Welcome back to part two of our student debt crisis series. Last time, we discussed the student loan numbers in real-time and how the problem has increased over the years. Today, we are going to shift gears and focus on repayment plans and how to intentionally change the way that families approach student debt both now and in the future.
Let’s dive in.
An Overview of Debt Repayment Options
There are several ways to repay student loans. Building the right plan for your clients depends on the type of loan, the loan balance, and their current financial situation. Let’s take a look at the most common repayment options out there.
The first step is to evaluate the type of loans your clients have. Federal loans and private loans have different repayment models. We still start with the most flexible type of loan: federal.
Repaying Federal Student Loans
There are two general strategies for repaying federal loans:
- Standard repayment
- Income-driven repayment
The standard repayment is spread out into equal monthly payments over 10 years (120 consecutive payments). Those who can afford the standard plan will end up paying less in interest over the life of the loan and pay it off faster than those in an income-driven plan. But with personal debt balances increasing, many of your clients should consider an income-driven repayment option.
The federal government provides four types of income repayment plans, each suited to a different situation.
- Income-based repayment
- This is a 25 year-term and caps monthly payments at either 10% or 15% of income depending on the enrollment date. Monthly payments are calculated by the borrower’s tax filing status. Should their income substantially increase, they may no longer qualify for this method, making it best for those with modest incomes.
- Pay As You Earn (PAYE)
- This plan has a 20-year repayment term and caps monthly payments at 10% of discretionary income. PAYE also limits the interest that can be added to the loan (10%). Those making a consistent lower salary should consider this option.
- Revised Pay As You Earn (REPAYE)
- Both the repayment terms and monthly payments remain the same as PAYE, but the revised pay as you earn is unique in its interest subsidy. Under this plan, a portion of interest can be forgiven—a huge benefit as interest over the life of the loan would be substantial. REPAYE is best for those making a lower salary and file their taxes as single. If you’re married, REPAYE considers your spouse’s income when determining monthly payments whether you file separately or jointly.
- Income-contingent repayment (ICR)
- The most expensive of the plans, ICR caps payments at 20% of discretionary income and has a 25-year term. This is the only income-driven repayment plan that accommodates Parent Plus loans.
Generally, people enroll in the repayment plan that offers the lowest monthly payments. It’s important to consider your client’s current and projected income, tax filing status, loan balance, interest rate, and more when selecting the right plan.
For income repayment plans, any remaining loan balance is forgiven after the repayment term. Keep in mind that the amount forgiven counts as ordinary income, which could present severe tax consequences. Plan ahead for this “tax-bomb” so it doesn’t surprise your clients come April.
A Note On Parent Plus Loans
Remember, Parent Plus Loans do qualify for the income-contingent repayment plan, but before PPLs play a central role in your client’s education funding plan consider how the debt will impact their future.
- Will they still be able to retire on time?
- Do they have to adopt any major lifestyle changes?
- Can they afford the payment?
- How will it impact their credit score and will that stand in the way of purchasing a new retirement home, etc.?
- Are they prepared for the “tax bomb” when the balance is forgiven?
Asking these questions beforehand will help you and your clients build a solution that works both now and in the future.
Evaluate Forgiveness Options and Eligibility
What about loan forgiveness? While there are several programs available, the Public Service Loan Forgiveness (PSLF) program is the most popular forgiveness vehicle. To qualify, the following must be true:
- Full-time employment by a U.S federal, state, local, or tribal government or a not-for-profit organization.
- Have Direct Loans
- Repay loans under a standard or income-driven repayment plan
- Make 120 consecutive, qualifying payments
With PSLF, any remaining loan balance is forgiven tax-free.
Research different loan forgiveness programs to see if it fits with your client’s plan. Alongside income-driven repayment plans and PSLF, the federal government offers loan forgiveness options to teachers, military personnel, AmeriCorps, and more. Taking advantage of these options could greatly benefit your client’s finances over the long term.
Repaying Private Student Loans
Private student loans don’t qualify for income-driven repayment options, and monthly payments are set by the lender. Should the payments be widely out of reach, consider consolidating and refinancing options. Refinancing for a lower interest rate can save thousands of dollars over the life of the loan, so take advantage of presently low-interest rates.
Can Borrowers Expect More Federal Intervention in Loan Forgiveness?
Student loan forgiveness proposals have been on the political stage for years and find themselves, once again, in the spotlight. An important CARES Act provision sent federal student loans into forbearance, meaning all payments and interest were suspended since March 2020.
The current administration extended the benefit to January 31, 2021, after which time, the burden will fall to the Biden administration, who has already announced their ideas about the student loan situation. Let’s look at some of the key student loan provisions Biden seeks to bring to the table. Keep in mind that these ideas must be approved by Congress, taking time to shape if they even occur at all.
- Up to $10,000 canceled per borrower
- Monthly payments capped at 5% for income-driven repayment plans
- Automatic enrollment in forgiveness and income-based plans
There is a lot of buzz around canceling up to $10,000 of student loans because it would mean that nearly 15 million borrowers would see their balance drop to $0. Under this plan, student debt doesn’t disappear completely, but it would add a meaningful cushion. If you remember from part 1, the average debt per person is about $37,000, so having $10,000 shaved off of that bill could significantly decrease the amount of time it would take to pay the loans off.
Remember, this is an evolving situation, one that will likely take time to change. It’s important to stay up to date with current policies, but it’s always best to first build a plan you and your clients can rely on. While several proposals exist, none create a fail-safe plan for families.
Does Student Debt Impact The Economy?
The short answer: yes. Let’s take a closer look at the role student loan debt plays in the U.S economy.
The rising cost of college
It comes as no surprise that college costs have skyrocketed over the years, and it’s only trending higher. College costs have inflated by 25% from 2009-2019 with several researchers predicting that number to increase.
Northwestern Mutual predicts that prices will continue to rise by at least 5% over the next 10 to 15 years, making a degree in 2025 roughly $112,000 for public schools and $254,593 for private schools. This estimate assumes a 4-year graduation rate, which is rare as many students take an average of 6 years to earn a bachelor’s degree.
Saving for college estimates that 4-year tuition in 2033 will be $94,800 for public in-state students and $323,900 for private schools. This study doesn’t include other spending factors like room and board, supplies, books, transportation, and more.
With college costs not slowing down, it puts a significant amount of pressure on students, families, and even the economy at large.
To cancel or not to cancel student debt
92% of student debt is backed by the U.S government, making student loans a national economic issue. There has been much talk over the years about canceling or reducing student debt, and there are merits on both sides of the coin.
Canceling debt could boost the gross domestic product by $86 billion to $108 billion per year according to the Levy Economics Institute. It could also spark economic activity, leading to more homeownership and small businesses.
It’s important to consider the flip side. The government receives a lot of money from student debt and proper measures would need to be taken to offset the government’s loss of revenue from canceling student debt outright.
Moody’s Investor Service predicts that while canceling student debt would incite massive economic stimulus, it could also boost the national deficit up to 6.9% by 2029 an increase from the current forecast of 6.3%.
Lack of economic stimulation
Outside the discussion of canceling or forgiving debt, those with massive student loans won’t be able to infuse as much money into the economy as generations past. Saddled by monthly payments and finding a good enough job to pay the bills doesn’t leave much room for discretionary spending, which will affect the economy over the long run.
Time and time again we hear that hefty student loans stand in the way of homeownership due to mortgage lender’s fear of a debt-to-income ratio, inability to save for a downpayment, and floundering credit scores. The Federal Reserve estimated that for every 10% of student loan debt, the chance of homeownership decreases by 1-2% during the first five years after school.
Homeownership isn’t the only area to suffer. A paper by Penn State Professor Brent Ambrose and Federal Reserve Larry Cordell and Shuwei Ma, The Impact of Student Loan Debt on Small Business Formation found that the increase of student debt reduced small business creation by 14% from 2000-2010.
The burden of student loan debt doesn’t just impact those at the start of their careers, a growing number of people carry student loan payments well into their 60s and beyond. Experian noted that the average student loan balance for consumers in their 60s sat at $33,804. That number only falls slightly to $28,757 for those in their 70s and $22,879 for consumers in their 80s. These startling numbers reveal that student debt can linger well into retirement.
Hope for the future
Student debt can be crippling, and future generations who are looking at $50-150k in debt for a bachelor’s degree won’t be able to effectively save for retirement, buy a home, and stimulate the economy as past generations have.
Advisors can be part of the solution by helping families choose affordable college options for their kids, and select funding wisely. It’s up to advisors and families to work together to change the way that we as a nation approach college planning.
Our goal at CAP is to empower advisors to help their clients reclaim control over the college planning process. Learn more about your role in ending the student debt crisis today!