Journal of Financial Planning: February 2018
Adam S. Minsky is one of the nation’s leading experts on student debt and remains one of the only attorneys in the country with a practice focused exclusively in this field of law. He has published numerous books and articles on student debt and regularly speaks about developments in student loan law and higher education financing.
Editor’s note: The following is an edited transcript of Adam Minsky’s April 2017 presentation at FPA Retreat. It has been updated by the author to reflect new information.
Student loan debt is the second-largest type of consumer debt (after mortgages), totaling $1.3 trillion. Forty-four million Americans have student loans—that’s about one in nine people. This article will explore the different types of student loans and repayment options, providing financial planners information they can use to help clients manage their loans.
One of the most important things a planner can do at the beginning of an advice session with a client is figure out what type of student loans that borrower has, because it’s the type of loan that’s going to inform their rights and their options for dealing with that loan.
What Kind of Loan Is It?
Federal loans are issued directly by the federal government through the U.S. Department of Education’s Direct loan program, or through a now-defunct program that issued many older loans called the Family Federal Education Loan (FFEL) program, also known as the guaranteed loan program, where a private lender fronted the money but it was backed by the federal government.
Under both the Direct and FFEL programs are these common loans: Stafford loans, which are either subsidized or unsubsidized; PLUS loans, which can be issued to students for graduate school or for parents to benefit their kids’ education; and Perkins loans, which are issued by the school, but it is also a type of federal loan.
Private loans are everything else. They can be issued by a traditional institutional lender, such as a school, or they can be issued by a commercial lender such as Sallie Mae, Navient, or banks. If it’s not issued by the federal government, if it’s not backed by the federal government, and if it’s not a Perkins loan issued to the school, it’s a private loan. There are also some state-based lending entities as well that issue private loans.
Once you have a clear picture of what loans are out there, next you need to determine who’s involved, because you need to know who to deal with as you’re figuring out a management plan for your client.
Who’s Involved?
The lender is the entity that originates the loan. For the Direct loan program, it’s the U.S. Department of Education. For the FFEL program, it’s a private lender that may have changed hands a few times.
The servicer is usually a contractor hired to handle the day-to-day billing operations of the loan; this is the most important entity you’ll be dealing with. You may have heard of Navient. Navient is a contracted servicer for the Department of Education. They’re also a servicer for the FFEL program. They’re also a servicer for private loans. They’re also a lender for private loans. When a client says, “I have a Navient loan,” that tells you nothing; you need to know what Navient is doing in that loan or for that loan.
A guarantor is unique to the FFEL program. When a borrower defaults on a FFEL program loan, the original lender or the current lender gets paid off and a guarantee agency—usually a non-profit or state-based entity—takes it over.
A collections agency is a third-party entity that is a contractor, like a servicer, but only for defaulted loans.
What’s the Loan Status?
The status of the student loan can play a role in what options the borrower has.
A grace period is a one-time-use period of time—usually six months immediately after graduation, but it can be more or less depending on the loan—during which no payments are due. One thing to know about a grace period is that if you use it once, you don’t get a second one for that loan if you go back to school.
Repayment is when the borrower is making payments on the loan under the terms of the contract.
Delinquency means the borrower has fallen behind on payments.
Default means the borrower has fallen so far behind on payments that the loan is declared to be in default, which triggers acceleration, under which the full balance of the loan is due at once. If the borrower can’t pay it all at once, it goes to collection. Federal loans go into default after 270 days of delinquency. If a client comes to you and says, “I’m three months late on a federal loan,” that’s bad but you have time to fix it. Private loans are much more variable, but they can go into default after just a couple of missed payments.
Deferment and forbearance are legal ways of postponing payments during certain conditions.
A deferment allows borrowers to postpone payments during at least half-time study in school, certain graduate fellowships, unemployment, and economic hardship. Generally, deferments are available only for federal loans. Forbearances, on the other hand, are available both for federal and private loans.
The difference between a deferment and a forbearance, for purposes of federal loans, is that during a deferment, the government covers interest accrual on subsidized loans; in other words, interest will freeze on that loan. Interest on unsubsidized loans, however, will continue to accrue. During forbearance, there is no interest subsidy; interest accrues on everything.
A client going into a long-term forbearance as a way of managing their loan is a very bad idea. That interest is going to grow and it’s going to capitalize. It’s going to be added to the principal balance and they’ll be accruing interest on interest. Forbearance on federal loans is available for a variety of reasons, and for better or worse, it’s very easy to get. The borrower calls their servicer and says, “I can’t afford my payment,” and they are put in forbearance.
Forbearance on private loans is also available, but it’s typically limited to one year, occasionally two. It is better to be in repayment than it is to be in forbearance; therefore, one way financial planners can help clients is getting them into payment plans that work for them.
Options for Repaying Federal Loans
Most student loans you’ll encounter as a financial planner will be federal loans. Of the $1.3 trillion dollars in student loans, more than $1 trillion is in federal loans. And they have numerous repayment plan options that can be broken down into two main types—balance-based plans and income-driven plans.
Balance-based repayment plans are typical debt repayment plans that have level payments for the length of the repayment term—which, depending on the plan chosen, can be 10 years, 25 years, or 30 years for some larger loans. There are also graduated plans where the borrower pays less in the beginning and the payments ramp up over time to compensate for those earlier, lower payments. Graduated plans were designed for a time when incomes were going up at a faster rate than student debt was; however, today they benefit few people.
Income-driven repayment plans provide a uniquely tailored monthly payment using a formula tied to the borrower’s income. It allows for affordable payments even for larger federal student loan balances. What’s more is that the goal of the plan is not necessarily to pay the loan off. It can happen, but if it doesn’t, there’s a failsafe. Any remaining balance gets forgiven after a certain number of years—20 or 25, depending on the plan—as long as the borrower has been making payments. And that can be shortened for certain types of loan forgiveness programs. These plans also have poverty exemptions.
The way income-driven plans work is, a formula is applied to the borrower’s income with a certain amount of income initially excluded. Most of these plans use discretionary income, which is not income minus expenses. For purposes of these plans, it’s the amount of the borrower’s adjusted gross income (as reported on their federal tax return) that is above a poverty exemption. From zero to a certain amount, usually around $15,000 to $20,000, is not counted. Then, it’s a percentage of the borrower’s income above that. The exemption is also adjusted for family size.
It’s renewed every 12 months. If the borrower’s income goes up, their payment goes up; if income goes down, the payment goes down. The borrower does this year after year after year, and they may not have to repay the loan in full. The catch is, at the end of the repayment term, any remaining balance that gets forgiven may be treated as a taxable event. There are possible exemptions to that, however, financial planners should be advising borrowers of the possibility of that being a taxable event.
Income-driven repayment plans come in four types. They are similar in how they work, but the devil is in the details: (1) income-contingent (ICR); (2) income-based (IBR); (3) pay as you earn (PAYE); and revised pay as you earn (REPAYE).
Income-contingent (ICR). Only Direct federal loans are eligible to be repaid under ICR. It’s the oldest and most expensive plan (with one exception explained later). It’s 20 percent of discretionary income, which for ICR, is the difference between the AGI of the borrower and 100 percent of the poverty level. It’s a 25-year term; any remaining balance gets forgiven at the end, but recall that the forgiven amount might be taxable.
Example. Consider a single borrower with a $50,000 loan. Their AGI is $40,000. The ICR payment would be $445.
Planning tip. ICR looks at the joint income of married borrowers, unless the spouses file taxes separately, in which case, only the borrower’s income is considered (the spouse’s income is excluded). That can be helpful for a married couple where the borrower has large amounts of federal debt and low income, but the spouse has high income. By filing separately, the borrower might be able to substantially reduce that monthly payment.
ICR is very expensive; it doesn’t make sense for most borrowers (the exception is for some parent PLUS borrowers).
Planning tip. Parent PLUS loans cannot be repaid under any income-driven plan. However, the Direct federal consolidation program allows borrowers to take out a federal loan that consolidates individual federal loans. That new, Direct consolidation loan that repaid the parent PLUS loans can be repaid under ICR, but only ICR (not any other income-driven plan).
Planning tip. If you have a client who has parent PLUS loans and he or she also has their own federal student loans—perhaps from when they got a master’s degree—if you consolidate the parent PLUS loans with their own loans, those parent PLUS loans taint the consolidation and now that consolidation loan can only be repaid under ICR; it can’t be repaid under other, better income-driven plans. Therefore, be very careful about advising clients to consolidate parent PLUS loans; you don’t want to whittle down the borrower’s repayment options.
Income-based (IBR). In general, income-based repayment is better than income-contingent. It’s the most widely accessible income-driven plan because it is available for Direct and FFEL loans. And it has a cheaper formula in two ways: (1) it’s a lower percentage of discretionary income, 15 percent instead of 20 percent; and (2) it has a higher amount of income that’s excluded, 150 percent of the poverty level instead of 100 percent.
IBR has a 25-year term, just like ICR. And if anything does get forgiven, it can be taxable. IBR treats married borrowers the same as ICR—joint income of married couples.
Example. For a single borrower with $50,000 in federal student loans and AGI of $40,000, the IBR payment would be $280.
Pay as you earn (PAYE). Pay as you earn came out in 2012, and it’s the cheapest and has the fastest track to forgiveness. Instead of 15 percent, it’s 10 percent of discretionary income. So that same borrower used in the last two examples would have a $190 payment under PAYE, compared to $280 for IBR, and $445 for ICR. It also has a 20-year repayment term instead of 25 years. Only Direct loans are eligible.
And like ICR and IBR, married borrowers filing separately results in just the borrower’s income being considered.
PAYE is limited to new borrowers who had no outstanding federal student loan debt as of Oct. 1, 2007 and took on new federal loans on or after Oct. 1, 2011.
Planning tip. No one knows the dates that they took out their loans, so have clients log into the National Student Loan Data System database (nslds.ed.gov) and pull the information. Once you see the disbursement dates of the loans, you will know whether the borrower’s going to be eligible for this plan. It’s the best plan, but it’s also the hardest one to access.
One of the benefits of PAYE is that if the borrower is negatively amortizing, which is very possible under these plans, there is a bit of an interest benefit. If that interest ever gets capitalized—which can be triggered by a variety of events, including leaving the plan, going into forbearance, or going back to school—interest capitalization is limited to 10 percent of the total principal balance at the time the borrower entered the plan.
Revised pay as you earn (REPAYE). The revised pay as you earn plan uses the same formula as PAYE, so that same borrower in our example would have $190 per month payments with REPAYE. Also like PAYE, only Direct loans are eligible.
However, REPAYE is different in several key ways from the other plans. There are no date restrictions; it doesn’t matter when federal loans were dispersed. Treatment of married borrowers is also different; it doesn’t matter how the borrower files taxes, if he or she is married, it’s joint income. This means some borrowers who are married would have a cheaper payment doing IBR and filing taxes separately than doing REPAYE.
REPAYE also has two repayment tracks: 20 years for undergraduate loans, and 25 years for graduate school loans. So, it depends on what program the borrower is in that determines when their loan is forgiven, if they have anything left.
Finally, there’s an interest benefit to REPAYE that is different from the other plans. If the borrower is negatively amortizing, half of the interest that accrues above their payment will be waived on a rolling monthly basis. The balance still grows; the loan is still negatively amortizing, but it’s doing so at a slower rate.
Planning tip. If you are advising your client on retirement, keep in mind that AGI is looked at to determine the repayment amount. If you’re able to lower that AGI through pre-taxed retirement contributions, that will lower their income-driven repayment plan payment. It’s not dollar-for-dollar, but it is a way to get something else back by contributing to a qualifying retirement plan.
Public-service loan forgiveness. Public-service loan forgiveness is a way for some borrowers who are working for a qualifying employer to significantly shave off the time they are in repayment. Under this program, borrowers can get their loans forgiven in as quickly as 10 years, as opposed to 20 or 25 years. A key element of public-service loan forgiveness is that the forgiven amount is not taxable.
It’s often talked about in the media like it’s a 10-year plan; and it is, if the borrower makes 120-qualifying payments consecutively. For any one payment to count, it must be the right type of loan, the right type of payment, and the right type of employment. It must be a Direct federal loan and the borrower must be in a qualifying plan.
A qualifying plan is either the 10-year standard plan, in which the loan is paid off in 10 years anyway, or any of the four income-driven repayment plans. For employment, the borrower must be working full time, at least 30 hours per week, for any government entity at any level, including federal, state, local, county, tribal, public schools, public libraries, public hospitals, or a 501(c)(3) non-profit organization (which includes most, but not all, charitable organizations). Other non-profits could qualify on a case-by-case basis; however, this is the basis of a lawsuit filed against the government for erroneous determinations.
Perkins loan forgiveness. Perkins loans have their own unique cancellation benefits based on the borrower’s profession. The government lists the jobs that qualify for loan forgiveness. Examples include nurses and medical techs, providers of early intervention services for the disabled, speech pathologists, special education teachers in certain low-income schools, public defenders and prosecutors, police officers, and firefighters.
Borrowers who qualify don’t have to pay a dime on their Perkins loan. Instead, the loan is put in a suspended status, and the government forgives up to 20 percent of the loan each year for up to five years. After five years the loan is gone. If you have a client working in one of those professions, get them on track for Perkins loan forgiveness.
Repayment assistance. Repayment assistance is another type of benefit to borrowers. It is not loan forgiveness; it’s where borrowers receive money to go toward their loans.
One of the most popular programs available for medical professionals is the National Health Service Corps, which provides repayment assistance to qualifying medical providers who make a two-year commitment to serving in designated, high-need communities.
There are also employer-based repayment assistance programs, which are becoming increasingly popular as an HR benefit, and school-based repayment assistance programs, particularly at law schools. Law grads who work in the public service field might be able to get a check from their school each year to help offset student loan payments.
Private Loan Refinancing
Federal loans can have high interest rates; private loans can as well. A lot of new players in the field, such as SoFi, Earnest, Lendkey, and CommonBond, can refinance borrowers’ loans, possibly at lower rates. The credit market dried up after the recession, but the past three to four years has seen a resurgence of private student loan refinancing programs.
The benefits to private loan refinancing are that some borrowers can get a lower interest rate, and some might be able to get better terms and conditions than their current loan.
The cons are that even if the borrower gets a lower interest rate, they are walking away from critical programmatic options and consumer protections. They are walking away from every program discussed here so far, including income-driven repayment, public service loan forgiveness, and generous deferment and forbearance options during times of hardship. They’re also walking away from a statutorily guaranteed death discharge and disability discharge. No consumer protection for a private student loan is as strong as what the federal government provides. And when a borrower refinances with a private loan, they can’t convert it back into a federal loan.
Planning tip. Some borrowers should refinance; but borrowers should be made aware of what they are exchanging for that lower interest rate. Financial planning in these instances might involve some additional steps to protect those borrowers from the loss of consumer protections, such as more life insurance so that the borrower’s family doesn’t get stuck with the bill if they pass away, and more long-term disability insurance if they become disabled and lose income. Some disability policies are now including a rider for student loans for this purpose.
If a borrower can get a lower interest rate by refinancing to a private loan, here are some things to consider: Per the contract, what happens if the borrower loses his or her job? What happens if they become disabled? If they need a cosigner, is there a provision that can release the cosigner if the borrower makes payments on time? Will massive origination fees offset some of the savings from the lower rate?
What’s in Store for the Future
The Higher Education Act (HEA) of 1965 is the governing statute for many of the federal programs, and it’s up for reauthorization in 2018.
Changes to the program require an act of Congress, passed by both the House and the Senate and signed by the President.
We’re going to see some changes; we just don’t know what. House Republicans recently released the PROSPER Act, which is their proposal to rewrite the HEA. Among many other provisions, the bill would eliminate the Direct loan program and replace it with a new federal loan program. As of mid-January, the PROSPER Act needs to be voted out of Committee before it goes to the floor for a House vote, and the Senate will have to pass its own version, so it’s possible (even probable) that there will be changes to the provisions of the bill. Meanwhile, student loan debt continues to grow and there is a lot of uncertainty about the future of many of these programs.
I often advise borrowers to create what I call an uncertainty fund—and I typically refer them to financial planners to do so. It’s a non-retirement investment account where instead of just throwing money at their loan that incentivizes paying as little as possible so they can get as much of it forgiven as possible, the borrower puts money into a fund that can tolerate some risk and has a long threshold.
Best-case scenario is the borrower doesn’t need the money in the uncertainty fund to pay their loans; they can use that money for something else, like retirement. Worst-case scenario is they’ve done something to protect themselves if changes do happen to the federal programs.
Sidebar
Important Resources
- nclc.org, the National Consumer Law Center, has a lot of free information on student loan rights and responsibilities.
- nhsc.hrsa.gov, the National Health Services Corps, provides information on the repayment assistance program for care providers.
- nslds.ed.gov, the National Student Loan Data System, is one of the best resources you can share with your clients. It’s where borrowers can access details on their federal student loans, including loan type, loan status, who the servicer is, what the disbursement date was, what the balance was when it was issued, and what the balance is today. It also has information on federal loans that are already paid off and when they were paid off.
- Studentaid.ed.gov has free information on a lot of the programs mentioned in this article.
- StudentLoans.gov is where borrowers can apply for an income-driven plan, consolidating, and more.