We all know that Millennials have had it rough. This is especially true when it comes to repaying student loans. Anybody who has taken out a student loan fears it, dreading the day when it needs to be repaid to their loan provider.
Background
Unfortunately, the Millennial generation seems to be facing the worst of the problems. Remember back in 2008 when the United States banking system nearly collapsed and the economy entered a recession? Investments and spending took a massive hit. Any college money that had been saved for students by their parents lost significant value or earned little interest. It became much more difficult for the parents, and 50% of those students, to find jobs after graduation since nobody was hiring. People struggled to pay their bills as a result; they could not even dip into their savings! What’s more, colleges responded by raising their tuition. Millennial students had no choice but to borrow more financial aid, only to be burdened with record student debt.
According to a 2017 study conducted by PwC, 45% of Millennial participants worrying about student loans worried the most about how the repayment of their student loans would negatively affect their other financial issues. 33% faced a situation so desperate that they began to withdraw money from their own retirement savings! Not cool.
The problems go back farther too. PwC had conducted a similar survey in 2015. 54% of Millennials were anxious about how they were going to afford to repay their student loans. In fact, 30% had to sacrifice too much money for their loans, risking unpaid bills. Of Millennials who could afford to go to college, a whopping 81% found themselves to be in debt for years on end— even decades!
Millennials are struggling financially, but aren’t we all? In 2016, the average student loan debt was $37,172, up 6.05% from the year before, according to Mark Kantrowitz, publisher and vice president of strategy for college scholarship website Cappex.com. Meanwhile, the Consumer Financial Protection Bureau collected 8,494 complaints that students had submitted about their federal loans. 11% were baffled about allocation, or how their loans would ultimately be repaid toward the principal balance plus interest and loan fees. Most of them were irritated at their loan providers for not giving straight answers. Sometimes it came down to how loan providers did not want to reveal the tricks up their sleeves that got them paid more, and with more student money! Providers sell loans, so naturally they tend to hide the unattractive aspects. Technically, the responsibility of understanding this agreement does not fall on their shoulders— it falls on yours!
As you can probably tell, loan providers do not always have— or know— the straight answers. That was just one example of why teens need to have a comprehensive course in personal finance, so that loan providers no longer benefit from confusing their customers or disguising the source of their information— those scheming financial service companies! That is exactly why there are apps out there, such as our own, that teach students financial literacy before the stress of the real world hits them after graduation. Introducing Map the Money Maze, designed by App to Succeed, Inc., a 501(c) (3), nonprofit organization founded by Teri Adler. Map the Money Maze equips American teens with comprehensive information that can impact their financial lives into adulthood. It is available on tablets, smartphones, and regular computers. Map the Money Maze helps students like you avoid the same fate as our friend Ned.
Ned’s Story
Now, to Ned’s dilemma. He has unfortunately made two detrimental mistakes.
Ned, a Millennial, has graduated with a Bachelor of Arts degree from an expensive four-year university. He is proud— for now.
Before Ned left for his first semester of college, he and his parents borrowed (took out) a $20,000 loan from his loan provider (let’s call them LoanJoan,) scheduled to be repaid in 10 years (120 months.) This is the principal (initial) amount of the loan. Foreshadowing… They had signed the promissory note (loan agreement,) which states that Ned must start making payments back to LoanJoan six months after he graduates. This grace period is a period of time designed to give students a chance to find employment and start earning some income for their loan payments. However, there is one problem…
MISTAKE 1: Ned Was Careless!
The loan that Ned borrowed was not really $20,000. It was actually $27,090! But how is that possible?! Because poor Ned neglected to read the fine print on the promissory note. Hmm… Let’s break this down.
The culprit was something called capitalized interest. Every year Ned was in school going to classes, hanging out with friends, working, and maybe even studying, including during the grace period, LoanJoan was capitalizing on his loan by charging him, so his loan gradually accrued (built) a whopping $6,120 of interest. This was not monthly interest, as Ned had assumed it would be. No, it was compounded annual interest! To “compound” means to add up over time. What a pesky contract! Ned did not realize that he was being charged interest right away, even though LoanJoan told him to start paying after the grace period. Every year, Ned was being charged an annual fixed interest rate (the same every year) of 6.8%. This means that LoanJoan was charging him the same amount annually just for having borrowed the loan in the first place! To do this, LoanJoan used a simple yet devious calculation:
[Principal] x [Interest Rate] x [Length of loan plus grace period, in years] = Total Interest Owed $20,000 x 0.068 x 4.5 = $6,120 owed in interest |
Ned did pay $113 per month for his first year of school before the loan started capitalizing, because he wanted to get some payments out of the way early. Good for Ned. However, after that, he has to pay interest for that first year; then, that multiplies again and he has to pay interest for that year too! All of this interest eventually accumulates into $6,120; this creates a grand total of $26,120. This is definitely not $20,000!
Loan providers can easily confuse students with pesky contracts, and this can create so much strife that students end up not knowing what to do— only 27% of those poor Millennials actively seek professional financial advice.
Luckily, you have access to App to Succeed, a straightforward financial literacy app that simplifies the complex world of finance right in the palm of your hand. The most incredible part of App to Succeed has to be Map the Money Maze, a fun and challenging game that prepares students for real-world financial decisions.
It is so easy to immediately blame Ned’s loan provider for being so greedy, but do not make a judgment yet. He easily could have prevented such a blow to his wallet with our app, but he did not. This would have helped him realize something else. Remember how I said that the loan was $26,120? That was only one of his loans; sorry, I forgot to mention that…
MISTAKE 2: Ned Consolidated His Loans!
Ned went to an expensive school that he could not afford without taking out not one, but two loans.
The loan that I have been describing so far was his direct unsubsidized loan. To “subsidize” means to contribute; the government charged Ned rather than helping him out. For this particular loan, Ned wanted to relax during his grace period and avoid paying that accrued interest during school. It was Ned’s fault that his interest capitalized for that loan— so was he the evil one here?
For his other loan, his direct subsidized loan, which also happens to be $20,000, the government and his school decided to help him out (subsidize) with financial aid since he decided to attend an expensive university. The federal government paid off the interest on this loan during Ned’s grace period so that it would not accrue, and so that it would not capitalize.
Does this mean that the government is not all that bad? Should we stop blaming loan providers for making college so expensive? Not yet, because Ned made another mistake.
Ned was worried about paying off his loans— aren’t we all? He thought that he should make it easier on himself by combining his two federal direct loans, the direct unsubsidized and direct subsidized loans, into one, simple loan— the direct consolidation loan (DCL). This process is called consolidation. It was a bad move for Ned.
His friend, Tanya, also a Millennial, has two loans too: one is a federal direct loan, and the other is a private loan. She also thought about combining her two loans, but instead of consolidating, she refinanced her loans. While Tanya had a similar promissory note amount, and had the same interest rate that Ned did (6.8%,) she was smarter about paying it all off than he was. Here is how (and I am keeping score.)
The initial total of Tanya’s two loans was $40,000, just like with Ned. Tanya is paying off her loan over the course of five years, while Ned is taking a decade of his life to pay off his DCL. One point goes to Tanya; zero points for Ned.
Tanya had combined her two loans, through the refinancing process, into one loan, meaning one monthly loan payment rather than two. As a result, she got to pay less interest per month after her grace period ended. Ned, on the other hand, decided to consolidate his two federal direct loans into a DCL and also have only one monthly payment, and without paying a fee to do so. The interest rate for a DCL is the average interest rate of the two combined loans, but Ned ended up paying the same amount of interest!
Two points for Tanya— but she would be winning by more if she had decided to repay the loan in ten years. That would have meant more interest per month, and possibly hundreds of dollars less of an overall monthly payment, assuming that she has a steady income. One pity point for Ned.
The final score: Tanya 2, Ned 1. Here is the question: should Ned blame himself, or the government?
Conclusion: Who Is To Blame?
Both Ned and the federal government are at fault here, but it was Ned who should have talked to his parents about making smarter financial decisions. He should have downloaded Map the Money Maze. Ned has made a bad example of Millennials: he did not take the opportunity to pay off interest during his grace period, he did not think about the long-term benefits of refinancing rather than consolidating his loans, and finally, he was just not smart because he did not ask the right people the right questions. At least now he can use his philosophy degree to ponder his mistakes!
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