Executive Summary
Student loans provide many the opportunity to pursue higher education and careers that would otherwise be difficult to attain.
Educational debt maintains a large impact on the lives of borrowers throughout their lifetimes.
Repayment options vary by loan type, which level of education the loan contributed to, and when the loan was taken.
Income, marital status, family and dependent size play an important role in determining loan amounts, repayment options and taxes.
Taking a proactive approach to managing educational debt, saving and investing early will pay dividends in many forms throughout the lifetime of each student and parent.
The Skinny on Student Loans
Impact of Student Loans
Student loans are utilized by degree candidates and to pay for the cost of attending university. Approximately 55% of undergraduate students, 14% of undergraduate parents, 54% of graduate students, and ~84% of medical students and those in specialized professional degree programs utilize student loans. (1)
Although the loans may be the only option for some students to pursue their careers, student loans have a lifelong impact on the livelihood of borrowers.
Many feel the need to quickly find a job to pay to begin repayment despite an ill fit.
Carrying the loan lowers net worth, delaying a borrower's ability to purchase a home and start a family, among others.
The stress of carrying loans is an often cited driver of not attending university or graduating.
Types of Student Loans
Federal Loans
Direct Subsidized Loans
Upon applying to a college or university, the financial aid office determines each prospective student's level of financial commitment. Students with financial need may apply for a Direct Subsidized Loan. The loan amount, however, may not exceed a specified amount of financial need.
Direct Unsubsidized Loans
These loans are available to both undergraduate and graduate students regardless of financial need. The university's financial aid office determines the maximum loan amount by evaluating the attendance cost and other forms of financial aid available.
Average interest rates vary by education level pursued: (2)
4.66% for Undergraduate Loans
6.22% for Graduate Loans
Direct PLUS Loans
Intended to cover expenses not covered by other forms of financial aid, Grad Plus Loans and Parent Plus Loans are only available to graduate and professional students, and parents of undergraduate students. Although these are federal loans, they are credit-based.
Average interest rate for Student and Parents: 7.27% (2)
Private Loans
Private student loans are provided by private banks and credit unions. In general, the costs of these are more expensive and can have fewer protections than federal student loans.
Calculating Cost of Attendance
Calculating cost of attendance is typically not as straightforward as looking at the tuition cost since most students do not live at home with their parents and tend to have other needs such as transportation. Some programs also have unexpected costs, such as attending a semester abroad.
Common factors to consider when determining the Cost of Attendance:
Tuition and Fees
Books, Supplies
Living Expenses
Room and Board
Food
Transportation
Loan Fees and Miscellaneous
Cost of a Study Abroad Program, if eligible
Cost of Disability Accommodations
Child Care Costs
Determining Expected Family Contribution (EFC)
Expected family contributions are what the federal government expects each student's family to contribute to the cost of their education. (3)
Repayment Options
There are seven loan repayment options in total, but eligibility depends on the type of loan and when it was taken out. (4)
Standard Repayment Plan
A repayment plan targeting a 10 year payback period, this is the default options and available for all student loans. If loans are consolidated, the payback term can range between 10-30 years.
Graduated Repayment Plan
The graduated repayment plan graduates payments over the payoff period, typically 10 years. The monthly payment amount increases overtime and is intended to provide more flexibility in the early years when the loanee is getting established and slowly increase the payment amount as the loanee’s earnings becomes more established.
For consolidation loans, the repayment period can range from 10 to 30 years.
Extended Repayment Plan
This option extends the repayment period from the typical 10 year term to a 25 year repayment target date. The extended repayment plan only applies to Direct Loan borrowers with >$30,000 in outstanding Direct Loans, and also provides the option to pay a level (fixed) or a graduated payment.
Revised Pay As You Earn Repayment Plan (REPAYE Plan)
Monthly loan payments are calculated by your income and recalculated each year. Typically, payments are 10% of calculated discretionary income. Outstanding balance will be forgiven if not paid in full after 20 years for undergraduate study, or 25 years for graduate or professional study.
Pay As You Earn Repayment Plan (PAYE Plan)
Monthly payments are 10% of discretionary income and capped at the amount you'd be required to pay under the 10-year Standard Repayment Plan
Payments are recalculated each year and are based on your updated income and family size.
Outstanding balance forgiven after 20 years.
Only applies to new borrowers on or after October 1, 2007 and must have received a Direct Loan disbursement on or after October 1, 2011.
Income-Based Repayment Plan (IBR Plan)
Must have high debt relative to your income.
Payments are 10-15% of calculated discretionary income
Outstanding balance will be forgiven after 20-25 years.
Repayment percentage and loan forgiveness horizon are dependent on when the loan was taken out.
Income-Contingent Repayment Plan (ICR Plan)
Monthly payment will be lesser of 20% of discretionary income or the amount you'd pay over a fixed 12 year term, based on your income.
Outstanding balance forgiven after 25 years.
Refinancing and Consolidation
There’s often interest in refinancing or consolidating student debt. A borrower’s current financial situation, loan marketing, and current market interest rates can make this an appealing option. Before making the decision to refinance or consolidate, it’s important to understand the pros and cons of each and make a detailed projection of how each can impact your finances.
Consolidation vs Refinancing
Consolidation is when you replace two or more federal loans with one federal loan, or replace two or more private loans with one private loan. Since you cannot consolidate a private loan with a federal loan, some turn to replacing all loans with one private loan. This is called refinancing.
Federal Direct Loan Consolidation (5)
For borrowers with federal student loans, there is an option to consolidate them with Federal Direct Loan Consolidation. Direct Loan Consolidation has the potential to increase your interest rate as the new rate will be an average of your current interest rates rounded up to the nearest 1/8th of a percent. The benefit here is locking in one rate, coordinating payment on one loan, and maintaining other provisions made available to federal student loans.
Additionally, Federal Family Education Loans (FFELs) and Perkins loan may be consolidated via this route and qualify for Public Service Loan Forgiveness (PSLF).
Private Consolidation Loan (6)
Also known as private refinancing, this is when you take out a private loan through a private lender—typically a bank or credit union—to replace some or all of your loans.
Some benefits include potentially lowering your interest rate, lowering monthly payments by extending the payback period, and/or releasing a co-signer from the original loan.
There are some risks involved in a private refinance.
Private loans are considered when applying for other loans such as a mortgage, student loans typically are not.
Sometimes loans are variable-rate loans, not fixed-rate loans. This means the interest rate can change as the federal interest rates change.
Borrowers working as teachers or in public service will lose loan forgiveness eligibility.
Income-Driven Repayment (IDR), deferment, cancellation, and forbearance options, all potential benefits of federal loans if the borrower runs into financial challenges, are lost with personal loans.
Not all private loans offer loan discharge benefits or forgiveness in the case of permanent disability or death.
If you are a servicemember on active duty, you qualify for the Servicemembers Civil Relief Act (SCRA), which makes you eligible for lower interest rates on student loans taken out prior to the start of your service. Consolidating while serving in the military will remove your ability to qualify for SCRA.
Student Loan Forgiveness
Student loan forgiveness has been a hot topic for the past few years with the Biden Administration, but several programs exist today in the form of cancellation and discharge.
Cancellation, also known as forgiveness, is when you are no longer required to make payments on your loans due to your job. Other circumstances, such as disability or the closure of the school you attended, typically result in a loan discharge.
Here are brief summaries of the current programs.
Biden Administration Student Loan Forgiveness
In August 2022, the Biden Administration announced it will forgive $10,000 to $20,000 in student loans for anyone making less than $125,000 per year.
Public Service Loan Forgiveness
Those employed by a government or not-for-profit may be eligible under the Public Service Loan Forgiveness (PSLF) program. If eligible, the PSLF will forgive the remaining balance of your Direct Loan after you have made 120 qualifying monthly payments under a qualified repayment plan while working full time.
Teacher Loan Forgiveness
Teachers who have completed five consecutive academic years of full time employment in a low-income elementary, secondary school, or educational service agency may have up to $17,500 of their FFEL Program or Direct Loans forgiven.
Closed School Discharge
If your school closed while you were enrolled or soon after your withdrawal, you may be eligible for discharge of your federal student loan.
Perkins Loan Cancellation and Discharge
Only available to Federal Perkins Loans, you may qualify to have some or all of your Perkins Loan cancelled based on employment or volunteer service. Discharge is also possible with other conditions, including Perkins Loan Teacher Cancellation.
Total and Permanent Disability Discharge
Available to those with Direct Loans, FFEL Program loans, and Perkins Loans, you may qualify for discharge if you are totally and permanently disabled.
Discharge Due to Death
"Federal student loans will be discharged due to the death of the borrower or the student on whose behalf a PLUS loan was taken out."
Discharge in Bankruptcy
Although rare, it is possible to have a loan balance discharged after declaring bankruptcy. This requires application and is not an automatic process.
Other
If you are a victim of fraud, the school falsely certified loan eligibility, or if the school you withdrew from did not return the required loan, you may be eligible for discharge.
Taxes
Commonly overlooked is the relationship between student loans and taxes.
Student Loan Interest Deduction
You may file a tax deduction up to $2,500 for the interest paid on student loans taken out for yourself, a spouse, or dependent.
American Opportunity Credit
A tax credit of up to $2,500 may be claimed as the student works toward a degree. This credit is per student per year but is limited to the first four years of school.
Lifetime Learning Credit
You may claim up to $2,000 for certain costs associated with college or career school attendance--tuition, fees, supplies, books, and equipment--if paid directly to the school. The credit is available per student per year.
NOTE: You cannot claim the American Opportunity Credit AND Lifetime Learning Credit at the same time.
Filing Taxes
Since income-based repayment is a commonly chosen form of repayment, is driven by the reported income and recalculated each year, how you file your taxes matters.
If you are married and file your taxes jointly, your combined income will be used to determine repayment. This may be worthwhile if one of you are in school, for example, because this will lower the total household income. If both of you are high earners, this can increase the income used to determine repayment. For this reason, many choose to file separately.
Since tax planning is highly personal, it's recommended to consult a professional to get tailored advice.
Loan Forgiveness
Debt relief is typically considered taxable income by the IRS. Student loan forgiveness is no different. The only exception may be from forgiveness that arises from public service or working in a particular profession. For those utilizing income-based repayment options, this is something to plan for.
For example, you are making payments on your loan and after the 25 year payback period you have $50,000 in student loans forgiven. The IRS would view this as you having received $50,000 is taxable income. The tax impact would be determined by the tax bracket you are currently in and whether or not the loan amount forgiven will bump you to the next tax bracket.
If you are married making $100,000, have no dependents and opt for the standard deduction, you would be in the 12% tax bracket with an estimated federal income tax of $8,481. The $50,000 in loan forgiveness would bump you to the 22% tax bracket with an estimated total tax of $18,536, an increase of $10,055.
Ultimately, paying $10,055 to not have to pay $50,000 is not a bad deal, it just means you have to plan for the extra tax payment. For most, this equates to setting a little aside each month or year over the course of the repayment period. In this example, that would likely equate to setting aside ~$400 per year.
Wrapping Up
Ultimately, student loans provide a great boost to those looking to pursue higher education and further their career, but they come with some complexity and obligation. If you currently have student loans, are contemplating student loans, or have a spouse with student loans, there can be a lot to think about and we hope this guide has provided you with valuable insight.
If you find yourself contemplating the best way to handle student debt, we're always happy to provide a complimentary review.
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