By Thomas N. Alvaré, CPA, PFS
Student loan debt doesn’t have a great reputation. Maybe because it’s directly associated with the high cost of college and how many of us must reluctantly borrow in order to enroll. Maybe it’s because the world of student loan options is complex, ever-changing, and difficult to navigate. Nevertheless, when compared to other forms of debt, we can clearly see that student loans are “good debt” rather than “bad debt.”
Debt is considered “good” when it is taken to improve your assets, your income, or your life. Student loan debt is such an example. According to 2017 data, the average annual earnings for those with a bachelor’s degree is 78% higher than earnings for high school graduates without degrees. For professional degrees, earnings are 158% higher. The improvement to income will generally lead to increased asset accumulation and, hopefully, an improved lifestyle.
Federal student loan debt also has many borrower-friendly features compared with other forms of debt. For one, you can defer payments while in school, on a fellowship, unemployed, or in financial hardship. With subsidized loans, interest charges are suspended while in deferment. Also, the repayment period can be stretched out over decades to reduce monthly payments.
Managing Your Student Loans
To manage your student loan debt, the first comes before college: create a funding plan that minimizes the total by reducing the cost of college. Basically, spend less to borrow less.
When finishing school, after accumulating student loans, match your choice of payment plan to your earning potential. Those who commit to working 10 years at a qualified public-service institution, those with large debt balances, and those with lower income growth potential may have options that could lead to the forgiveness of remaining balances after 20 or 25 years (10 years for public-service loan forgiveness). If, however, loan balances are modest (under $45,000) or income growth potential is high, forgiveness may be out of reach. There is a great calculator provided by the federal government to help size up your prospects.
The typical approach to debt is to pay it off as fast as you can afford. However, that can lead to onerous monthly payments, especially when just getting started in a new career. One student loan repayment option is based on income and resets the monthly payment amount each year (at 10%, 15%, or 20% of discretionary income, depending on the option chosen). The availability of the Pay-As-You-Earn (PAYE), Revised-Pay-As-You-Earn (REPAYE), and Income-Based-Repayment (IBR) options for new borrowers depends on loan type and when the loans originated. They present the best options for forgiveness at the end.
Therefore, the student loan repayment strategy for large loans is to pay as little as you can to increase the likelihood of not having to repay the loans in full. A valuable tip to help lower the loan payments is to lower the “discretionary” income used to set the payments. Employees typically have choices under their company benefit plans to contribute to company retirement accounts and health savings accounts. Electing to contribute to these savings vehicles will reduce income and the corresponding loan payment amount. However, you don’t lose those funds; they are invested for the future. To accumulate sufficient retirement assets for a happy life after career, graduates need to start saving at least 10% of their income from the first paycheck and throughout their earning years. For those with large student debt, it will also reduce your loan payments and total loan costs if it also leads to debt forgiveness at the end.
Other life factors, such as marriage and children, add complexity to selecting repayment plans. Before you elect a repayment plan, seek assistance from a CPA or a qualified student loan counselor.
Thomas N. Alvaré, CPA, PFS, is managing principal, senior lead advisor, with JFS Wealth Advisors in Doylestown, Pa.
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