Managing Student Debt Without Compromising Financial Goals

If you're one of the millions facing student loan debt with no idea how to tackle it, there are options available to you that can help you manage your loans and get on track with the rest of your finances.

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Thanks to one generous donor, not one of the Morehouse College 2019 graduates are leaving school with student loans. It’s a tremendous gesture, but as they say: right place, right time. Not all of us have that same fortune.

In fact, 69% of 2018 college graduates left school with loans with an average balance of $29,800. They join the 45 million strong that have student loan balances today, and their balances contribute to the $1.5 trillion in outstanding loan balances today.

There are lots of staggering statistics that may discourage you if you do have student loans, but let’s look on the bright side. You are not alone. Not even close. Those loans provided opportunities at school you may not have had elsewhere, and helped prepare you for your career and future. And most importantly, you have options.

Your loans may not disappear overnight, but creating a plan and sticking to it will help you pay off debt and build towards your financial future.

Remember, debt payoff is a goal just like saving for retirement or buying a home. As you tackle your student loans, make sure to keep these four things in mind.

Know Your Types of Loans

Broadly speaking, you can have two types of loans: Federal or Private.

There are four types of Federal loans that are offered through the Department of Education. You can double check your Federal loans through the National Student Loan Data System. Private loans are obtained through a non-government source, like a bank. Since there is a cap on how much Federal loans one can take, you may even have a combination of Federal and Private loans.

While it might seem like a simple suggestion, understanding the type of loans you have is the first step in determining your available payment options and other potential ways to manage your loan payments.

Pro tip: Federal loans come with a 6-month grace period after graduating (private loans may offer a grace period, depending on the loan provider). If you’ve just graduated and still have time before you have to start making loan payments, use it to start building your emergency fund, or Safety Net. Generally, you want to have 3-6 months of expenses in a Safety Net, but at the very least you should have about one month of living expenses saved before you focus on loan payments.

Federal Loan Repayment Options

This largely depends on the type of loans you have. If you have private loans, you’ll generally be subject to the repayment schedule set by your lender.

Pro Tip: See if you can negotiate a fixed interest rate on your loan to keep your payments steady and to help ensure there are no surprises if interest rates go up. Additionally, set up an automatic payment plan, as lenders may offer a discount of 0.25% or more on your interest rate when you set up automatic payments. If you have Federal loans, you get the benefit of flexibility in payment plans. If you’re struggling to meet your monthly payment, consider one of the Income-Driven Repayment (IDR) plans.

The four available options are:

  1. Pay As You Earn
  2. Revised Pay As You Earn
  3. Income-Based Repayment, and
  4. Income-Contingent Repayment

Under these IDR plans, your payment is generally based on a percentage of your income, which is subject to change each year. Note that other factors, such as your tax filing status, can impact your payment, so be conscious of any changes to your household.

Payments under an IDR are generally made over 20-25 years, which can allow you to better control your monthly cash flow, but you will likely pay more in interest over the course of the loan.

If you can’t qualify for an IDR plan but need some relief early in your loan payments as you get your career started, consider a Graduated Repayment Plan. Your loan payments start out smaller but increase every few years, so that ultimately the balance is paid off in 10 years.

If you can afford to pay your loans under a standard 10 year repayment plan, it may be best to stick with that as you’ll likely pay the lowest amount of interest compared to other repayment options.

StudentLoans.Gov offers a calculator so that you can estimate your monthly payment using each of the options above.

Loan Forgiveness

Did you just say the “F” word?

Let’s say you’ve opted for an IDR plan, but it seems as though you’ll never have your loans paid off. There are programs that you could qualify for to have your loan balance forgiven.

One of the most popular forgiveness programs is Public Student Loan Forgiveness (PSLF). This is available to people who work for non-profits, government agencies, or other public sector jobs and have Federal loans on an IDR plan. After ten years of monthly qualifying payments, your remaining balance could be forgiven.

Even if you aren’t working in the public sector, your Federal loans may be forgiven if you are on an IDR plan. You’d have to make payments for a longer time - i.e. on-time payments for 20-25 years - to qualify for forgiveness.

If your Federal loan balance is much higher relative to your income and you’re set on sticking to an IDR, forgiveness may be right for you. But just like with all things, there are some drawbacks.

  • With PSLF, if you are granted forgiveness, your remaining loan balance will not be considered taxable. But “if” is the big question; only a small percentage of those who qualify have been granted forgiveness. Plus, there is always the chance that this program could be eliminated some day. Also, you may decide that you want to change careers in the middle of your path to forgiveness, which could change your loan payment plan altogether.
  • Those on IDR plans but not in the public sector have to wait a longer time for forgiveness, and could pay a lot more in interest. Additionally, if your loans are forgiven after all those payments, you may have to pay income tax on the amount that is forgiven. This is known as a “tax bomb”, and is something that those aiming for this type of forgiveness should plan ahead for so that you don’t accrue additional tax debt after being relieved of student debt.

While loan forgiveness is most commonly in reference to Federal Loans, there are some programs for Private loans as well. These are generally profession-based (healthcare, lawyers, military) and may be offered on a state-by-state basis.

Pro tip: While not necessarily forgiveness, more employers are starting to offer student loan assistance as an employee benefit. These programs function similarly to a 401(k) match and can help you pay off your loan balance more quickly.

Consolidation And Refinancing

While both Federal Loan Consolidation and Private Refinancing allow you to consolidate your loans, there are some key differences that you should know before making any decisions.

With Federal Loan Consolidation, you can take all your different Federal Loan payments and group them together. Doing so won’t lower your interest rate, but you do get the benefit of making just one monthly payment.

Additionally, you get to keep all the flexible benefits of Federal Loans, so you can still choose an IDR and qualify for Loan Forgiveness. However, when it comes to forgiveness, consolidating may wipe out the past qualifying payments you’ve made and in those cases the payment countdown to forgiveness would restart.

Private Loan Refinancing, on the other hand, is available for both Federal and Private Loans. We previously wrote about the pros and cons of refinancing, but the main benefit would be to consolidate different loans into one easy payment while also potentially reducing your interest rate and/or changing your payment time horizon.

Note that while lowering your interest rate could save you thousands of dollars in interest, refinancing Federal Loans to Private loans means that you are forgoing the Federal payment flexibility and loan forgiveness options.

Minimum Debt Payments

Before you get started on your journey to zero debt, there is one rule you should live by: always, always, always make your minimum loan payments.

If you are struggling to make payments, review the options above. If you need additional relief, review options to defer your loans as a potential short-term solution.

Depending on your loans, you may not even have to pay interest during the time you aren’t making payments. There is no set deferment program for Private loans, but it can never hurt to ask your lender if you can pause or adjust your payments.

Despite difficult times, simply stopping your payments without contacting your loan provider to discuss potential options will only make a bad situation worse (crush your credit score, being subject to additional fines/fees, or even sued).

Of course, it is good practice to limit expenses while paying loans, knowing every extra dollar you save each month can go a long way.

Using 529 Money to Pay Off Student Loans

On December 19th, 2019, the U.S. Congress passed the SECURE Act, which stands for Setting Every Community Up For Retirement Enhancement. The SECURE Act also includes an additional benefit to help with student loans. You can now withdraw $10,000 tax-free from a 529 plan to make student loan payments. 

Keep in mind that $10,000 is a lifetime limit that covers the 529 plan beneficiary and each of the beneficiary’s siblings. If you are a parent and custodian of a 529 plan, you can use $10,000 for each of your children to pay off their student loans. If you happen to have a 529 that you are the beneficiary of, perhaps leftover from school, you could withdraw up to $10,000 tax free to make payments on your own student loans.

With regards to taxes, while the SECURE Act allows for another avenue to pay for student loans, it does not allow you to take double-dip on other existing federal tax benefits. In particular, note that student loan interest paid for with tax-free 529 withdrawals cannot be deducted using the student loan interest deduction. 

My colleague, Eric Bronnenkant, shared his key takeaways from the SECURE Act. The SECURE Act contains 30 sections in all, which you can read about in more detail in Division O of H.R. 1865.

Light At The End Of The Tunnel

So you’ve finally freed up your cash flow and have extra money each month after making minimum monthly debt payments. If you’re wondering what to do next, consider following our 5 step action plan:

  1. Continue making minimum debt payments on time.
  2. If your employer offers a match on your 401(k), make sure you are contributing enough to get the full match.
  3. Next, make extra loan payments if your debt is above 5%. If you have multiple loans at one provider, make sure to contact them to ensure that your extra payments go to the right loan.
  4. Continue building your emergency fund.
  5. Save more for retirement/other goals.