Dealing With Financial Difficulty

Even the most careful consumers occasionally encounter unanticipated financial hardships, which can make repaying student loans and other debts difficult. Financial difficulty can be caused by unemployment, underemployment, disability, illness and injury. There are, however, many approaches to addressing the financial difficulty.

General Advice

Talk to the lender before deciding to skip a payment. Lenders tend to be more flexible with borrowers who contact them first. Borrowers lose options if they default first. Ignoring the problem will not make it go away. It will only get worse. The consequences of defaulting on student loans are very serious and often increase the cost of repaying the loan.

Get help from a family member or a financial professional, such as an accountant (CPA) or financial planner (CFP). A non-profit credit counselor, such as those certified by the National Foundation for Credit Counseling (NFCC) might also be able to help.

Bankruptcy is generally not an effective solution for student loans. Federal and private student loans are almost impossible to discharge in bankruptcy. A bankruptcy discharge requires the borrower to demonstrate undue hardship in an adversarial legal proceeding, a very harsh standard. Most bankruptcy attorneys will not even try to get student loans discharged.

Solutions for Short-Term Financial Difficulty

Furlough: A furlough is a temporary leave of absence for some of a company’s employees, often due to economic conditions or changes in demand for the company’s products and services.

If a borrower has a short-term financial difficulty due to job loss, a temporary job furlough or medical or maternity leave, a temporary suspension of the obligation to repay debt can help. These include deferments and forbearances.

Deferments and forbearances are not good solutions for long-term financial difficulty, since interest may continue to accrue on the loans during a deferment or forbearance. If the interest is not paid as it accrues, it will be added to the loan balance, digging the borrower into a deeper hole. An extended period of nonpayment can significantly increase the amount of debt. For example, 10 years of nonpayment may double the total payments over the life of the loan.

Borrowers should continue making payments on the loan until they receive written confirmation that the deferment or forbearance has been approved.

Solutions for Long-Term Financial Difficulty

If a borrower has a long-term financial difficulty due to underemployment, with no prospects for increasing income, an alternate repayment plan may be a solution. Options may include extended repayment, graduated repayment, income-based repayment, pay-as-you-earn repayment, and revised pay-as-you-earn repayment, depending on the type of the loan.

These repayment plans reduce the monthly payment by increasing the term of the loan or length of the repayment period. For example, increasing the term of a loan from 10 years to 20 years reduces the monthly payment by about a third. Unfortunately, it comes at a cost, because it more than doubles the total interest paid over the life of the loan.

Refinancing a high-interest loan may yield some financial relief. Interest rates on private consolidation loans are based on the current credit scores of the borrower and cosigner (if any). If the borrower’s credit scores have improved after graduation, he or she may be able to qualify for a better interest rate on the original amounts borrowed. The borrower’s parents or other family members might be able to get a lower interest rate on a home equity loan and use that to pay off the borrower’s student loans. But, reducing the interest rate might not save as much money as most borrowers assume. A one percentage point decrease in the interest rate will reduce the monthly payment by about four percent to six percent. Cutting the interest rate in half does not cut the loan payments in half. For example, cutting the interest rate on a 10-year, $40,000 loan from 10% to 5% reduces the monthly payment from $528.60 to $424.26, a 20 percent reduction in the monthly loan payment.

If a borrower is in a “you can’t squeeze blood from a stone” situation, such as when the borrower is living near the poverty line with no prospects for increasing income and no assets, the borrower should ask the lender about options for loan modification. Some lenders will reduce the loan balance or interest rate for borrowers who are experiencing long-term financial difficulty, especially if they agree to make the monthly payments automatically.

Loan cancellation, discharge and forgiveness may also be options. For example, borrowers who are totally and permanently disabled may be eligible for cancellation of their remaining debt.  Borrowers who are working in a public service field may be able to qualify for public service loan forgiveness on their federal student loans.

Borrowers who are already in default may be able to settle the defaulted student loans for less than what is owed. Student loan settlements often forgive part of the interest that has accrued since the loan went into default or waive the collection charges. Defaulted borrowers also have a one-time opportunity to rehabilitate their federal education loans, which will allow the borrower to regain eligibility for federal student aid and remove the default from the borrower’s credit history.

Increasing Income and Cutting Expenses

Borrowers can also deal with too much long-term debt by increasing income and decreasing expenses.

If the borrower’s monthly loan payments exceed 40% of the borrower’s gross monthly income, cutting expenses will not be enough. The borrower will need to find a way to increase income.

• Getting a part-time job in the evenings and weekends can help a borrower earn extra income to pay down debt. An added benefit is that the borrower will have less time available for spending money.
• Borrowers can ask for a raise from their employers, especially after taking on extra work.
• Switching jobs often leads to a 10 percent to 15 percent pay increase, so borrowers should search for a new job that pays better.
• Borrowers can start a part-time business in their spare time, such as selling homemade craft items on eBay.
• Ask friends and family to help pay down the debt instead of giving birthday and holiday presents.

There are also several steps a borrower can take to cut expenses.

• Create a descriptive budget by tracking all spending for a month using a spreadsheet or a free tool like Mint.com. Just being aware of spending patterns is the first step toward exercising control over spending. This can also help borrowers understand whether their finances are completely under water or just barely getting by.
• Reviewing the descriptive budget can help identify opportunities for savings. Label each expense as either mandatory (a need) or discretionary (a want). Be realistic. Cable or satellite TV is a luxury, not a necessity.
• Applying extra money to the loan with the highest interest rate will save money.
• Borrowers can save on housing costs by getting a roommate or by moving back in with their parents or other relatives.
• Borrowers can cut transportation costs by selling an expensive car and buying a less expensive used car or using public transportation.
• If a cell phone is needed for work, get the boss to pay for it. Or switch to a less expensive cell phone service. Threaten to leave the carrier unless they reduce the cost of the cell phone plan. Economy plans can cost less than $200 a year.
• If a cell phone is needed just for emergencies, drop the service carrier entirely. All cell phones can still dial 911 even without paid cell phone service.
• Avoid eating out or paid entertainment unless someone else is paying the bills.
• Substitute free items and activities for paid expenses. For example, substitute a daily walk around the block for the expensive gym membership. Borrow books from the library instead of buying the latest bestsellers. Read newspapers online for free.
• Clip coupons to save on groceries and other household items.

Borrowers who are up to their eyebrows in debt should also consider selling off extra belongings to get extra money to pay down the debt. Anything that hasn’t been used for over a year is a possibility.

Dealing with Financial Stress

Financial difficulties can exact an emotional toll, especially when the borrower is inundated with never-ending calls from bill collectors.

It is important to keep a positive frame of mind. Money problems do not magically transform a good person into a bad person. Consider using a community-based organization that provides free or low-cost support groups and counseling for people facing financial challenges.

Borrowers can start by identifying ways in which they are still in control of the situation. Focus on things that can be done immediately to move in a positive direction. Taking small steps toward a goal can help a borrower avoid being overwhelmed by the debt.

When bill collectors call, ask them for practical steps for dealing with the debt. Sometimes they will be able to suggest practical solutions. But, if the conversation turns nasty, borrowers can exercise their rights under the Fair Debt Collection Practices Act (FDCPA) to tell the collection agency to stop contacting them.