An Update on Federal Student Loans

An Update on Federal Student Loans

An Updated New Student Loan Repayment Plan

As tuition costs have increased over 5% annually between 2000 and 2020 at four-year public colleges (National Center for Education Statistics), the current outstanding federal loan balance has grown to $1.64 trillion, and the average federal student loan balance per borrower is almost $38,000 (Education Data Initiative). Though federal student loan payments were paused in March 2020 at the start of the pandemic, borrowers will need to restart their monthly payments in October.This summer the U.S. Supreme Court struck down a Biden Administration proposal that would have canceled up to $10,000 of Federal student debt per borrower, but another component of the proposal, a new Income-Driven Repayment SAVE (Saving on A Valuable Education) plan, appears to be moving forward. According to the Department of Education’s final regulations, the SAVE program will replace the existing REPAYE Plan on October 1st. Let’s take a closer look at the SAVE plan and how it may provide debt relief for some borrowers.

Reduced Monthly Payments

Under the existing REPAYE plan, loan payments were calculated to be 10% of a borrower’s discretionary income. Discretionary income was defined as household adjusted gross income above 150% of the Federal Poverty Level. Under this new student loan repayment plan, the payments for undergraduate loans have been reduced to 5% of discretionary income, and the definition of discretionary income has been increased to 225% for both undergraduate and graduate loans.

This will have the effect of decreasing monthly loan payments for the vast majority of borrowers. The reduction will be much more impactful for borrowers with undergraduate loans, since the discretionary income calculation is reduced by half and does not apply to graduate loans (whose reductions will be more modest). The Student Loan Planner website has a discretionary income calculator to get an idea of what new payments could be reduced to, depending on the borrower’s circumstances.

Expanded Forgiveness Options with the SAVE Program

Under the existing Income-Driven Repayment plans, loans can be forgiven after borrowers have been making payments for between 20 (undergraduate) to 25 years (graduate). The SAVE Plan allows for loans with combined original balances (undergraduate and graduate)  of $12,000 or less to be forgiven after making payments for only 10 years (120 months), instead of 20-25 years. For original loan balances between $12,001 and $21,000 (undergraduate) and between $12,001 and $21,000 (graduate), loans will still be forgiven in a timeframe ranging between 10 and 25 years.

Also, the Department of Education’s new regulations add several criteria that allow months where payments were not made to count towards the loan forgiveness calculation. Currently, months in which payments not made due to economic hardship still count towards the amount of time required for loan forgiveness. The new regulations add the following criteria to this list of months that still qualify:

  Deferments for cancer treatments;

·         Deferments for rehabilitation training programs;

·         Administrative and bankruptcy forbearance

·         Unemployment deferments;

·         Military service and post active-duty student deferments;

·         National service, national guard duty, and Department of Defense Student Loan Repayment forbearance;

Elimination of Negative AmortizationNegative amortization can occur when a loan payment is not enough to cover the loan interest, so the remaining interest gets added to the loan principal and the balance can balloon beyond the original loan amount. Under the old REPAYE Plan, interest was subsidized during the first 3 years of the loan, but afterwards only 50% of the interest was subsidized.

The SAVE plan subsidizes the full amount of interest until the loan is paid off. This can be especially beneficial for borrowers who will eventually have their loan balances forgiven after the 10-25 year repayment period (depending on their circumstances). The IRS considers debt cancellation as taxable income in the year of forgiveness. If the loan balances for borrowers with negative amortization had continued to grow, it would have been possible for some of them to owe tax on more than the original loan balance.

Married-Filing-Separate Borrowers Can Exclude Spouses’ Incomes

One problem with the existing REPAYE Plan is that borrowers were required to include their spouse’s income in determining their monthly payment amount, causing borrowers married to high earners to make higher monthly payments than they would pay as single filers. The new student loan repayment plans however allows Married Filing Separately taxpayers to exclude their spouse’s income from the monthly payment calculation.

Only a very small percentage of married Americans file their taxes using Married Filing Separately status, as there are many tax credits unavailable unless taxes are filed jointly. However, in some cases it could actually be worth it if the savings amount from reducing loan payments by excluding the income more than makes up for the loss of tax credits available to joint filers.

As always, it is best to consult with a financial professional before making important decisions about tax filing status, or any other items you may have questions about. Please feel free to reach out to us. We are here to help!

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Scott Adair, CFP®

Your wealth management goals are in good hands. Scott Adair hones in on your investment strategies and comes up with a plan that works for you. Scott is an Investment Advisor Representative and Certified Financial Planner (CFP®). His advice is tailored to each individual client.

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