Student loan debt has emerged as one of the most significant economic challenges for millions of Americans, 43 million of whom owe $1.2 trillion in student loans. That amount tops credit card debt and any other type of household debt except mortgages.
The average loan outstanding is $27,000 and many struggle to repay what they owe. One out of four graduates in 2009 defaulted on their loans within five years of graduation, a percentage likely to rise in the near future, according to a recent report from the New York Federal Reserve Bank.
So it should come as no surprise that helping clients’ children manage their student debt is becoming increasingly important for financial planners. They can help college graduates avoid delinquency and default while developing a broader financial plan, and build on their relationship with those graduates’ parents or grandparents who are already clients. At the same time planners can expand their client list to include members of the Gen Y (born between 1965 and 1980) and Gen X (born after 1980) generations.
Here are five of the most common recommendations planners have for those dealing with student debt
#1: Know What You Owe, and Your Repayment Options
First off, “know what you owe” in terms of your loans, advises Katie Brewer, president of Garland, Texas-based Your Richest Life, a member of the XY Planning Network, which focuses on Gen X and Gen Y members.
Then, she advises students and their parents to “know the differences in your payment plans and options about repayment.” She suggests that graduates gather their student loan statements and create a spreadsheet, and visit the National Student Loan Data System if they don’t have that information.
“Take ownership of your debt,” says Douglas Boneparth, VP of Life and Wealth Planning in New York. “Know what your loans are, who’s servicing them, what’s the obligation, interest rate, phone number to call. It’s your responsibility.”
#2: Explore Student Loan Repayment Plans
There are seven types of repayment plans for federal student loans: standard, graduated and extended repayment plans as well as plans that limit payments based on income. These include income-based (IBR), pay as you earn, income contingent and income sensitive repayment plans.
IBR limits payments to 15% of monthly discretionary income; the limit for pay as you earn is 10%. After 20 or 25 years of regular payments the remaining balance of most of these income-linked repayment plans is forgiven unless the graduate works in government or in the nonprofit sector. Then loans may be forgiven after only 10 years of regular payments under the Public Service Loan Forgiveness Program.
As of year-end 2014 almost 12% of student loan borrowers were enrolled in the IBR plan—up from just 6% in the third quarter of 2013, according to the U.S. Dept. of Education.
Graduates may be able defer payments or stop them temporarily under a program known as forbearance, but interest may continue to accrue, depending on the particular plan chosen and the lender.
Graduates are not automatically enrolled in any of these plans. They need to know the details, including eligibility, and file their paperwork on time. And if, for example, they don’t know how long they’ll stay in the government or nonprofit sector to qualify for forgiveness, they should file for that program anyway because otherwise they certainly won’t qualify, says Sophia Bera, president of Gen Y Planning in Minneapolis.
#3: Beware Programs Extending the Loan’s Term or Rates
Planners advise that student loan debtors know how particular repayment plans affect the amount of money they’ll owe in the long run. Any plan that lengthens the term of a loan or continues to accrue interest while repayment is on hold will ultimately cost more.
“The biggest mistake … is to keep putting loan payments on hold,” says Brewer. “ Any time you do that interest is ticking away, and a $40,000 loan put on hold can become a $70,000 loan.”
Another tactic that can increase loan payments over time is consolidation. Under consolidation, a new loan is taken out to pay off existing ones, which simplifies the repayment process but can lengthen the term of repayment and definitely increases the interest rate. The rate on the new loan is the weighted average of the rates on the old existing loans, rounded up to the nearest one-eighth of one percent. “I’m not a fan of consolidation,” says Bera. “You’ll be paying more.”
#4: Develop a Broad Financial Plan
Once graduates have done their homework, knowing what loans they have, repayment terms and options, they should consider their student debt as part of a broader financial plan—one that includes rainy day funds, retirement and likely home ownership.
“Identify priorities and financial goals,” says Boneparth. “Then become a master of cash flow so you can calculate student loan payments into your budget…You want to at least pay your interest.”
Brewer suggests that all fixed expenses including student loans not exceed 50% of income.
Advisors caution that graduates shouldn’t obsess about paying off their student debt leaving little to invest to meet other financial goals. For many of them, “investing is a low priority, retirement is so far away,” says Scott Stratton, president of Good Life Wealth Management in Dallas. “They want that student loan money off their back.” He likes to show recent graduates a chart showing the time value of money, which for many is “eye-opening.” The chart illustrates that investing $5,000 annually for 10 years, earning 8% starting at age 25, yields $615,000 by age 60 while investing $5,000 annually for 25 years starting at age 35 yields about $432,000 by age 60—or 30% less on an investment that’s more than twice as large.
#5: Pay Off the Most Expensive Debt First (and Pay on Time)
Advisors recommend paying off the most expensive debt first, which for many is their credit card debt. Then they suggest paying off first those student loans with the highest interest. “Focus on paying down anything with interest of 5 or 6% or more,” says Bera.
Advisors also suggest setting up automatic payments so that borrowers don’t fall behind on payments, which could affect their overall credit and disqualify them from remaining in some repayment programs.
The consensus of advisors? Student debt can and must be managed and should be viewed as just one part of a broader financial plan.
--- See these additional ThinkAdvisor college planning articles:
- 5 Tips for Saving for College in 2015
- Should Parents Sacrifice Retirement Saving For College Tuition?
- 30 Worst Paying College Majors: 2014
- 30 Best Paying College Majors: 2014
- 14 Best Paying Jobs for College Business Majors: 2014