Student loan repayments and interest are back in January for the unforgivable
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For many federal borrowers, developing repayment strategies is key, given that payments, interest and collections — paused since March 2020 — are expected to resume after Dec. 31.
This is true even though nearly 45% of borrowers, or nearly 20 million people, would see their debt fully forgiven under President Biden’s federal student loan forgiveness plan, according to early estimates, although developments recent policies have reduced the eligibility of some loan holders.
If you have student debt that won’t be forgiven under the Biden plan, the next steps to take depend on the borrower’s specific situation, according to professionals who advise on student loan matters.
Here are six considerations:
Understanding Your Eligibility for Forgiveness Comes First
Application for the Biden administration’s forgiveness plan is expected to open around early October, and borrowers are encouraged to apply by Nov. 15 for relief before loan payments resume, according to Federal Student Aid.
Borrowers whose loans are held by the US Department of Education are eligible for relief if their individual income is less than $125,000 ($250,000 for households). Eligible borrowers who were Pell Grant recipients can receive up to $20,000 in debt relief; otherwise, the maximum relief is $10,000. Borrowers whose outstanding loan balance is less than their maximum debt relief amount will receive relief equal to their total loan balance, according to Federal Student Aid.
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Don’t try to make repayment decisions based on the expectation of further large-scale forgiveness because that’s unlikely, said Michele Streeter, senior director of college affordability at the Institute for College Access & Success. There are, however, other assistance programs such as the Civil Service Loan Forgiveness or the Income Contingent Repayment Forgiveness to consider in the financial analysis.
Take control of your post-pardon balance
Loan balances remaining after the relief is applied will be re-amortized, according to Federal Student Aid. This means that borrowers’ monthly payments will be based on their new balance. Loan servicers should communicate the new, potentially lower amount.
Some borrowers may want to pay off or repay their balance near the resumption of payments, to take advantage of the zero rate environment. “In some cases, clearing the remaining balance before restarting is a great strategy,” said Michael Lux, attorney and founder of a website dedicated to student loan education, strategy and advocacy. “It’s a great way to take advantage of the 0% interest rate and reduce future interest expense on debt.”
However, this may not be an appropriate strategy for everyone.
Investigate other student loan forgiveness options
Some borrowers with larger balances may be better off sticking to minimum payments once they resume in January while they work toward other forgiveness.
If they have not already done so, borrowers should check to see if they qualify for additional forgiveness under time-limited modifications to the Civil Service Loan Forgiveness Program, which are available until October 31. They can visit the Federal Student Aid website to learn more.
Borrowers could also benefit from a new income-focused repayment plan proposed by President Biden. Among other things, borrowers shouldn’t pay more than 5% of their monthly discretionary income on undergraduate loans, said Lindsay Clark, chief borrower advocate at Savi, which provides borrowers with advice related to student loans. “That’s down from the 10% available under the last income-based reimbursement plan,” she said.
This could be particularly beneficial for low- and middle-income borrowers whose remaining balances are high after widespread government cancellation. However, the proposal still has to go through procedural channels, and some experts do not expect the new plan to be available until at least the summer.
Calculate the debt figures
How to approach repayment is a personal decision based on an individual’s overall financial situation.
Lauryn Williams, Certified Financial Planner on the CNBC Advisor Council and Senior Student Loan Advisor at Student Loan Planner, gave the hypothetical example of a borrower who earns $75,000 a year, has student loan debt of $170,000 and receives $20,000 from the pardon. This borrower, whose debt after cancellation is still double what he earns, is a good candidate for income-based repayment.
So, instead of rushing to pay off student loan debt, the borrower should consider putting that money into their 401(k) or 403(b). Because student loan repayments are based on adjusted gross income, you can get a lower student loan repayment by saving for retirement in a pre-tax retirement account, Williams said.
If, however, a borrower who earns $75,000 and owes $30,000 after Biden’s forgiveness relief might consider repaying the loans more aggressively. The borrower could set aside money in a savings account for the next few months and then make a large lump sum payment before the end of the year to reduce the loan balance before interest resumes, said Williams.
Borrowers with relatively low balances who have a strong financial footing and do not expect to need the various protections that federal loans offer, including income-based repayment and forbearance, might also consider refinance at a lower interest rate with a private lender, Williams said. .
The tax factor
Borrowers whose debt was canceled under the Biden plan will not owe federal taxes. But many could be responsible for state taxes. Indiana, for example, recently said the rebate would trigger state income taxes, and some borrowers may owe county levies in addition to state income tax. Mississippi and North Carolina have made similar announcements, and state-level taxation may be possible in Arkansas, California, Minnesota and Wisconsin.
Borrowers whose government will or is likely to levy taxes should ensure that they have a sufficient reserve to cover this obligation when weighing their repayment decisions.
The big picture
Borrowers who plan to make a voluntary payment should also ask their servicer how much outstanding interest they will owe before they can start repaying the principal, Clark said. When the payment pause is lifted, the unpaid interest will be capitalized and added to their existing balance. “You may want to pay off any outstanding interest to avoid having a larger overall balance at the end of the break,” Clark said.
Borrowers should be sure to think about the bigger picture when making decisions about student loan repayments, Lux said. “Borrowers may find it more beneficial to save for retirement or a home, depending on the interest rate on their student loan,” he said.
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