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Student loans

3 Basic but Crucial Things to Know About Student Loans

As an eager but clueless student accepted to New York University about a decade ago, I signed away my financial future to the entities that lent me the money to attend. I had no clue how student loans worked, and N.Y.U.’s meager attempts to explain didn’t help much, so I just figured I’d worry about all that stuff later.

Of course, that “later” has come for me and most of my peers: About seven out of 10 college graduates have student debt, averaging around $30,000. I, like many others, dutifully but mindlessly make my monthly payments, mostly resigned to being in debt forever.

But robotically making monthly payments doesn’t have to be the whole story. I’m not ashamed to admit I don’t know much about money, but my pal Ron Lieber — The Times’s personal finance columnist — sure does.

Here are three lessons I’ve learned from Ron on how to be more strategic about student loans.

Do you know how your interest and payments work?

Let’s start at the beginning with principal and compound interest.

When you make a student loan payment, your money is applied first to the interest and then to the principal, which is the original amount you borrowed. If your payment is late, however, your money is applied first to your late fee.

As your principal shrinks, so too does the interest you pay, since you’re charged interest only on the remaining balance. This means that over time, the proportion of your payments that goes to your principal will gradually become larger. This is a good thing.

Should you increase your monthly payments so you can be debt-free sooner?

Maybe, but in most cases, probably not.

The most important thing to consider is whether, in the (very) long term, you’ll make more money by ridding yourself of student debt early or by putting that extra payment money into a retirement savings plan.

There are many variables that go into making this decision, but in nearly all cases, the smarter move is to put that extra money into a retirement savings account before putting it toward student loans — especially if you have an employer that will match retirement savings contributions. You can cheat yourself out of hundreds of thousands of dollars by forgoing retirement savings early on.

What is refinancing? Is it worth it?

Let’s say you, like me, have five student loans with five different interest rates. If you refinance your loans, those five loans would be combined into a single loan that would have a single interest rate.

This can be a smart move if you can get a lower interest rate, which may be possible if you have a great credit score. However, that new rate might be variable and could potentially increase over time. (Your current student loans are most likely fixed, meaning the rate doesn’t change.) And, keep in mind, the larger the debt, the more important it is to have the lowest rate possible.

Perhaps an even bigger issue to keep in mind if you’re thinking about refinancing is that you might lose access to benefits you get from having federal loans, such as the ability to make payments based on income (which caps your payments at a certain percentage of your income), loan forgiveness, death and disability discharges, and longer deferment and forbearance options.

Generally, if you’re doing O.K. with your loans and your interest rate isn’t outrageous — say, 8 percent or below — you don’t have to worry much about refinancing. But if you have a rate much higher than that, you might want to reach out to a professional to get advice on refinancing.

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