Navigating Student Loan Repayment Programs

I had the fortunate / unfortunate experience of attending a seminar on the various repayment programs available to young professionals and the parents of these young professionals with student loan debt.  I can summarize it in three words: “What a mess!!”    As a financial planner, we are seeing firsthand the impact of the mounting student loan debt epidemic.  Only a few years ago, we would have a handful of young professional reach out to us throughout the year looking for guidance on the best strategy for managing their student loan debt.  Within the last year we are now having these conversations on a weekly basis with not only young professionals but the parents of those young professional that have taken on debt to help their kids through college.   It would lead us to believe that we may be getting close to a tipping point with the mounting student loan debt in the U.S.

While you may not have student loans yourself, my guess is over next few years you will have a friend, child, nephew, niece, employee, or co-working that comes to you looking for guidance as to how to manage their student loan debt.  Why you?  Because there are so many repayment programs that have surfaced over the past 10 years and there is very little guidance out there as to how to qualify for those programs, how the programs work, and whether or not it’s a good financial move.  So individuals struggling with student loan debt will be looking for guidance from people that have been down this road before.  This article is not meant to make you an expert on these programs but is rather meant to provide you with an understanding of the various options that are available to individuals seeking help with managing the student loan debt.

Student Loan Delinquency Rate: 25%

While the $1.5 Trillion dollars in outstanding student loan debt is a big enough issue by itself, the more alarming issue is the rapid rise in the number of loans that are either in delinquency or default. That statistic is 25%.  So 1 in every 4 outstanding student loans is either behind in payments or is in default.   Even more interesting is we are seeing a concentration of delinquencies in certain states. See the chart below: 

Repayment Program Options

Congress in an effort to assist individuals with the repayment of their student loan debt has come out with a long list of repayment programs over the past 10 years.  Upfront disclosure, navigating all of the different programs is a nightmare.   There is a long list of questions that come up like:

Does a “balanced based” or “income based” repayment plan make the most sense?

What type of loan do you have now?

It is a federal or private loan?

When did you take the loan?

Who do you currently work for?

What is current interest rate on your loan?

What is your income?

Are you married?

Because it’s such an ugly process navigating through these programs and more and more borrowers are having trouble managing their student loan debt, specialists are starting to emerge that know these programs and can help individuals to identify which programs is right for them.  Student loan debt management has become its own animal within the financial planning industry.

Understanding The Grace Period

Before we jump into the programs, I want to address a situation that we see a lot of young professional getting caught in.   Most students are aware of the 6 month grace period associated with student loan payment plans.  The grace period is the 6 month period following graduation from college that no student loan payments are due.  It gives graduates an opportunity to find a job before their student loan payments begin.  What many borrowers do not realize is the “grace period’ is a one-time benefit.  Meaning if you graduate with a 4 year degree, use your grace period, but then decide to go back  for a master degree, you can often times put your federal student loans in a “deferred status” while you are obtaining your master degree but as soon as you graduate, there is no 6 month grace period.  Those student loan payments begin the day after you graduate because you already used your 6 month grace period after your undergraduate degree.  This can put students behind the eight ball right out of the gates. 

What Type Of Loan Do You Have?

The first step is you have to determine what type of student loan you have.  There are two categories:  Federal and Private.  The federal loans are student loans either issued or guaranteed by the federal government and they come in three flavors:  Direct, FFEL, and Perkins.  Private loans are student loans issued by private institutions such as a bank or a credit union.

If you are not sure what type of student loan you have you should visit www.nslds.ed.gov.   If you have any type of federal loan it will be listed on that website. You will need to establish a login and it requires a FSA ID which is different than your Federal PIN.  If your student loan is not listed on that website, then it’s a private loan and it should be listed on your credit report.

In general, if you have a private loan, you have very few repayment options.  If you have federal loans, there are a number of options available to you for repayment.

Parties To The Loan

There are four main parties involved with student loans: 

• The Lender

• The Guarantor

• The Servicer

• The Collection Agency

The lender is the entity that originates the loan.  If you have a “direct loan”, the lender is the Department of Education.  If you have FFEL loan, the lender is a commercial bank but the federal government serves as the “Guarantor”, essentially guaranteeing that financial institutions that the loan will be repaid.

Most individuals with student loan debt or Plus loans will probably be more familiar with the name of the loan “Servicer”.  The loan servicer is a contractor to the bank or federal government, and their job is to handle the day-to-day operations of the loan.  The names of these servicer’s include: Navient, Nelnet, Great Lakes, AES, MOHELA, HESC, OSLA, and a few others.

A collection agency is a third party vendor that is hired to track down payments for loans that are in default.

Balance-Based Repayment Plans

These programs are your traditional loan repayment programs.  If you have a federal student loan, after graduate, your loan will need to be repaid over one of the following time periods: 10 years, 25 years, or 30 years with limitations.  The payment can either be structure as a fixed dollar amount that does not change for the life of the loan or a “graduated payment plan” in which the payments are lower at the beginning and gradually get larger.

While it may be tempting to select the “graduated payment plan” because it gives you more breathing room early on in your career, we often caution students against this.  A lot can happened during your working career.  What happens when 10 years from now you get unexpectedly laid off and are out of work for a period of time?  Those graduated loan payments may be very high at that point making your financial hardship even more difficult.

Private loan may not offer a graduated payment option.  Since private student loans are not regulated by any government agency they get to set all of the terms and conditions of the loans that they offer.

From all of the information that we have absorbed, if you can afford to enroll in a balanced based repayment plan, that is usually the most advantageous option from the standpoint of paying the least interest during the duration of the loan.

Income-Driven Repayment Program

All of the other loan repayment programs fall underneath the “income based payment” category, where your income level determines the amount of your monthly student loan payment within a given year.   To qualify for the income based plans, your student loans have to be federal loans.  Private loans do not have access to these programs.   Many of these programs have a “loan forgiveness” element baked into the program.  Meaning, if you make a specified number of payments or payments for a specified number of years, any remaining balance on the student loan is wiped out.   For individuals that are struggling with their student loan payments, these programs can offer more affordable options even for larger student loan balances.  Also, the income based payment plans are typically a better long-term solution than “deferments” or “forbearance”.

Here is the list of Income-Driven Repayment Programs:

• Income-Contingent Repayment (ICR)

• Income-Based Repayment (IBR)

• Pay-As-You-Earn (PAYE)

• Revised Pay-As-You-Earn (REPAYE)

Each of these programs has a different income formula and a different set of prerequisites for the type of loans that qualify for each program but I will do a quick highlight of each program.  If you think there is a program that may fit your circumstances I encourage you to visit https://studentaid.ed.gov/sa/

We have found that borrowers have to do a lot of their own homework when it comes to determining the right program for their personal financial situation.  The loan servicers, which you would hope have the information to steer you in the right direction, up until now, have not been the best resource for individuals with student loan debt or parent plus loans.  Hence, the rise in the number of specialists in the private sector now serving as fee based consultants.

Income-Contingent Repayment (ICR)

This program is for Direct Loans only.  The formula is based on 20% of an individual’s “discretionary income” which is the difference between AGI and 100% of federal poverty level.  For a single person household, the 2018 federal poverty level is $12,140 and it changes each year.  The formula will result in a required monthly payment based on this data.  Once approved you have to renew this program every 12 months. Part of the renewal process in providing your most up to date income data which could change the loan payment amount for the next year of the loan repayment.  After a 25-years repayment term, the remaining balance is forgiven but depending on the tax law at the time of forgiveness, the forgiven amount may be taxable.   The ICR program is typically the least favorable of the four options because the income formula usually results in the largest monthly payment.

However, this program is one of the few programs that allows Parent PLUS borrowers but they must first consolidate their federal loans via the federal loan consolidation program.

Income-Based Repayment (IBR)

This program is typically more favorable than the ICR program because a lower amount of income is counted toward the required payment.  Both Direct and FFEL loans are allowed but Parent Plus Loans are not.   The formula takes into account 15% of “discretionary income” which is the difference between AGI and 150% of the federal poverty level.  If married it does look at your joint income unless you file separately.   Like the ICR program, the loan is forgiven after 25 years and the forgiveness amount may be taxable income. 

Pay-As-You-Earn (PAYE)

This plan is typically the most favorable plan for those that qualify.  This program is for Direct Loans only. The formula only takes into account 10% of AGI.  The forgiveness period is shortened to 20 years.  The one drawback is this program is limited to “newer borrowers”.  To qualify you cannot have had a federal outstanding loan as of October 1, 2007 and it’s only available for federal student loans issued after October 1, 2011.  Joint income is takes into account for married borrowers unless you file taxes separately. 

Revised Pay-As-You-Earn (REPAYE)

Same as PAYE but it eliminates the “new borrower” restriction.  The formula takes into account 10% of AGI.  The only difference is for married borrowers, it takes into account joint income regardless of how you file your taxes. So filing separately does not help.   The 20 year forgiveness is the same at PAYE but there is a 25 year forgiveness if the borrow took out ay graduate loans. 

Loan Forgiveness Programs

There are programs that are designed specifically for forgive the remaining balance of the loan after a specific number of payment or number of years based on a set criteria which qualifies an individual for these programs.  Individuals have to be very careful with “loan forgiveness programs”.  While it seems like a homerun having your student loan debt erase, when these individuals go to file their taxes they may find out that the loan forgiveness amount is considered taxable income in the tax year that the loan is forgiven. With this unexpected tax hit, the celebration can be short lived. But not all of the loan forgiveness programs trigger taxation.   Here are the three loan forgiveness programs: 

• Public Service Loan Forgiveness

• Teacher Loan Forgiveness

• Perkins Loan Forgiveness

Following the same format as above, I will provide you with a quick summary on each of these loan forgiveness programs with links to more information on each one. 

Public Service Loan Forgiveness

This program is only for Direct Loans. To qualify for this loan forgiveness program, you must be a full-time employee for a “public service employer”. This could be a government agency, municipality, hospital, school, or even a 501(C)(3) not-for-profit. You must be enrolled in one of the federal repayment plans either balanced-based or income driven. Once you have made 120 payments AFTER October 1, 2007, the remaining balance is forgiven. Also the 120 payments do not have to be consecutive. The good news with this program is the forgiven amount is not taxable income. To enroll in the plan you have to submit the Public Service Loan Forgiveness Employment Certification Form to US Department of Education. See this link for more info: https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service

Teacher Loan Forgiveness

This program is for Federal Stafford loans issued after 1998.  You have to teach full-time for five consecutive years in a “low-income” school or educational services agency to qualify for this program.  The loan forgiveness amount is capped at either $5,000 or $17,000 based on the subject area that you teach.   https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/teacher#how-much

As special note, even though teachers may also be considered “Public Service” employees, you cannot make progress toward the Teacher Loan Forgiveness Program and the Public Service Loan Forgiveness Program at the same time.

To apply for this program, you must submit the Teacher Loan Forgiveness Application to your loan servicer.

Perkins Loan Forgiveness

As the name suggests, this program is only available for Federal Perkins Loans. Also, it’s only available to certain specific full-time professions. You can find the list by clicking on this link:  https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/perkins

The Perkins forgiveness program can provide up to 100% forgiveness in 5 years with NO PAYMENTS REQUIRED.  To apply for this program you have complete an application through the school, if they are the lender, or your loan servicer.

Be Careful Consolidating Student Loans

Young professionals have to be very careful when consolidating student loan debt.  One of the biggest mistakes that we see borrows without the proper due diligence consolidate their federal student loans with a private institution to take advantage of a lower interest rate.   Is some cases it may be the right move but as soon as this happen you are shut out of any options that would have been available to you if you still had federal student loans.  Before you go from a federal loan to a private loan, make sure you properly weigh all of your options.

If you already have private loans and you want to consolidate the loans with a different lender to lower interest rate or obtain more favorable repayment term, there is typically less hazard in doing so.

You are allowed to consolidate federal loans within the federal system but it does not save you any interest. They simply take the weighted average of all the current interest rate on your federal loans to reach the interest rate on your new consolidated federal student loan.

Defaulting On A Student Loan

Defaulting on any type of loan is less than ideal but student loans are a little worse than most loans.  Even if you claim bankruptcy, there are very few cases where student loan debt gets discharged in a bankruptcy filing. For private loans, not only does it damage your credit rating but the lender can sue you in state court. Federal loans are not any better.  Defaulting on a federal loan will damage your credit score but the federal government can go one step further than private lenders to collect the unpaid debt. They have the power to garnish your wages if you default on a federal loan. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.