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, and this is why I made a personal rule to never read comments on stories posted. It always always always goes bad.
This story happened to be on student loan debt. There is so much 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 called 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.
Today 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 anxiety that having a mountain of debt can bring.
There are 2 separate programs for Student Loan Forgiveness.
The most important thing we need 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. What happens at the end of the day is totally different between the two programs. The Public Service Loan Forgiveness is for employees of non profit organizations or government services. The second program of Federal Student Loan Forgiveness is for everyone else.
Public Service Loan Forgiveness 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
- Follow the Program to a T
Currently 33 million people qualify for PSLF
According to the US 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. 56,353 individuals have been denied for not meeting the requirements 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 and lots of theories. It all comes down to the program starting in 2007, and the requirements on loan types and repayment methods. 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 services 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 major differences. The first being that the repayments required are longer. 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 total balance due 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? Shocking and a bit depressing?
Planning ahead with your student loans will pay off in the end
Planning ahead with your loans in mind will pay off in the end. While you are in repayment 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 program, you 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 Joint. If they filed Married filing Separate, it could save $731 a month or $8,772 a year. I would refer this couple to their tax planner for a comparison in 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. The 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 Standard Repayment is considered to be part of the program. 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. Income based repayments are ways more budget friendly, and will save you serious coin in the long run. If you qualify for Public Service Forgiveness, it really is at your advantage to manage your income to keep payments down and more dollars in your pocket.
Income driven options almost always guarantees negative amortization
Simply put, negative amortization is bad. And.. by bad I mean really ugly. It means that your repayment 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, it doesn’t matter. After 10 years of qualifying payments in the program your balance is written off tax free.
For others…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 loans are the only type of loans that qualify for Public Student Loan Forgiveness
Direct or direct consolidated student loans are the only loans that qualify for the Public Service Forgiveness. Private Loans DO NOT Count. You can consolidate other types of federal student loans — 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 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.
Qualifying payments for PSLF are:
- 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
- or if your loans are delinquent or in default.
You must apply for the Public Service Loan Forgiveness Program
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 great practice to get your employment certifications each year, and keep it 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 is 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 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 to setup a no cost consultation! It may save you money in the long run!
Until next time...this is Melissa Making Cents!
Melissa Anne Cox
CERTIFIED FINANCIAL PLANNER™