Welcome back to Melissa Making Cents!
As a financial professional and frankly a human being, I have created a few rules for myself to follow! This is sometimes it is necessary to handle the hoards of bad advice that is given to others. Rules such as making your bed every morning, drinking eight glasses of water, and not getting into online discussions with others makes may day go a little smoother.
Well...I broke a personal rule this week, and it made me sad, angry, and a little agitated.
I read the comments…
You know how it goes, you see a story online, click to read it, then keep scrolling down to the comment section. It usually goes the same way no matter what the topic - It always always always goes bad. This is why I made a personal rule to never read comments on stories posted online.
This story happened to be on student loan debt. The story and the comments were just one instance of what I see all too often - misinformation regarding how the loan forgiveness programs work. I constantly hear people talking about how they feel like their debt isn’t declining. In my recent blog post titled Do Student Loans Make Cents, I explained how loans work and mentioned that sometimes you don’t want to make an extra loan payment. Today I will tell you why.
I hope I can clarify a little of the student loan mystery. My hope is that this truly helps you gain a better understanding of the process, and it can relieve a little of the anxiety that having a mountain of debt can bring.
There are two separate programs for student loan forgiveness programs.
As a financial planner, I believe the most important thing to clarify is that there are two programs associated with student loan forgiveness. Both programs require you to pay a certain number of loan payments before your balance is forgiven, though they work in different ways. One program is the Public Service Loan Forgiveness program. it is for employees of non-profit organizations or government services. The other program is the Federal Student Loan Forgiveness program, and it is for everyone else. Creating a financial blueprint to knock out your student loan debt will depend on which plan you qualify for!
Public Service Loan Forgiveness program is great for those that qualify
The Public Service Loan Forgiveness (PSLF) was created in 2007 as part of the College Cost Reduction and Access Act. PSLF is a federal program designed to encourage students to enter relatively low-paying careers like firefighting, teaching, government, nursing, public interest law, and the military. Once graduated, students are required to make 10 years, or 120 months, of payments before their student loan balances are forgiven tax free.
To qualify for the program you must meet the following requirements:
- Work full time for a qualifying employer
- Have the correct type of loans, or consolidate
- Switch to income-driven repayment
- Make 10 years’ worth of payments
- Apply for forgiveness
Currently 33 million people qualify for the Public Service Loan Forgiveness program
According to the U.S. Department of Education, as of March 2019 there were only 86,006 total applications for the program. A small 1% of applicants have been approved so far. It’s this 1% number that is leading people to believe that the program is a myth, or impossible to qualify for. As of March 2019, 56,353 individuals have been denied for not meeting the requirements and 18,785 were denied for missing information, such as a missing social security identifier.
So… why are so many people being denied? I’ve heard lots of theories. One idea is that there has been a lack of clarity and information. When the program was created there was a lack of clear repayment details provided to borrowers. There was also a lack of direction for loan servicers and lenders. It took a little while for people to get on the right track. Now that the word is out on the street, we should see a rise in the numbers of loans forgiven. Fingers crossed it can bring relief to lots of worthy folks!
The Federal Student Loan Forgiveness is completely taxable!
Confused? The programs sound an awful lot alike! For the most part they are, but there are a couple of major differences. The first difference is that you are required to make payments for a longer period of time. In this program it’s 20-25 years compared to the 10 years for the PSLF program. The second difference is that the balance forgiven at the end of the program is completely ...TAXABLE. Yep.. you read that right. Not only do you pay longer, but the loan amount that is forgiven is going to be taxed as income.
If you are relying on this program, you have a bit of planning to do. Right out of college your starting salary may not be a rainmaker. However, most people are lucky enough to earn more as time passes and more experience is gathered. Think about how much your income will be 20 years from now. What would tax look like on a balance of $30,000 to $300,000 taxed at the marginal rate you will have when you are earning more twenty years from now? Shocking and a bit depressing?
Planning ahead with your loans in mind will pay off in the end. While you are repaying your loans it is important to manage your income to maintain status in one of the required Income Based Repayment options. This might mean deferring as much income as possible into your employer’s retirement plan. If you know that you will not qualify for the Public Service Loan Forgiveness program, you'll want to start saving for the taxes due. Saving for the hefty taxes upfront will help minimize the heartache down the road.
Evaluate the effect filing your taxes has on your student loan repayment
Everyone assumes that married filing jointly is the “cheapest” way to file income taxes. And, for tax purposes, that may be correct. However, the status you use could significantly increase your income based repayments. Getting married increases the family income, and therefore the debt to income ratio improves. (Unless you both have debt.) In the income based repayment options, that might mean doubling or even tripling your monthly payments. Compare the annual costs of your loan payments to the estimated taxes based on married filing joint or married filing separate. It could make a big difference in your monthly budget.
The example above shows how a single borrower’s monthly loan payments might change due to the change in tax filing status. She will go from paying $547 a month as a single person, to $1,441 a month by filing Married Filing Jointly. If they filed Married filing Separately, it could save $731 a month or $8,772 a year. I would refer this couple to their tax planner for a comparison of the taxes paid.
Income Driven Repayment Options are the only way to loan forgiveness
The federal government offers four income-driven repayment plans that can lower your monthly bills based on your income and family size. All income-driven repayment plans share some similarities: Each cap payments to between 10% and 20% of your discretionary income and forgives your remaining loan balance after 20 or 25 years of payments. The four plans are:
- Income-Based Repayment
- Income-Contingent Repayment
- Pay As You Earn
- Revised Pay As You Earn
When monthly budgets are tight, income-based repayments are favorable. They offer lower payment options that will adjust up or down as incomes fluctuate. Nevertheless any payment made under any of these methods qualify for loan forgiveness.
Technically the default Standard 10 year Repayment method is considered to be part of both loan forgiveness programs. However with this repayment method you are required to repay the entire loan over 120 months, which is when you would then qualify for PSLF if you decided to use the income-driven repayment methods. Income-driven repayments are ways more budget friendly, and will save you serious coin in the long run. If you qualify for the Public Service Loan Forgiveness program, it really is at your advantage to manage your income to keep loan payments down and more dollars saved in your pocket.
Beware that income-driven repayment almost always guarantees negative amortization
Simply put, negative amortization is bad. And by bad I mean really ugly. It means that your monthly loan payment is often less than than the interest accruing on your loan. You can see how it works in the example below. No doubt you have heard the complaints of people paying their student loans back for 10 years and the balances haven’t dropped. Negative amortization is the reason behind the mess.
Negative amortization occurs when the interest accruing on your loans is higher than the payment being made. The point of the income driven repayment program is to help keep payments as low as possible. For the borrowers that qualify for Public Service Loan Forgiveness program, it doesn’t matter. After 10 years of qualifying payments in the program your balance is written off tax free.
For others, using the Federal Student Loan Forgiveness program, it can be a big deal, because of the tax implications at the end of the term. At this point we find people complaining about the scam they call the student loan system. And to a point they are right. Why is it you make payments for 20-25 years, only to have to pay tax on the balance? It truly sounds like a bum deal, and it is! But as they say, “You can’t have your cake and eat it too”.
Direct or direct consolidated student loans are the only loans that qualify for the Public Service Loan Forgiveness. Private Loans DO NOT count. You can consolidate other types of federal student loans, for example — Federal Family Education Loan loans (FFEL) or Perkins loans — to make them PSLF-eligible. If you need to consolidate your loans to qualify, you will want to do it ASAP. Consolidating the loans erases any qualifying payments, and starts the clock over on the 120 payments required.
You must make 10 years of qualifying payments for Public Service Loan Forgiveness
You must make 10 years or 120 months of payments for the Public Service Loan Forgiveness program. You also must be working for a qualified non-profit or government agency while making these payments. They do not have to be consecutive. This means you can pause and go into forbearance, or even change jobs. Loan forebearace allows borrowers to temporarily stop or reduce their monthly payments.
Qualifying payments for PSLF are:
- Made on or after October 1, 2007
- Required payments, extra payments do not count
- For the full amount due.
- On time, meaning within 15 days of your due date.
- While you’re working full time for a qualifying employer and on a qualifying repayment plan.
Payments that do not count:
- While you are in school
- In deferment or forbearance
- In a grace period
- Loans that are delinquent or in default.
You must apply for the Public Service Loan Forgiveness Program to be able to qualify
Finally, once you’ve met all of the above requirements, submit the Public Service Loan Forgiveness application to FedLoan Servicing. FedLoan Servicing will let you know when they get your application.
Remember, you must be working full time for a qualifying employer when you apply.
Along with the application, you’ll need to submit an employment certification form for your current employer and each employer you had while making the 120 payments. It’s a great practice to get your employment certifications each year, and keep them with a record of all the qualifying payments you made for the year.
So.. that’s it in a nutshell.
It’s really easy to see why there are not a lot of people applying for the loan forgiveness programs. From the outside in, it is very complicated and it’s easy to get lost in the middle of who, what, when and where. But the great news is that there is help available!
As a financial planner and College Funding and Student Loan Advisor, I work with families to create college funding plans that minimize the impact of student loan debt. If you or someone you know needs help navigating the student loan system, call or click here to setup a no cost consultation!
Until next time...this is Melissa Making Cents!
Melissa Anne Cox
CERTIFIED FINANCIAL PLANNER™ is also a College funding and Student Loan Advisor in Dallas, Texas