With rising college costs and increasing pressure to achieve higher education, more students are saddled with student loan debt than ever before.
As of November 2021, American student loan debt reached $1.75 trillion dollars. Even more alarming? This debt grows six times faster than the entire nation’s economy.
Paying off student debt is a challenge for many and has been exacerbated by the COVID-19 pandemic, adding more stress, late payments, and fees to the process. But in March of 2020, there was some relief.
The Coronavirus Aid Relief and Economic Security Act (CARES Act) suspended federal student loan payments with zero interest — a provision helping over 35 million borrowers.
However, the era of no student loan payments is ending. The current administration offered its final extension of the student loan moratorium on federal loans through August 31, 2022.
As the deadline to resume student loan payments approaches, it’s natural to have questions about how to pay back these loans and whether you should consider loan forgiveness opportunities.
Stressed about student loans?
Federal vs. Private Student Loans: What’s the Difference?
Not all student loans are created equal; they fall into two broad categories: federal and private.
As you may have guessed, the government provides federal student loans and private sector companies offer private student loans.
The fundamental differences lie in the details: benefits, interest rates, repayment opportunities, and terms and conditions.
Understanding Federal Student Loans
Federal student loans are the most popular option by far. Of the 44 million people who have student loans, 42 million carry a balance on a federal direct loan — approximately 90% of borrowers.
- Direct subsidized loans. With incredible interest benefits, these loans are available to undergraduates with demonstrated financial need (determined by the Free Application for Federal Student Aid (FAFSA)). The federal government pays interest on your loan while you’re in school (if you attend at least part-time), during the six-month grace period after you graduate, and if your student loan payments are postponed or in a deferment period. This means getting an interest-free loan all through school and six months after graduation!
- Direct unsubsidized loans. Undergraduate, graduate, and professional students can qualify for this loan, which is not based on financial need. You are responsible for all interest as soon as the loan is taken. Interest accrues throughout your time in school and the six-month grace period, but repayment doesn’t start until the grace period is complete.
- Direct PLUS loans. The government designed PLUS loans for graduate and professional students, as well as parents who want to take loans out on behalf of their children. This loan does come with a credit check, so if your credit history is spotty, you could end up with less favorable terms like higher interest rates.
- Direct consolidation loans. With this program, you can consolidate all qualified federal direct loans into one service provider. Consolidation can help you better track payments and streamline the repayment process. Be careful with terms and conditions. Sometimes consolidation can adversely effect specific repayment and forgiveness tracks.
How much can you borrow each year?
The amount you can borrow from federal loans depends on your school and unique financial aid package. But the government also sets specific borrowing parameters based on whether you’re an undergrad, graduate student, or professional student, what year of school you’re in (freshman, sophomore, senior), and your dependency status (found on the FAFSA).
- Undergrads can take out $5,500 to $12,500 per year in direct subsidized and unsubsidized loans.
- Graduate and professional students can take out up to $20,500 in unsubsidized direct loans. You can supplement remaining tuition costs with PLUS loans.
- If you’re a parent taking out a loan, you can use a PLUS loan to fund costs not covered by other financial aid.
The Federal Student Aid website has an excellent chart that further explores borrowing limits.
Remember, to apply for any federal student loan, you’ll need to fill out the Free Application for Federal Student Aid (FAFSA).
Understanding Private Student Loans
Private student loans are often much simpler than federal student loans. You can obtain a private student loan with an individual lender like a bank, credit union, or other institution.
Since private loans aren’t affiliated with the federal government, terms and conditions are set by each lender, which can be less beneficial than federal loans in the long run. For example, the CARES Act student loan moratorium only applied to federal loans, not private loans. Borrowers had to rely on lenders for support — and while some did, others didn’t.
Private loans also require a credit check. For undergraduate students with short credit histories, this can lead to higher interest rates and less favorable loan terms. The average interest for private student loans varies greatly depending on your credit score. Bankrate found this can range widely from 1% to 13%, so the impact of a strong credit score can’t be underestimated.
Most private lenders require you to start paying them back while you’re still in school, though some offer deferment until graduation. Keep in mind that interest will keep accruing regardless.
It’s rare for private lenders to subsidize loans, meaning you’ll be responsible for all interest payments throughout the life of the loan.
You also aren’t likely to find loan forgiveness or flexible repayment options with private lenders. Federal loans offer several options for loan repayment like forgiveness, income-related payment plans, and more.
One benefit of private loans is you can easily consolidate and refinance them for more lucrative interest rates. Given the low-interest rate climate over the past year, many borrowers took advantage of both consolidation and refinancing.
Breaking Down Loan Consolidation
Consolidating student loans can be a mindful way to condense your loans into one simple monthly payment.
This means instead of keeping track of three to four different loans, you can have them all in one place and only make one payment per month. Doing so opens up better cash flow opportunities and helps you create a consistent plan to pay your debt off.
Consolidating can also open you up to refinancing opportunities with better interest rates and terms. You could refinance for lower interest rates and even swap variable interest rates for fixed rates over the life of the loan.
Several lenders offer consolidation opportunities, so if you’re interested in consolidating, shop around to find the best option for you. How do you know if you’re getting a good deal? Here are some to watch for:
- Interest rates. If you go through the consolidation process, you want to make sure it’s worth it. How much lower of an interest rate can you get? Will you end up paying more or less over the life of the loan after you consider factors like fees, repayment time, and more?
- Type of interest. Fixed or variable? While every situation is different, fixed interest rates are often more beneficial, especially if you find one at a low rate (1 to 4%).
- Repayment terms. When you consolidate loans, you’ll likely have a longer repayment period. Be sure to weigh the pros and cons. Does paying the loan and interest for 30 years really save you money, or does it actually mean you’ll pay more over the life of the loan?
- Lender fees. Before you commit to a lender, do your research and understand any fees the lender may charge you throughout the process.
Be careful about consolidating federal loans. If you consolidate federal loans into private loans, you will likely become ineligible for federal repayment programs like loan forgiveness or income-based repayment plans.
What is Student Loan Forgiveness and How Can I Qualify?
Student loan forgiveness programs help eliminate borrowers’ student loan debt. There are several different programs that require people to meet specific conditions for eligibility.
2021 was a record-breaking year for borrowers who had their student loans forgiven, partly because the government expanded eligibility for the popular Public Service Loan Forgiveness (PSLF) program. The Department of Education estimates that changes to the PSLF will positively impact 550,000 borrowers.
While good news, the actual dollar amount forgiven in 2021 was less than 0.6% of the outstanding balances — so there’s still a long way to go. Here are some common loan forgiveness avenues:
Public Service Loan Forgiveness and the 2021 Revamped Program Changes
PSLF is a federal program that offers loan forgiveness for those who work in public service or nonprofits.
How do you qualify?
- You must be employed full-time for a US federal, state, local, or tribal government, or a nonprofit organization, including military service
- You have federal direct loans
- You must make qualifying payments (traditionally with a specific income-driven repayment plan, but a new waiver allows borrowers to “count” prior loan payments toward PSLF; more on that below)
- You must make 120 consecutive qualifying payments
In October 2021, the US Department of Education initiated an overhaul of the existing Public Service Loan Forgiveness program (PSLF). Per the US Department of Education:
“The Department estimates that the limited waiver alone will help over 550,000 borrowers who had previously consolidated their loans see their progress toward PSLF grow automatically, with the average borrower receiving 23 additional payments. This includes approximately 22,000 borrowers who will be immediately eligible to have their federal student loans discharged without further action on their part, totaling $1.74 billion in forgiveness. Another 27,000 borrowers could potentially qualify for $2.82 billion in forgiveness if they certify additional periods of employment. For reference, just over 16,000 borrowers have ever received forgiveness under PSLF prior to this action. We anticipate that many more will also receive additional credit as we implement other changes over time, such as counting previously ineligible payments that were not affected by a loan consolidation.”
Let’s quickly review the highlights of the overhaul plan and how it impacts borrowers.
- The Coveted One-Time Waiver. All borrowers who have made loan payments that didn’t qualify for PSLF can submit a PSLF application by October 31, 2022, to have those payments counted toward loan forgiveness. Currently, only income-driven repayment plans qualify for PSLF. This waiver aims to remedy past miscommunication and misinformation that prevented public service employees from selecting the right payment plan to put them on the path to loan forgiveness.
- Qualification, Simplified. The US Department of Education is also working to simplify the qualification process for borrowers. There are current talks to set up rulemaking to make long-term improvements to the PSLF program. These improvements are still in progress, but it could mean adjusting what counts as a qualified payment in 2022 and beyond while also adjusting payment deadlines and rules for application.
- Improved Access for Military Members. This initiative is also focused on improving access to PSLF for military members. Under the new rules, all months or years spent on active duty can count toward PSLF “payments” (even if the military member’s loans were deferred or in forbearance while deployed). This rule applies to borrowers who were previously on active duty as well, and is expected to eliminate the student debt of many military service members this year.
- The Government Will Take Another Look at Previously Denied Applications. The review and approval process for PSLF applications has long been viewed as overcomplicated and riddled with errors by applicants and the US Department of Education alike. Many applications have been denied even if they technically qualify or missed the mark by a small margin (i.e. a day late on one payment, pennies away from paying the appropriate amount). The Department is now reviewing these applications and working to “further strengthen the oversight of PSLF.”
- (Much) Better Communication. Candidly, the PSLF program has never had great word of mouth, largely from poorly handled communication between service providers and borrowers. It’s a well-worn tale as many applicants missed PSLF qualifications from this lack of communication. The US Department of Education aims to rectify this problem by improving communication between the PSLF program, loan service providers, and borrowers to increase awareness and ensure a seamless experience moving forward.
Four Federal Repayment Plans that Offer Loan Forgiveness
Sometimes, student loan payments aren’t easy to add into your monthly cash flow — especially as a new graduate.
To offer support, the federal government has income-driven repayment plans designed to cap payments according to your income and family size. Once you meet the repayment terms, any outstanding loan balance is forgiven. There are four different plans available:
- Income-Based Repayment Plans (IBR). The rules for this plan changed on July 1, 2014, so borrowers who enrolled either before (or on/after) that date will follow different rules. For the latter group, payments are capped at 10% of discretionary income for 20 years. That limit increases to 15% and 25 years for those who enrolled before July 1, 2014.
- Income-Contingent Repayment Plan (ICR). You’ll either pay the lesser of 20% of your discretionary income or what you would pay on a fixed 12-year payment plan, whichever is lower. ICR Plans are 25-year terms.
- Pay As You Earn Repayment Plan (PAYE). Your monthly loan payments will be capped at 10% of your discretionary income for 20 years.
- Revised Pay As You Earn Repayment Plan (REPAYE). This plan also caps payments to 10% of your income, but the repayment term depends on whether your loans were for graduate or undergraduate study. For undergraduate work, it’s a 20-year term; this moves to 25 years for graduate and professional work.
Some repayment plans are better than others depending on your filing status, household size, household income, and more.
While income-driven plans can be helpful from a cash flow perspective, they may also extend your payment terms, leading to you paying more interest over the life of the loan. Work with your financial advisor to help weigh your options.
You’ll also want to prepare for taxes once your loan is forgiven, depending on when that occurs. Any amounts forgiven after 2026 are counted as ordinary income and also taxed as such. You’ll also want to prepare for taxes once your loan is forgiven. The amount forgiven is counted as ordinary income and also taxed as such. This provision catches many borrowers by surprise and leaves them with a tax bill they aren’t prepared to pay. Keep a cash reserve for your expected tax liability so you aren’t overwhelmed by the “tax bomb” (as it’s affectionately known).
Additional Loan Forgiveness Opportunities
If you don’t qualify for the above programs, there are other options depending on your situation.
- Perkins Loan Cancellation. These are low-interest federal loans offered to students based on financial need. You might be eligible to get these100% of these loans canceled depending on your employment (and possibly volunteer work). You must work in public service for at least five years. Those who may qualify include teachers, nurses, firefighters, and volunteers through AmeriCorps, Vista, or Peace Corps, among others.
- Teacher Loan Forgiveness Program. Full-time teachers in low to middle-income public elementary or secondary schools could be eligible for loan forgiveness after working five consecutive years. If they qualify, they can have up to $17,500 in federal direct loans forgiven.
- Student Loan Forgiveness for Nurses. Nurses have a few ways to pursue loan forgiveness, the most common is through PSLF. You can also review the Nurse Corps Loan Repayment Program, which can pay up to 85% of your education debt if you meet the criteria.
You may also have access to state-sponsored programs, so contact your state’s higher education department to see if you qualify.
Reach Out to an Advisor
Student loans are a common way to pay for college and can help people attain their education goals. But they are complex vehicles which should only be taken on with a clear-eyed plan.
An Abacus advisor can help you create a comprehensive education plan that accounts for student loans, including how much to take out, which loans are suitable for you, and the best practices for paying them off.
Is college planning on your mind? Let’s talk about it together. Set up a call with an Abacus advisor today and let us help you expand what’s possible with your education.