What You Need to Know
- The CARES Act and other legislation enacted in 2020 provides student debt relief.
- There are important eligibility differences between federal and private loans.
- Biden hopes to overhaul the income-based repayment program.
Rising college costs and low borrowing restrictions on student loans mean that many young clients and their parents are struggling with education debt. Advisors need to be aware of changes brought about by the CARES Act and other legislative actions taken in 2020 that provide some relief for borrowers.
One form of relief came through the suspension of payments on federal loans held by the Department of Education. The suspension period was originally set to apply from March 13, 2020 to Sept. 30, 2020, but was subsequently extended to Sept. 30, 2021. During this period, payments were automatically stopped for borrowers with qualifying loans.
Another form of relief came from dropping interest rates to 0% on these same loans. This sounds straightforward, but advisors need to be aware that there are really three primary types of loans: federal loans, private loans, and hybrid federal/private loans offered through the Federal Family Education Loan (FFEL) Program.
The emergency relief benefits apply only to borrowers with federal loans held by the federal government, and do not apply to the majority of federally backed FFEL loans issued by private lenders before 2010.
Borrowers With Existing Federal Student Loan Debt
The CARES Act greatly benefited those with PLUS loans, which generally carry higher interest rates, and those working toward loan forgiveness under either one of the income-driven repayment (IDR) plans such as Pay As You Earn (PAYE) or Income-Based Repayment (IBR), and those working toward loan forgiveness under the Public Service Loan Forgiveness (PSLF) program.
An interest waiver is worth most to borrowers whose loans have higher interest rates and those who are still able to pay during relief periods.
For those borrowers working toward loan forgiveness, the 10-month suspension of payments will count as if qualifying payments were made toward the 20- or 25-year repayment period for borrowers in an IDR plan and 10 years under PSLF.
Under the current rules, borrowers who are working toward PSLF and were still able to make payments during relief periods were better off not making them since this would reduce the value of the tax-free loan forgiveness they are working toward.
In a nutshell, borrowers who aren’t working toward or planning on forgiveness should make payments during grace periods and when interest waivers are available to reduce the overall cost of borrowing, while those who are working toward forgiveness may be better off investing their funds elsewhere to maximize the value of loan forgiveness, whether it is tax-free as is under PSLF or taxable as it currently stands for IDR forgiveness.
Borrowers With Private Student Loans or FFEL Loans
Unfortunately, emergency relief did not apply to holders of private and most FFEL loans. Borrowers of FFEL loans may have considered consolidating their loans using a direct consolidation loan to benefit from the relief measures, but consolidating takes time and could have also jeopardized the borrower’s ability to qualify for loan forgiveness.
Consolidating can be a good thing and can make borrowers eligible to participate in certain IDR plans and work toward forgiveness under PSLF, but one instance in which consolidating could be detrimental is when the FFEL loan borrower has already made a significant amount of qualifying payments under the income-based repayment (IBR) plan.
This is because IBR is the only IDR plan for which FFEL loan borrowers can receive forgiveness. When a borrower consolidates into a direct consolidation loan and enrolls into an income-driven repayment plan, the 20- or 25-year repayment clock resets!
Knowing which type of loans the borrower has (federal or private) and distinguishing the lender from the servicer are critically important when advising on student loan matters.
While a borrower may have wanted to benefit from the short-term relief provided by the CARES Act and recent legislative actions, not fully understanding the options available and their consequences could potentially cost the borrower much more in the long run.
And while private loan borrowers did not receive standardized relief under the CARES Act, many private lenders have offered some form of relief for borrowers primarily through forbearance as opposed to interest rate waivers.
This means that even if the borrower were not forced to make payments over a short period of time, interest on these loans would still accrue and increase the cost of borrowing over time.
Despite the lack of standardized relief, many private loan borrowers can take advantage of today’s low interest rates. Borrowers holding loans with higher interest rates should consider refinancing, assuming their credit is good enough and they weren’t affected economically by the pandemic.
For employees who aren’t able to secure better rates on their loans, it is possible their employers might start chipping in now to share some of the cost.
Under the CARES Act and from recent legislative authority, employers are now able to establish an education assistance program under IRC 127 to help repay principal and interest on qualifying loans for employees. Up to $5,250 per year (through 2025) of assistance is deductible by the employer and excludable from the gross income of the employee.
This has become an increasingly popular tax-efficient employee benefit used to retain skilled workers, and advisors should become more familiar with enhanced education-related tax benefits for both employees and business owners.
Borrowers With High-Interest-Rate Federal Loans and Prospective Borrowers
What about borrowers who hold federal loans with higher interest rates, as is the case with many graduate and parent PLUS loan borrowers? What about prospective students and parents considering financing options for later this year or in future years?
Let’s tackle the current borrowers first. The main thing these borrowers need to determine is which benefits are most valuable to them.
Do they value the repayment plan flexibility and ability to have monthly payments tied to their “ability to pay”? Do they value the prospect of the government stepping in to provide sweeping emergency relief? Do they plan on receiving loan forgiveness based on their current and projected debt-to-income ratio? Or are they planning on repaying quickly and value obtaining the loan with the lowest interest rate possible?
In addition, advisors need to know which type of borrower they are working with: Undergraduate students? Graduate students? Parents?
It may be worth it in the long run to refinance high-interest-rate federal loans using private loans (and forgo the benefits) if the primary objective is to repay the debt as quickly as possible, the borrower has the means to do so, and the borrower does not plan on working for a qualifying public service organization.