The ABC’s of Student Loan Planning

The phrase Student Loan Debt likely inspires dread in the minds of many struggling to repay years-old loans for an education that may or may not have been worth the cost.  While many view student loans and the mounting debt crisis with disdain, student loans have funded the education of millions in the past decades.  Since the '80s, college tuition inflation has outpaced both actual inflation and salary escalation, leading to increased borrowing to fund educational goals.  This led to the ballooning of student loan debt and the student debt crisis I’m sure you’re sick of living through.

When borrowers find themselves behind on their loan payments, it’s most commonly due to a lack of planning. Often, students take out large loans relative to their projected or actual income and fail to plan to pay them back effectively, or they don’t have an accurate picture of college costs versus future income and misjudge their ability to repay any outstanding loan balances. – Transition – Let’s look at actionable steps you can take to avoid being too indebted proactively.

Pre-College:

Before enrolling in a four-year degree program, we have the most opportunity to proactively plan to fund you or your child’s college education.  We previously held an education funding webinar on the topic, and I will link it here.  Some key takeaways include:

·         Fund for educational goals utilizing 529 accounts or prepaid tuition accounts.

·         Utilize scholarships.

· Research the schools you want to attend versus their degree offerings and starting salary numbers.

Today, our focus is on student loans, whether there is any funding need at the time of enrollment, and strategies and methodologies for efficiently filling this need.

Before agreeing to take out significant student loan debt at 17 or 18, we urge prospective borrowers to research their potential career paths and majors they will be studying for at college. Look into jobs you think you will enjoy and consider the average starting salaries and the salary escalation in these professions.  You must balance the trade-off between student loans and salary; it doesn’t make sense to take out a large student loan balance to chase a low-paying career.  We suggest researching college degrees, costs, and their starting salaries, which are linked as a few resources.

Another important consideration is the role of private versus public colleges and in-state versus out-of-state schools.  While there are exceptions: public colleges tend to be less expensive than private colleges, and in-state is cheaper than out-of-state. 

For example, tuition at Virginia Tech was $12,000 a year or $6,000 a semester for an in-state student, and the median earnings for a general business degree are $55,000, with roughly a 7-10% raise for your first few years.  Not such a bad gig. 

However, a private university (Washington and Lee) just 90 minutes away charges nearly $30,000 a semester or $60,000 a year.  The same business degree and entry-level business job would be difficult to justify if you needed to utilize loans to fund your education.  However, if you were to start in a higher-paying field, say law or computer science, W&L may make more sense.

While we don’t want to shut the door on anyone's dream school, major, and career, we do want borrowers to be pragmatic about what they can afford and make the best decision for them so that they will not end up with a mountain of student loan debt and insufficient income to pay it off.

Another point we want to stress is that college is not right for everyone coming directly out of high school.  There are many alternate paths either to or around a traditional four-year university, including:

·         Gap Year: Living at home and working can allow students to earn some money and save a big chunk of it to help fund their college education.  Also, students report learning more while at college because they appreciate the material more after working in the “real world.”

· Military: Some students find themselves wanting to serve their country while learning skills, getting paid to serve, and receiving free college tuition paid for by the GI Bill.

·         Trade School: We are increasingly seeing students opt out of traditional four-year degree programs, attend trade schools for a fraction of the time and cost, and move into the workforce younger and often at higher salaries than college students.

·         Community College to a 4-year Degree: As college costs have skyrocketed many are choosing to attend their local community college for two years before enrolling at a traditional four-year college.  This saves money and allows students to work and live at home while getting the same college degree.

Now that you’ve gotten accepted into your dream school the nightmare bill shows up at your front door and you realize you may have to take out loans to get there, what next?  First, fill out your FAFSA.  This is the Free Application for Federal Student Aid; your FAFSA will determine how much your family is expected to be able to contribute to your education and what aid is available to you from the Federal Government.  You must have a completed FAFSA to get any aid or loans from the federal government, and most colleges require one to apply/attend school there.

After completing the FAFSA, see what federal student loans you qualify for.  Federal student loans come in two flavors: Subsidized and Unsubsidized.  Subsidized student loans are offered to borrowers with more financial need, and interest on the loans doesn’t accrue while in school.  Interest only starts after graduation or if the student drops below part-time enrollment.  These loans are available only to undergraduate students.  Unsubsidized student loans are more broadly available regardless of financial need and may be used for grad school.  These loans start accruing interest as soon as you take them out and generally have higher loan limits than subsidized loans.

The last type of loan the government offers is PLUS loans or Parent Loans for Undergrad Students.  These loans are based on the parent's credit score and if the parent and student meet certain requirements (citizenship or resident alien status).  These loans come with relatively low fixed rates and can be set up to be repaid over a standard 10-year term, a graduated 10-year term, or an extended term.  The parents will be responsible for repaying the loan and cannot transfer it to the child.

If you do not qualify for federal student loans or need to borrow more, your other option is to take out private loans.  These can vary wildly in terms of the repayment schedule and the interest rate.  The interest rates may be adjustable which may start low and then end up well over 10% after a few years, these are unavailable for any federal student loan forgiveness programs.  Private loans are generally less flexible but have higher borrowing limits, making them attractive for students chasing high-paying careers that require additional or expensive schooling.

In short, exhaust your federal student loan options before pursuing any private loans. Federal loans can be consolidated more easily and are eligible for forgiveness through the government, whatever that looks like. Private loans will typically have higher interest rates, may have adjustable rates and hidden fees, and are generally less flexible.

University Years:

            While enrolled in school, you will not have any required payments for federal or private student loans.  If you have unsubsidized student loans, you can pay down the interest portion of the loans so that additional interest will not accrue while you're in school.  If you can afford to do so, we highly recommend keeping the accumulated interest to a minimum.

            Echoing earlier comments, continue to evaluate what majors and jobs you find attractive as you progress through your education and weigh potential salaries against the cost of tuition.  If you only took out a few loans to complete your degree, you will have more flexibility in the job market.  However, if you choose to attend an expensive school or you were forced to take out a lot of debt, please consider higher-paying careers or understand that student loan repayment may be a central part of your financial picture upon graduation.

Post Grad:

            Congratulations on your graduation and four (or sometimes more) years of hard work.  Now that you’ve got a paycheck and your loans are coming due, it's time to start repaying your student loans and figuring out how they fit into your financial picture and for how long.  Student loan repayment can look different for everyone based on the type of loan, outstanding balance, interest rate(s), and income.

Traditional federal student loan repayment plans include:

·         10-year straight repayment: This plan is as simple as it gets, you can use a financial calculator to figure out what your monthly payments are, make 10 years of that payment and your student loans will be repaid in full.

· 10-year graduated repayment: Your student loans will start low, and every two years, your monthly balance will increase as your income hopefully rises to support these payments.  After 10 years, you’ll be fully paid off.

·         Extended-term repayment: You may have up to 25 years to repay your student loans.  With this option, you can opt for a straight repayment or a graduated schedule.

 The federal government offers a bevy of student loan repayment plans beyond the aforementioned ones.  These other repayment options include:

·         PSLF -> Public Student Loan Forgiveness is available for borrowers who have made 120 monthly payments while working for qualifying employers (qualifying employers are government or non-profit organizations); we typically see PSLF for physicians who end up working for universities or other public hospitals or attorneys that work as a public defender.

· SAVE -> The Newest option will replace all but the IBR and ICR plan by July 2024.  This plan allows borrowers to pay back 5% of their discretionary income (income over 225% of the federal poverty line) for 20 years if loans were used for undergrad or 25 years if loans were used for graduate school.  At the end of these 20 and 25-year terms, any remaining student loan balance will be forgiven.

·         REPAYE -> This program is being replaced by SAVE, and current enrollees will be enrolled in SAVE.  This plan offered between 10%-20% of discretionary income (income over 150% of the federal poverty line) to be repaid for 20 years if for undergrad loans and 25 years of graduate school loans.

·         PAYE -> This repayment plan consists of monthly payments that are generally equal to 10% of your discretionary income (income over 150% of the federal poverty line) divided by 12 (months) but never more than your standard 10-year repayment amount.

·         IBR -> Generally 10% of your discretionary income (income over 150% of the federal poverty line) divided by 12 (months) but never more than your standard 10-year repayment amount.  This may be 15% of your discretionary income if you had outstanding student loans as of July 1st, 2014.

·         ICR -> Lesser of 20% of your discretionary income (income over 150% of the federal poverty line) divided by 12 (months) or your standard 12-year repayment amount adjusted for income.

While these plans are currently all options for repayment, SAVE and IBR will be the only two remaining plans open for new enrollees as of July 1st, 2024.  If you would like to learn more about either of these plans, we have previously posted a companion blog discussing the SAVE program and the replacement of the REPAYE plan.  It is worth noting that you can change plans without major consequences as your income and life situations change (add kids and spouse to the equation the best plan for you will likely change).

            We can’t comment on the veracity of the claims that we’ll get full-fledged student loan forgiveness anytime soon, but the SAVE program is a step in the right direction for many borrowers living with outstanding student loans.

            If you have tons of outstanding loans, it may be in your best interest to consolidate them and turn them into one big loan which will take on the weighted average interest rates of your outstanding loans.  If your loans are private or federal, they will retain that character.  However, if you have a mix of federal and private loans then they will all be characterized as private and will lose any future ability to enroll those loans under the repayment or forgiveness programs.

            As previously discussed, your private student loans will likely have less attractive interest rates than federal student loans and are unable to be forgiven.  These loans may also have adjustable rates, which is a less scary way to tell you that your 3% loan could become 13% in a few short years.  Because of this and the lack of prepayment penalties, we strongly encourage you to make the minimum payment required for your federal loans and the maximum possible for your private loans.  The sooner you can eliminate high-interest debt like these student loans or credit cards the better off you’ll be.

            A common topic in the news is debt deferment or forbearance.  While these are both options for postponing the payments of your loans, they are not the panacea that you may see claimed online.  Student loan deferment occurs when you have subsidized loans or other need-based loans, and interest accrual will be suspended for the term of your deferment.  On the other hand, forbearance is available for a wider variety of loans, though interest will continue to accumulate, and you will need to provide a temporary financial challenge such as returning to school or the loss of a job.

Wrap up:

            Student loans can be and often are a headache for many and it can be easy to find yourself in over your head.  As previously mentioned, college tuition inflation has outpaced both wage growth and inflation making attending college more expensive than ever before.  Because of this, the room for error in calculations for funding and repaying loans has shrunk.  With careful and intentional planning, we can minimize the likelihood that you will graduate with a mountain of debt and no plan to attack it.

A few general rules of thumb:

·         Maximize your federally provided funding before turning to private loans. 

·         Pay off your private loans first while making minimum payments on your federal loans.

·         If you can, pay off your student loans as quickly as possible or get on one of the repayment plans (IBR or SAVE).

·         If you need to go into forbearance or have unsubsidized loans during college, try to pay off the interest portion of your loans.

Thank you for making it this far in the blog.  I know that this is dense material and I hope that it was easily digestible from your perspective.  If you have specific questions about your situation or would benefit from guidance, please reach out.  We are happy to help you navigate your student loans and tackle any other life and financial goals.