Student Loan Overload

Two years after graduating, Dufresne, now 24 years old, finds himself in a much different situation. His job as an electronics store manager in Lowell, Mass., pays $24,000 a year, while his student loan balances have exceeded $50,000. More than $40,000 of that is in two private student loans, which carry variable interest rates that over the past two years have increased to 8.5% and 13.7%.

As a result, what started as a total bill of $299 a month in 2004 is now a hard-to-handle $436. Between rent, car payments and basic expenses, Dufresne is grateful that his roommate picks up the electricity and cable bill whenever he can.

"I imagined that [my loan payments] would just be something else added to my monthly bills but did not imagine it to explode over time," he says. "Each month it's up in the air what I should pay first and whether I'll have enough money to pay everything."

As interest rates have increased substantially over the past two years, many recent graduates are finding themselves in a similar situation. While they have been able to consolidate their federal loans and lock down low rates, that isn't an option with private loans.

The interest rates on private loans — even if consolidated — are variable and can increase indefinitely, explains Mark Kantrowitz, publisher of FinAid.org, an online financial aid resource. Typically, the interest rates are pegged to the prime rate or the LIBOR and are determined by each lender based on the borrower's credit score and other factors, including the college they attended. (For more on this, read our primer on private education loans.)

Granted, private loans are still a relatively small chunk of the total dollars borrowed for school. But the volume of private loans is growing at a fast pace: 18% of all educational loans in the 2004-05 academic year were private, compared with 10% in 2000-01, according to the College Board.

Needless to say, the worst thing you can do if your student loan payments become overwhelming is ignore them. "Call your lender right away and tell them you've got problems," says Gary Carpenter, executive director of the National Institute of Certified College Planners (NICCP). "The lenders are pretty open to it." After all, it's in your lender's best interest that you continue paying off your debt, Carpenter adds, rather than have to collect it through a collections agency if you defaulted.

Here's what you can do to lighten your load:

1. Change your repayment plan
Private student loans aren't as flexible as their federally-guaranteed cousins when it comes to repayment options, Kantrowitz says. Still, it doesn't hurt to ask how they can help lower your payments. A common solution is extending the loan term, so you pay off the loan over 20 or even 30 years instead 10 or 15. Just keep in mind that while your monthly payments will go down, the total amount you'll fork over to the lender in interest will increase. Some lenders may also offer a repayment plan that allows interest-only payments for a fixed period of time.

In the meantime, if you have federal loans, your options are more varied. One is an income-sensitive schedule where payments are a percentage of your monthly income; another is a graduated repayment schedule, where payments start out low and gradually increase over the following years. You are also entitled to get an economic hardship deferral on your federal loan if you meat certain criteria. Click here for a calculator that will help find out if you qualify.

While private loan payments cannot be deferred, most lenders offer a similar solution called forbearance. It allows you to stop making payments for a fixed period of time, typically six months. The requirements vary from lender to lender, but you usually need to prove you have difficulty making your payments, Kantrowitz explains. The drawback: While you're taking a break from payments, the interest on the loan will continue to accrue.

2. Refinance
Private loans can't be consolidated the way you consolidate Federal Stafford and PLUS loans, namely locking in a fixed rate for the life of the loan. Instead, you simply combine two or more private loans in one for the convenience of one payment, while the interest rate remains variable and can change monthly or quarterly.

The best part: You don't have to consolidate with your original lender, Kantrowitz says. "Consolidation is like a refinance: One lender pays the loan off and issues a new loan." These loans don't carry prepayment penalties, so nothing prevents you from shopping around.

Currently, about a dozen lenders offer consolidation loans, and the terms can vary significantly. Be sure to compare consolidation fees, the loan's terms, as well as any repayment incentives like lowering your rate if you make a number of consecutive payments on time. "Make sure you're not jumping out of the frying pan and into the frier," Carpenter says. For an updated list of private consolidation loan, go to FinAid.org.

3. Consider a home equity loan
If you or your parents own a home that has appreciated in value over the past few years, some of that equity could be used to pay off the loans. We're talking about taking out a home equity loan, or HEL. (For the basics on HELs, click here.) You won't get much of a break in interest rates. These days, the average $30,000 home equity loan is 8.03%, according to Bankrate.com. But since those rates are fixed, you are locking down a rate for the life of the loan.

The drawbacks: Should interest rates fall in the future, your payment with a regular private student loan will also go down. Not so with a HEL. In addition to that, if the term of the HEL is shorter than the term of your student loans, your monthly payments may not decrease. (To figure out your monthly payment with a consolidation loan, use our calculator.)

Finally, borrowing against the equity of your house in the midst of a housing slowdown may not be a great idea. If prices decline in the near future and you have to sell, you'd owe the bank more money than your home is worth.