Although a minority of our clients have student debt, those that do not almost always have children or grandchildren planning on attending college. Costs of college attendance have inflated so fast that we discuss it with parents of newborns. We’re seeing a steady increase of borrowers with six figure debt levels, making student debt repayment the most important part of those households’ financial plans. What follows is a primer on the options for a student graduating with debt. Obviously as laws and policies change, this advice may become outdated, but it is up to date as of January 2018.
Federal Loans are Eligible for Income-Driven Repayment Programs and “Forgiveness”
Most student debt we see is federal: Stafford, Perkins, Direct Subsidized/Unsubsidized, and PLUS loans are all government loans that have similar repayment options upon graduation. The default offer is a 10 year payoff calculated like a mortgage: a $100,000 loan at 6% yields monthly payments of $1,110. Because the government realizes many new graduates can’t afford this plan, they offer several income-driven repayment plans (IBR, ICR, PAYE, REPAYE¹).
Graduates using these plans report their income annually and make qualifying payments based on a calculation that involves the poverty line. For example, a single borrower earning $60,000/yr has payments capped at $332/month. At low debt levels, this can smooth payments over a few additional years. However, for six figure debts, interest accumulates and can double the initial debt over a period of twenty years.
If using an income-driven plan, any remaining debt after 20 years is forgiven. However, this forgiveness creates taxable income. This means 20 yr forgiveness is NOT usually a good strategy; it generates a tax bill in year 21 that will put the borrower in a high tax bracket.
Public Service Loan Forgiveness IS a Good Strategy…Today
Public Service Loan Forgiveness² (PSLF) is an income-driven strategy for borrowers that work for a non-profit, including public universities. Any remaining debt is forgiven after 10 years of income-driven payments. Congress made a special exemption for this program and forgiveness is not taxable. This means borrowers could purposefully keep income low (say, by maxing out retirement contributions) and let their loans run up knowing they’ll be forgiven. We’ve run this projection for new doctors, who have low income for several years as residents, and it can result in six-figure savings. However, what Congress gives it can also take away. It is my opinion, once the public hears about doctors being forgiven $500,000 debts tax-free using a program designed for social workers, this program will be killed in a hurry. This program was created in 2007, so the first borrowers only became eligible for forgiveness in the fall of 2017. I expect it will be an increasingly popular reform target. Therefore, I only recommend this program to clients who can afford to make payments and redirect those funds into investments as a type of leverage; I am fearful for those who bank on the strategy as their only plan.
Without a Special Repayment Plan, Look at Refinancing Privately
Income-driven repayment plans are only beneficial for a very narrow range of borrowers. Public Service Loan Forgiveness may be politically risky. If a borrower isn’t utilizing these options, or some other special option like Teacher Loan Forgiveness, they should look to refinance high-interest loans. Federal loans have been as high as 6.8%, while borrowers with good earnings have refinanced below 5%. This option does eliminate the ability to use hardship forbearance if you become unemployed, but it can substantially reduce the lifetime cost of repayment.
Most Borrowers with Six-Figure Debt Need Help
Most borrowers will ultimately have to repay their student debt unless they become insolvent. With the national average debt of roughly $25,000, payments amount to about the same as a car loan. However, borrowers with large debts will have mortgage-sized payments that will severely hinder their economic opportunities. Imagine a 25 year old with a Masters level history degree who wants to start a business; it will be financially impossible.
Three Ways to Help a Child or Grandchild
- Save Early- To send a newborn to a state university, based on the current rate of tuition inflation, would require about $600/month in savings. Any amount a parent/grandparent can save will put the same compound interest that hurts debt-holding graduates to work in their favor.
- Pay Tuition Directly- If you have a graduate with student debt, anything over $15,000 ($30,000 for couples) in 2018 is a taxable gift. However, you can pay tuition directly to the university without limit. If you know they will graduate with a mountain of debt and you will want to help, simply pay the tuition directly while they are in school.
- Educate- Schools are competing for students with dorms that more closely resemble luxury condos that what most baby boomers remember inhabiting. Recruiters focus on these amenities rather than costs or value in terms of enhanced career potential. You’ll need to educate your student on the long-term weight of debt and the benefits of taking on as little student debt as needed. We are happy to help you educate family members and discuss personal college scenarios by request.
- Income Driven Repayment Plans https://studentaid.ed.gov/sa/repay-loans/understand/plans/income-driven
- Public Service Loan Forgiveness https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service