Know your options for student loan repayment

The student loan space can be an oftentimes daunting and unnecessarily complex space. The aim of this article is to provide some clarity with regards to the various options when it comes to federal student loans repayment options and the Public Service Loan Forgiveness program.

Pay as You Earn (PAYE)

This plan is typically best for clients looking for forgiveness of their loans since it will likely be the lowest payment option if a spouse is involved. The reason is because this program allows you to file your taxes separate from spouse and isolate only your income; therefore, only paying a payment based on your income and not grouped in with your spouse’s. There is also a cap on the payment amount that cannot exceed that of a Standard 10yr repayment.

The monthly payment is going to be 10% of your discretionary income but unfortunately, not everyone qualifies for this program. To qualify, you need to show a “partial financial hardship” and you cannot have taken out any loans prior to October 1st, 2007. Also, if you make payments on this program for 20yrs, they will forgive your loans, but the forgiven sum will be considered taxable income in the year that it is forgiven.

Income-Based Repayment (IBR)

This program is typically there for those who want the perks of the Pay as you Earn program but do not qualify. This program allows for you to file taxes separately from a spouse to isolate your income for your payment sake and the same cap on the payments as with PAYE. Like with the PAYE program, this cap can be beneficial for those seeking PSLF forgiveness but who have a high-income job.

There is both a “New” IBR and an “Old” IBR. If you took loans out before July 1st, 2014, you would only qualify for the old IBR plan and if you only took out loans after July 1st, 2014, you would only qualify for the new IBR. The old IBR has payments based off 15% of discretionary income, whereas the new IBR program is only 10%. The long-term taxable forgiveness is 20yrs for the new IBR and 25yrs for the old IBR.

The only main difference between the new IBR program and the PAYE is that there is no cap on how much interest can be capitalized when if you leave or switch programs. With that said, if you qualify for the PAYE, it is likely a better option than IBR in most instances.

Revised Pay as You Earn (REPAYE)

This program is the default income-driven repayment option. This program is typically best for those who are single and/or planning on refinancing their loans in the future. This program will always group in your spouse’s income into the payment calculation regardless of tax filing status. This program offers some great interest subsidies and can forgive a portion of your unpaid interest that is typically building up while making payments lower than the amount of interest that is accruing. They will forgive 50% of unpaid interest on all direct loans and 100% of unpaid interest on any subsidized loans for the first 3 years. This helps to keep your overall amount owed down.

This program is based off 10% of your discretionary income but has no cap on how high the payment can go in the future, unlike other options. There is no need to show a partial financial hardship and so therefore most everyone should qualify for this program. If you have graduate loans, you will have to make payments for 25yrs before the taxable forgiveness will take place.

Consolidating student loans

Many people are led to consolidating their loans under the guise of “needing to” or for “simplicity's sake”. In most instances, it is not necessary and most of the time not recommended. There are some substantial consequences to consolidating your loans if you are not aware and so be sure to educate yourself and or speak to a financial professional who is educated on student loans prior to doing so.

The benefits of consolidating lie in the fact that by doing so, it might allow for some of your loans that do not qualify for the PSLF program (i.e FFEL loans, Perkins loans, etc) to be grouped into a direct consolidation loan that is eligible for a qualifying income-driven repayment. Consolidating can also allow for extended repayments all the way out to 30yrs which could be a good option for those who are planning to pay off their loans but cannot refinance their large sum at a lower interest rate with a private bank and/or want to maintain the government protections on their loans in the event of their passing away. If you are delinquent or have defaulted on a loan, this may also be a sound option for you to get that paid and off your record.

The biggest downside to consolidating is that it resets the clock for any potential forgiveness for that loan. This means that if you have 5 of the 10yrs towards the PSLF forgiveness under your belt and then you decide to consolidate your loans, this will wipe your record clean and force you to restart your 10yrs. This also applies to the long-term taxable forgiveness options on the various income-driven repayment options. When you consolidate your loans, all your loans are put into one with a weighted average of the various interest rates. This limits your ability to target certain high-interest loans if you are trying to pay these down efficiently in the future while maintaining them with the federal government.

Public Service Loan Forgiveness program

The infamous Public Service Loan Forgiveness program is one that is highly sought after yet riddled with hoops that you must jump through to qualify. If done properly, this is one of the most efficient ways to pay off your loans but we must move towards the PSLF forgiveness with caution and have a backup plan if it were to not work out.

There are three main steps to ensuring that you are properly enrolled in the PSLF program. The first step is to make sure that Fed Loans is your loan servicer. If they are not your servicer, you are not properly enrolled in the PSLF program. Second, you must make sure that all your loans are “Direct” loans. Any of your loans that do not say the word “direct” in front of it will not qualify for the program. If this is the case, you can consolidate those to be apart of the program or simply move forward knowing that you will have to pay those off separately.

The third step is to ensure that you properly enroll in one of the income driven repayment programs (IBR, REPAYE, PAYE, ICR). We oftentimes see first year residents have a $0 required payment, but if they are properly enrolled in one of those repayment programs, those months will count toward PSLF. Be sure to never pay more than your required amount as this can put your account in “paid ahead” status and disqualify those months from the PSLF program.

Lastly, you need to ensure that you are working full time for a qualifying institution. We typically like to see our clients filing the Employer Verification form every 10-12 months to make sure that everything is good order. This form is what will trigger Fed Loans to update your “Qualifying PSLF Months” on your Department of Education file. A proper financial professional will be able to pull your official record each year to ensure you are staying on track and check the work of the loan servicer. The loan servicers are known for making errors and so it is critical to have a professional checking their work for you.

After you make go through all the above steps and your official record shows that you have 120 qualifying payments (does not need to be consecutive), you will be eligible to file the application to have your loans forgiven, tax-free.

Cautions and Conclusion

The federal student loan space can be overwhelming, yet it is critical that you educate yourself and consider seeking the help of professionals to hold your hand through the process. Watch out for the private consolidation firms who might reach out to you during training or leave you frightening messages about your loans. There have been many lawsuits against these companies who have been trying to scam students. No matter what professional that you are working with, be sure to never give out your FSA login information to anyone. If you decide to work with a financial professional, you should consider their expertise, education, background, and other pertinent factors. You may want to consider looking for someone that has specialized training or education in the world of student loans.

This article was originally published on Medical Economics®.

Michael Foley, CFP, CSLP, is a Comprehensive Financial Advisor with North Star Resource Group. For any other questions with regards to your personal situation, please feel free to contact him at Michael.foley@northstarfinancial.com and 480-993-9491.

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