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Student Loans: What Relief Is Out There? (Part III)

| March 30, 2018

In Part 1, we detailed several options for students to pay for their college education, including both governmental loans as well as private lenders. In Part 2, we explained some of the debt consolidation techniques out in the marketplace. In Part 3 below, we explain some of the student debt strategies you should implement in order to get out of debt in the most efficient way possible.

This May Be Obvious, But…

The following strategies may seem rather conspicuous, but by not following these strategies, borrowers are burning a hole through their pocket. Many post-grads begin with the bare minimum with payments, and in doing so, are making very little dent in their student loan balances. Over time, you might even find you’ll be paying as much interest on your loans as the original principal amount. Putting a short fuse on the debt bomb will inspire a significant financial turnaround, and while it may put some financial strain early on, it will pay huge dividends later in life. Putting yourself on a strict budget is the key to success; instead of splurging on high rent and Starbucks Lattes, consider (gulp) living at your parent’s home for a year and making your own coffee. The more of your disposable income you can throw at your debt, the better off you will be in retirement; simple compounding of savings early in life can have a profound impact. The key is to make a strict cash budget and not veering off the path.

It is not simply a matter of aggressively paying down the debt, it is also determining the best loan to pay down. First, it is important to pay the minimums on all of your student debt. The biggest mistake you can make is to not make the minimum payment, ruin your credit and have creditors after you, especially when one of those creditors is Uncle Sam. Second, you should chart out a spreadsheet of all of your loan balances and interest rates, and aggressively pay down the loan with the highest interest rate while also paying the minimum balances on your other loans. The less you pay in interest, the better.

Federal Programs

There are several governmental programs that individuals can take advantage of. The issue is, many people are not even aware of them. Not only that, but as you will see, the programs are quite confusing. There are dozens of governmental programs, but we have narrowed them down to the most popular options. We have tried to simplify each of the following programs as much as possible:

  • Income Based Repayment
  • Pay As You Earn
  • Public Service Loan Forgiveness

Income Based Repayment (IBR)

This is a program to help individuals with high debt/low income. This program applies to Direct subsidized and unsubsidized loans, PLUS loans made to students, direct consolidation loans with no parental PLUS loans involved, Stafford loans and FFEL loans and consolidation loans (as long as they weren’t made to parents). If your monthly payment through this program does not cover interest, the government will help pay your interest on qualifying loans for up to 3 years (after which interest will begin to accrue). Income-based repayment caps monthly payments at 15% of your monthly discretionary income (10% for new borrowers) up to the fixed 10 year standard repayment amount Discretionary income is calculated based on the difference between adjusted gross income (AGI) and 150% of the federal poverty line that corresponds to your family size and the state in which you reside. This essentially means it would take more than 15% of whatever you earn above 150% of poverty level to pay off your loans on a standard 10-year payment plan. If you are able to calculate this yourself, more power to you – but there is a nifty calculator that calculates your monthly payments under each govermental program for you.The repayment period is 25 years (unless you are a new borrower, where the repayment period is 20 years), and your loans are forgiven if you still have a balance at the end of the repayment period. A nice rule of thumb is that if your total debt exceeds your annual salary, then you may benefit from IBR or the Pay As You Earn program noted below.

However, there are a few drawbacks to this program. First, as can be seen, it is hard to qualify – you need to have a very low amount of income. You also need to submit annual documentation in order to determine your monthly payment, which may change year to year. If your loans are in fact forgiven after 20 or 25 years, such loan forgiveness is considered income and fully taxable to you. Also, interest is capitalized until you do not qualify for this program, and you may pay more in interest over the long haul, especially if your income is expected to rise significantly year over year. In that case, it may make sense to avoid this program, as this program could potentially leave the borrower after several years of repayment owing a larger debt than they started with. However, if you are in need of some breathing room and have lower income that will most likely remain stagnant, this program is a great way to lower your monthly payments and perhaps forgive a great portion of your debt.

Pay As You Earn (PAYE)

This program, unveiled by Obama in 2012, is essentially the IBR plan above on steroids. Stafford and Direct Plus Loans, as well as consolidated federal loans (except Parent Plus Loans) qualify (but NOT FFEL loans). While plan is very similar to IBR in terms of qualification, however, monthly payment caps are at 10% of discretionary income as opposed to 15% under IBR under the 10 year standard repayment plan, and your loan is forgiven after 20 years as opposed to 25 years under IBR (thus, if you are an older borrower and would be at 15% under IBR, this plan seems like it would be a better option if you qualify, but REPAYE is also available). Another nice benefit of this program is that the amount of capitalized interest is capped at 10% of the original debt – this benefit does not exist under IBR.

Revised Pay As You Earn (REPAYE)

This 2015 plan allows all Direct Loan student borrowers (though not Parent Plus borrowers) to cap their monthly payments at 10% of their discretionary income, regardless of when they borrowed. Borrowers of Direct loans will have any outstanding balance forgiven after 20 years of repayment, and borrowers with eligible Direct loan debt received for any graduate or professional education will have their balance forgiven after 25 years (which may make PAYE a better option for these borrowers). One of the key advantages of this program is that it offers more protections against snowballing interest: under REPAYE, borrowers whose payments are insufficient to cover the interest accrued during the month will only be charged for up to 50% of the unpaid interest, and interest is not capitalized if the borrower no longer has a partial financial hardship. Borrowers who would face negative amortization (i.e., those whose payments are not enough to pay off their monthly accrued interest) can thus save on interest under REPAYE.

There are some key drawbacks. Unlike PAYE/IBR, however, a spouse’s income is included in the calculation of discretionary income. Additionally, REPAYE does not cap monthly payments at the “standard” repayment amount, as under PAYE and IBR—so as borrowers’ income rises some may face higher monthly payments under REPAYE than PAYE

Public Service Loan Forgiveness (PSLF)

This program is an extension of each of the programs noted above, but offers better benefits. First, in order to qualify, you must work in “public service,” thus Jobs in a public office (Federal, State or Local) or a non-profit organization as defined by the IRS qualify for PSLF. Subsidized and Unsubsidized Stafford Loans, PLUS Loans and Federal Direct Consolidation Loans qualify for PSLF. If you make 120 on time, full, scheduled monthly payments (10 years of payments), and you are a part of one of the many repayment plans, your remaining loan balance may be forgiven. This is, without a doubt, the best way to go, especially if you meet the stringent requirements of this program.

Avoid Forbearance

Many graduates who carry high levels of debt and experience tight liquidity during their residency, internship, job search or first year of employment may rely on forbearance to postpone their student loan payments. Many borrowers believe forbearance is the only viable option to delay payments once their grace period ends. However, borrowers must recognize that while forbearance does suspend payments, it can be a costly option because loans continue to accrue interest. For example, a graduate with $165,000 in debt at today’s rates accrues close to $1,000 a month in interest during the forbearance period, all of which will be capitalized or added to the total loan balance to be repaid. This is delaying the evitable, and is a sure-fire way to pile up loads of debt.

Will Your Parents Help?

Unlike a bank or the federal government, your parents love you, and are not trying to make money off of your misfortune. While this may be a last ditch effort, your parents may feel better about helping you pay your loans so you are not bleeding interest to non-family members (the government/private lenders). While we are not completely sold on having your parents borrow to pay off your loans, if they have the excess cash flow, you may want to ask; it is well worth a discussion – you should not let your pride get in the way of a very important financial decision.  

How About My Employer?

If you work in a field that requires a specialized degree (health care especially), you could search for an employer offering to pay off student loans as part of the package, or ask your employer to put money toward your loan in exchange for paying you a lower salary. Employers are willing to do this because over the long run it costs them less in salary payments. But you must show you are committed to staying in your job for some time in order to prove it is worth their while – it’s sort of like a signing bonus. If you are a new grad and interviewing at a small company that can’t give you a high salary, bring this up during salary negotiations. If you are already an employee, talk to HR about the possibility in your next review, confirming that you’re committed to the company. It never hurts to ask.

Run Your Ideas By Us!

Navigating the ins and outs of repaying your loans can be cumbersome and difficult. We are here to help, so if you would like to discuss any of these strategies, please reach out to us. Good luck!

Karen DeRose and Anthony DeRose are registered representatives of Lincoln Financial Advisors Corp.

Securities offered through Lincoln Financial Advisors Corp a broker/dealer (Member SIPC) and a registered investment advisor. DeRose Financial Planning Group is not an affiliate of Lincoln Financial Advisors Corp. Lincoln Financial Advisors does not provide legal or tax advice.

*Licensed but not practicing on behalf of Lincoln Financial Advisors.