STRATEGIC APPROACHES TO STUDENT LOAN REPAYMENT Jeffrey E. Hanson Jeffrey Hanson Educa0on Services HansonEdServices@gmail.com (302) 540-1286 WASFAA Conference Spring 2014
Federal student loans are unique 2 Borrowers should never miss a payment or default Payment relief op6ons exist that provide financial safety nets Payments can be less than 15% of AGI Flexible payment op6ons including income- driven repayment plans that can limit debt- to- income ra6o impacts Debt could be gone within 25 years Por6on of debt could be forgiven if not fully repaid This educawonal mortgage should not prevent them from: þ Pursuing their desired career þ Achieving their financial goals
As such, faster may not be be>er when repaying federal student loans! 3 Borrowers may want to: Consider taking as long as possible to repay their federal student loans Why? They may have beler uses for their extra funds from an opportunity cost perspec6ve
Opportunity Cost 4 It s about trade- offs Borrowers have scarce resources Time Money They should ask themself: If I did not spend my 6me/money on this now, what else could I use it for and would that be beler for me?
What other uses? 5 Borrowers must decide how to allocate their monthly income among four buckets... debts Past living expenses Present savings, investments Future charitable donations Philanthropy
The Future Bucket 6 They also should be: Saving for a rainy day the emergency fund Minimum of 6-9 months of their average monthly living expenses Inves6ng for re6rement Minimum of 10% of their gross monthly income Saving for their children s educa6on Minimum needed uncertain- - may need to start paying for children s educa5on much sooner than expected (e.g., elementary school) Saving for the down payment for a home Minimum of 10% of purchase price
What should borrowers do? 7 Borrowers should consider: Why? Choosing the repayment plan that offers the LOWEST scheduled monthly payment This provides maximum cash flow flexibility so they can: Maximize amount they are prepaying in a targeted way at their most expensive debt (e.g., Grad PLUS Loans), AND/OR Allocate extra cash for other purposes (e.g., FUTURE bucket).
8 Won t this debt prevent them borrowing for other purposes, e.g., buying a home?
The EducaWon Mortgage 9 Increasing majority of students now must borrow money to pay for school Federal student loan debt levels are increasing Many undergraduates now graduate with federal loan debts exceeding $30,000. For graduate/professional students, the average now exceeds $100,000; and for a growing number it is more than $200,000 Borrowing money is not a bad thing if it allows students to obtain their educa6on NOW it is an INVESTMENT just as a home is an investment
But with this Mortgage 10 they don t get a house!
So, can they swll buy a house? 11 Surprisingly, the answer probably is: Sooner than they might think, IF they make STRATEGIC financial decisions! Qualifying for a conven6onal mortgage requires: Sufficient collateral Willingness to pay Ability to pay Down payment
Will they qualify? 12 Sufficient collateral Typically not an issue Realtors should discourage buyers from offering to pay more for a property than its worth
Will they qualify? 13 Sufficient collateral Willingness to pay Based on credit score Federal student loan debt does not seem to have a significant nega6ve impact on credit score if all other aspects of consumer s credit are good
Will they qualify? 14 Sufficient collateral Willingness to pay Ability to pay Based on monthly debt to income ra6o Ra6o should not exceed 36-40% including home mortgage payment Federal student loan monthly payment need not exceed 15% of household s adjusted gross monthly income so that leaves at least 20-25% of gross monthly income for mortgage payment
Will they qualify? 15 Sufficient collateral Willingness to pay Ability to pay Down payment Probably need at least 10% of purchase price Cannot come from borrowed money But, federal student loan borrowers could start saving for the down payment much sooner if they chose to pay the smallest amount possible on their federal student loans it s about gelng financially posi6oned to qualify for a mortgage
Will they qualify? 16 Sufficient collateral Willingness to pay Ability to pay? Down payment Conclusion: It does not have to be the federal student loan debt that prevents a borrower from qualifying for a mortgage; it more likely could be the lack of a down payment!
17 The 15% Reality
Federal Direct Loans have 18 Flexible repayment op6ons including income- driven payment plans: Pay As You Earn (PAYE) Income- Based Repayment (IBR) Income- Con6ngent Repayment (ICR) No other form of personal credit (including campus- based federal student loans and private student loans) offers income- driven op0ons. 18
Federal Direct Loans have 19 Payment relief op6ons: Deferment Forbearance Adjustments to monthly payment Payment relief (if it is available at all) is much more limited with other forms of personal credit (including campus- based federal student loans and private student loans). 19
Federal Direct Loans have 20 Loan Forgiveness Public Service Loan Forgiveness (PSLF) Teacher Loan Forgiveness Loan Cancella6on Cancella6on with income- driven repayment plans Loan Discharge Discharge in case of death or total/permanent disability (TPD) of the borrower 20
Why are Federal Direct Loans so different from other forms of credit? 21 Eligibility for Federal Direct Loans (as well as other federal student loans) is NOT based on the borrower s ability to pay Eligibility for all other forms of credit (except campus- based/private student loans) does require ability to pay on the front end 21
Why does all this mager? 22 Financing a post- secondary/post- graduate educa6on can be viewed differently from financing for all other expenditures Federal Direct Loans allow for affordable repayment op0ons without sacrificing: Career aspira6ons Inves6ng for the future (e.g., re6rement, home ownership, children s educa6on, building up an emergency fund, etc.) 22
Repaying Federal Direct Loans 23 is all about choices and strategy
Repayment Strategy Choosing the Right Plan 24 In developing a strategy, borrowers should: Understand their op6ons Es6mate their budget Define their goals Evaluate possible tradeoffs Leverage loan repayment flexibility Choose the plan that best meets all their needs
Loan Repayment OpWons Stafford, PLUS and ConsolidaWon Loans 25 Op6ons Payment Structure Payment Period Based on DEBT Based on INCOME Standard Fixed 10 years Graduated Tiered 10 years Extended Fixed or 6ered 25 years Adjusted annually based on: - Household AGI 20 years* Pay As You Earn (PAYE) - Household size *Any debt remaining aeer (Direct only) - Poverty guideline 20 years is cancelled (amount - State of residence cancelled taxable) 10% of annual Discre5onary Income Income Based (IBR) Income- Con6ngent (ICR) (Direct only) Adjusted annually based on: - Household AGI - Household size - Poverty guideline - State of residence 15% of annual Discre5onary Income Adjusted annually based on: - Household AGI - Household size - Total amount of Direct Loans Approx. 20% of discre5onary income 25 years** **Any debt remaining aeer 25 years is cancelled (amount cancelled taxable) 25 years** **Any debt remaining aeer 25 years is cancelled (amount cancelled taxable)
26 PAYE AddiWonal Eligibility Requirements Must be a new borrower on or aser October 1, 2007 (10/1/2007) No Direct or FFEL loans before 10/1/2007, OR No outstanding balance on an exis6ng Direct/FFEL when you borrowed your first federal student loan on or aser 10/1/2007 Must have had a disbursement of a federal student loan on or aser 10/1/2011
EsWmaWng Monthly Payments Repayment EsWmator at: StudentLoans.gov 27 To SIGN IN enter: SSN First two letters of your last name Birthdate Dept. of Ed PIN Duplicate PIN available at: PIN.ed.gov
28 Payment Comparisons - - Undergraduate Student $35,000 Federal Direct Student Loan Debt (Assumed interest rate = 3.86%) Household AGI = $30,000 (Household Size = 1) (Es0mates calculated using Repayment Es0mator at: StudentLoans.gov) *Assumes household AGI increases by 5% per year and federal poverty guideline increases by 3.3% per year Projected Loan Forgiveness is taxable under current IRS rules
29 Payment Comparisons - - Undergraduate Student $35,000 Federal Direct Student Loan Debt (Assumed interest rate = 3.86%) Household AGI = $30,000 (Household Size = 1) (Es0mates calculated using Repayment Es0mator at: StudentLoans.gov)
30 Payment Comparisons - - Professional Student $100,000 Federal Direct Student Loan Debt (Assumed interest rate = 6%) Household AGI = $60,000 (Household Size = 1) (Es0mates calculated using Repayment Es0mator at: StudentLoans.gov) *Assumes Household AGI increases by 5% per year and federal poverty guideline increases by 3.3% per year Projected Loan Forgiveness is taxable under current IRS rules
31 Payment Comparisons - - Professional Student $100,000 Federal Direct Student Loan Debt (Assumed interest rate = 6%) Household AGI = $60,000 (Household Size = 1) (Es0mates calculated using Repayment Es0mator at: StudentLoans.gov)
Loan Prepayment 32 Borrowers can make prepayments on their federal student loan(s) without penalty Will reduce total interest paid on loan Must contact the loan servicer before they make a prepayment Ask what steps are needed to submit prepayments Advise servicer they want to prepay the loan rather than advance the due date Target prepayment at loan(s) with highest interest rate
33 ConsolidaWon
34 ConsolidaWon Can be confusing! Consolida6on COMBINING loans Consolida6on = REFINANCING loans
ConsolidaWon A Refinancing OpWon 35 Borrowing a new loan Federal Direct Consolida6on Loan Only federal student loans are eligible Interest rate is fixed but does not get borrower a beler deal Equals weighted average of interest rates of loans being consolidated then rounded up to nearest 1/8 th percent Now apply online at: StudentLoans.gov Loans must be in grace, repayment, deferment or forbearance Can opt to delay funding of new loan un6l end of grace period Can select loan servicer for new loan
Reasons to Consolidate 36 Simplify repayment by reducing number of lenders/servicers Convert variable- rate Stafford Loans into a fixed- rate Direct Consolida6on Loan Convert FFEL loan(s) into Direct loan debt for Public Service Loan Forgiveness (PSLF) Program and PAYE eligibility Convert Perkins/HPSL/LDS loan(s) into Direct loan debt for PSLF, IBR and PAYE eligibility Lengthen repayment period to reduce monthly payment on federal student loan debt (including addi6on of Extended Repayment eligibility) Release endorser from Grad PLUS Loan Refinance Federal Direct Loans borrowed before 10/1/2007 so that the debt is now part of a Federal Direct Consolida0on Loan that was disbursed amer PSLF became available on 10/1/2007
37 A few final comments
A shiling paradigm 38 Federal Direct Loans are a unique form of credit Payment relief op6ons Flexible repayment including income- driven payment op6ons Forgiveness, cancella6on and discharge provisions Borrowers (and parents) need to be educated on these unique features so that they can make strategic borrowing and repayment decisions
Takeaways 39 What is best for students? It depends on student s: Concerns over debt Short- term and long- term financial goals What can you do to help students? Educate them so that they are more able to make an informed strategic decision Provide tools/resources such as a checklist of factors to consider, calculators and other online informa6on
When making decisions about repayment 40 Borrowers need to weigh importance of reducing interest costs vs. ability to achieve other financial goals more quickly Beware of risks Uncertainty of future income Uncertainty of future expenses
For more informawon 41 General loan and repayment informawon: StudentAid.gov Repayment EsWmator and applicawon for income- driven repayment opwons: StudentLoans.gov Public Service Loan Forgiveness (PSLF program): StudentAid.ed.gov/publicservice