every payment is applied first to interest and second to the principal balance. A lower monthly student loan payment means less money is applied to the principal balance of the loan. This slows your progress in paying down the debt, meaning that more of each payment will continue to be applied to interest. If you double the repayment term, you are more than doubling the total interest paid over the life of the loan.

REPAYMENT TERM	LOAN AMOUNT	INTEREST RATE	MONTHLY PAYMENT	TOTAL INTEREST PAID
10 years	$10,000	5%	$106	$2,728
20 years	$10,000	5%	$66	$5,838

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In the example above, if you choose the 20-year repayment plan, even though your monthly payments go down, you’ll end up paying $3,110 more. Instead, you should choose the repayment plan with the highest monthly payment you can afford. Not only will this pay off all your student loans quicker, getting you closer to financial freedom, but you will also pay less interest over the life of the loan. You will save more by paying more.

Using the previous example, if you pay an extra $25 a month on the 10-year loan, you will cut 2.3 years off the repayment term and save $668 in interest. If you pay an extra $50 a month, you will cut 3.8 years off the repayment term and save $1,070 in interest. If you pay an extra $100 a month, you will cut the repayment term in half (to 4.6 years) and save $1,532 in interest.