There is a tremendous amount of conversation occurring about student loans – from those attending college, those who recently graduated, and those who graduated years ago. Let’s see if we can define some of the information surrounding student loans.
Part of the confusion centers around the different types of loans. Federal loans come in a variety of subsidized and unsubsidized. Subsidized loans are given to those whom it is determined to have a financial need. They have a lower interest rate, and the interest rate does not start accruing until after you graduate, leave school, or drop below full-time.
All students can be eligible for unsubsidized loans. They are at a higher interest rate than the subsidized loans, and the interest starts accruing when the loan is taken out. You can elect to start paying the interest immediately, or you can elect to wait until after graduation to begin paying the interest amount.
The subsidized and unsubsidized loans are federal loans received directly from the school through a federal agency. There is a limit each year as to the amount that a student can be awarded. Private student loans are obtained from an outside source – from a financial institution such as a bank or credit union. Interest generally starts accruing from the day the loan is taken out.
Point one – student loans require repayment. Therefore, when calculating tuition credits on your tax return while in school, they do not count as “financial aid” when determining the amount eligible for the credit. Even though you may not have paid any cash out to attend school because you received student loans, you may still be eligible to claim the education credit.
Point two – it is important that you understand what types of student loans you have. Federal government student loans are rarely forgiven. These loans are required to start being repaid six months after graduation, leaving school, or dropping below full-time attendance. If you fail to pay these loans, you can have your federal and state income tax returns taken to pay the loans. You can have your wages or retirement accounts garnished to pay the loans. These loans usually are not forgiven in bankruptcy.
Private student loans have their own rules and regulations. Frequently, they also delay until six months after graduation, leaving school, or dropping below full-time. They do not have to, but most often, they choose to do so. The other features are closer to other types of loans. They often require a co-signer since the student does not have the income to support the loan. The interest rates are generally higher. If you fail to pay private loans, the co-signer will have to make the payments. These loans can potentially be forgiven in bankruptcy.
Federal subsidized and unsubsidized loans and private student loans are all loans taken out by the student and are the student’s responsibility to repay. Parents can get federal loans, also – called Parent Plus loans. These loans can be set to start repayments of interest only immediately, start repayments of principal and interest, or you can defer payments until graduation, the student leaves school or falls below full-time enrollment.
Point three – many parents take out Parent Plus loans expecting their children will later make the payments. This may not be possible for the child to do. If they are paying their own loans or not finding employment with sufficient wages, they may not be able to make the payments. Or – it may be if they are trying to make all the loan payments, it means they are still living in your house because they cannot afford to live elsewhere.
Think carefully about taking Parent Plus loans and their impact on your ability to retire or manage your finances if you also must repay this loan. It may be better to take out a personal loan, a home equity loan, or even refinancing your mortgage because of lower interest rates, the need to start repayment, and/or the repayment terms immediately.
There is a saying, “Your child has a long time to repay education loans. You cannot take out loans to finance retirement”. Be careful about what you commit for your child’s education if you are not set for your retirement.
Sometimes avoiding loans is the better option. Some suggestions:
• Making installment loan payments from current income and paying over the school year.
• If you will qualify for the tuition tax credit, this means up to $2,500 additional refund. You could consider changing your withholding to get that upfront to help with installment payments.
• Consider colleges that avoid the need for loans. Start at community college and transfer. Find colleges that are offering financial aid and that you can afford.
• Have your child spend time researching and applying for scholarships – thousands of them are not used every semester.
• Avoid taking out loans for living expenses if your child is still living at home. While this can put money in your pocket today, it can be costly money to borrow long-term.
• If you are comfortable with your retirement savings, it may be possible to use some of those funds for education without an IRS penalty.
For those that have taken out loans, you need to understand repayment terms. Again, federal loans and private loans are different.
Once graduation occurs, the subsidized and unsubsidized loans are treated the same. The interest rates may be different, but otherwise, they are now the same. Repayment is required to begin six months after graduation, leaving school, or falling below full-time status.
Point four – you can elect to start making payments sooner than six months. By doing so, when they calculate what your required payment will be, the payment will be lower because the outstanding balance is lower. This is also true with the current pandemic deferral – if you continue to make voluntary loan payments now, even though the deferral, your payments when you must start paying should be lower or end quicker. Many individuals believe if they make some payments, they are now forced into scheduled payments. This is not true – all your current payments are voluntary and can be whatever amount you wish. You are currently in control of those payment amounts and the timing of the payments.
Federal loans can be consolidated into one. If you consolidate, the interest rates will be averaged together.
Point five – if you think you will make “extra payments,” it might make sense to avoid consolidating loans. If you want to make additional payments and you leave the loans separate, you can make those payments against the highest interest rate loans first to pay loans off the quickest.
In general, for federal loans, the repayment terms are set up to pay the loans off in 30 years. There are a lot of other options that can apply also. Other options include:
• You choose the income-repayment option. Each year, you notify the student loan organization of your income. They will determine your required payment for the next 12 months. If your income is low enough, there is the possibility that your payment will be zero. Interest does continue to accrue, and we suggest you go back and re-read point four above.
• For those who work for a not-for-profit and specific agencies, with ten years of on-time payments, the balance of your federal loans will be forgiven.
• For those who do not qualify for the 10-year option, your loans can be forgiven after 25 years of on-time payments.
Point six – The 10-year loan forgiveness program is just reaching the point where graduates ask for forgiveness. Many find they do not qualify because of the failure to make 100% of their payments on time or not meeting other requirements. Be careful, especially on the 25-year option, of counting on this happening.
Funding college expenses is a significant undertaking. Getting through college is a major undertaking. Once you graduate, if you took out student loans getting those paid off is a critical undertaking. Planning with Purpose can assist you in determining how to pay for college – from helping to fill out the FAFSA form, determining how to pay for college, determining who gets to take the student loan interest deduction, and calculating the impact of education credits. We can also talk about how to get student loans paid off and create a realistic repayment plan. Please give us a call if we can be of assistance – we are available to have any number of conversations regarding educational expenses.
