BY Catherine Lightfoot, CPA, CHBC, Director, Healthcare, EEPB
The wait is over. The US Supreme Court voted 6-3 against President Bidens’ broad student loan forgiveness plan on Friday, June 30, 2023. During the forbearance, which began in March 2020, federal student loan payments were not required to be paid and interest did not accrue. Three years and nine extensions later, student debt bills could come as a shock to approximately 44 million borrowers. And borrowers who graduated in 2020, or later, will be making their first-ever loan payment. Due to a provision voted on June 3, there is little chance of a further extension. This provision, part of the debt ceiling bill, stated that debt repayment would begin sixty days from the earlier of a Supreme Court decision or June 30, 2023. Therefore, loans will begin to accrue interest starting on September 1st, with the first payment being due in October.
Choose a repayment plan
The good news is you do have choices. Read on to see which plan is right for you based on your earnings vs affordability.
Standard Repayment Plan – This plan will save you the most because it is paid off in the shortest amount of time. That means you will pay the least amount of interest over the life of the loan. This plan spans ten years and might not be affordable depending on the amount of your debt and your earnings.
Graduated Repayment Plan – This plan has lower payments at first that gradually increase, usually every two years, with an ending term of ten years.
Income-Driven Repayment (IDR) Plan – There are several more economic options available, including the Income-Based Repayment, Income-Contingent Repayment, Pay as You Earn, and Revised Pay As You Earn plans. Basically, these options have you making payments at 10-15% of your discretionary income updated annually. After 20-25 years of on-time payments (just 10 years if you qualify for the “public service” loan forgiveness program), the remaining balance is forgiven. The downside is you will usually pay more over time than under the 10-year Standard Plan. Fortunately, for those already under an IDR plan, please note that each month that passed during the deferment period still counts toward the total months you are required to be in the program.
For further detail, go to https://studentaid.gov.
Plan your loan payment
I suggest you make a budget with a bias toward debt repayment. Personally, I like the 60/25/15 rule of thumb. Sixty percent of your earnings are designated for spending, which includes debt repayment. Twenty-five percent is for taxes, and fifteen percent is for savings. Then subtract your monthly living expenses (shelter, food, insurance, etc.) to see how much you have left for debt repayment. It will be tempting to forgo the savings and try to put more towards debt, but I rarely see this successfully executed—only in extreme cases, when someone is driven to get out of debt in less than five years. Normally, the money is still spent, the debt is not paid off faster, and the compounding benefit of saving over time is lost.
Avoid lifestyle inflation
Another piece of advice…work on increasing your income while reducing your expenses, or at least keeping them level. If you get a pay raise, add the difference to your debt pay-down. Did you get a tax refund or a large cash gift from a relative? Direct these “windfalls” to your debt paydown. Do you have the opportunity to do bonus work, for example, an additional on-call schedule? Adding a few days a month could go a long way to reaching debt relief faster. Remember, the less time you are in debt, the less it will cost you to pay it off.
Consider debt refinancing or debt consolidation
We have all watched as the Fed raised interest rates ten times since March 2022. While federal student debt rates have also trended upward, borrowers with strong credit ratings may still find a lower rate. However, I recommend waiting to refinance federal loans until after the interest-free forbearance is over, September 1st. If you refinance, your federal loans will become private and no longer eligible for federal benefits, like the forgiveness programs. Therefore, even if it is a current lower monthly payment, it might not be worth losing federal benefits to refinance.
Conclusion
The COVID-19 pandemic, for all of its challenges, did bring a bit of a silver lining to student loan borrowers. If you were enrolled in an IDR plan, the deferred months counted toward your required term. All borrowers were allowed to defer payments without the risk of foreclosure. And interest did not accrue for a period of more than three years, saving everyone something. Now that the break is over, I encourage you to set a realistic plan that will allow you to pay down student loan debt as quickly as possible. Regardless of the type of loan repayment plan, time is not your friend as long as interest is accumulating.