Student Loans Weighing you Down?

grad - smallOver 40 million Americans currently carry student loan debt with average balances of $29,000. If medical school was part of the equation that number could easily triple or quadruple.

If you find yourself grappling with hefty student loans and all the decisions that come along with them, make sure you fully understand the details of your loans and all of your options before devising a plan to deal with your debt. The details can be overwhelming, so we’ve done our best to break down some key points for you here.

The Basics

There are a number of different types of student loans available to borrowers. If you’re in the process of applying for a student loan, understand the details before accepting the loan. If you already have student loans, understand consolidation options and payback choices so you know how to properly deal with them.

Federal Loans are loans offered by the federal government which offer benefits that are not available if taking a loan out from a private institution. These include flexible repayment options (see below), deferment (postponing payment for a period of time), forbearance (postponing payment or reducing payment if not eligible for deferment), and sometimes more attractive interest rates.

Here are the types of Federal Loans you may encounter:

  • Direct Subsidized (or Stafford) Loans are available to undergraduate students who demonstrate a financial need to help pay for costs of higher education. The financial need is determined by completing a FAFSA form when applying for the loan. Because this type of loan is based on financial need, the benefit is that the U.S. Department of Education pays the interest on these loans while you’re still in school, plus the first six months after leaving school (grace period), and also during any periods of deferment.
  • Direct Unsubsidized Loans are available to undergraduate and graduate students and there is no requirement to demonstrate a financial need. Because these are not based on financial need, the interest begins accruing and is payable immediately upon receiving the loan. The grace period with unsubsidized loans applies only to principal repayment, not interest.
  • Direct PLUS Loans are loans that parents of dependent undergraduate students or graduate/professional students can take out to help pay for higher education costs. These loan amounts are limited to the cost of attendance minus any other financial aid received. The interest rates for PLUS loans are typically higher than subsidized and unsubsidized student loans.
  • Federal Perkins Loans are offered to undergraduate and graduate students who are determined to have a financial need. Perkins loans are awarded and serviced through the university, so eligibility depends on availability of funds at the college.

Private Student Loans are nongovernment loans offered by a private institution such as a bank, credit union, state agency or school. These types of loans do not offer benefits that may accompany federal loans such as deferring payments, deferring interest while you’re in school, and flexible repayment options.

What’s more, private loan interest rates may be variable rather than fixed meaning they can increase at any time. You may also need a cosigner for this type of loan and/or an established credit record. If you have a financial hardship, you will likely not be able to defer payment as you could with a federal student loan.

Interest Rates

The chart below includes current interest rates for the different loan types outlined above. Each year federal student loan interest rates are determined based on a formula tied to the 10 Year Treasury rate.

Loan TypeBorrower TypeInterest rate for loans first disbursed between July 1, 2013 and July 1, 2014Current Interest Rates for loans disbursed between July 1, 2014 and July 1, 2015
Direct Subsidized LoansUndergraduate3.86%4.66%
Direct Unsubsidized LoansUndergraduate3.86%4.66%
Graduate or Professional5.41%6.21%
PLUS LoansParents, Graduate or Professional Students6.41%7.21%
Perkins Loans*Undergraduate or Graduate students5%5%
Private LoansUndergraduate, Parents, Graduate or Professional StudentsVariable (determined by the institution servicing the loan)Variable (determined by the institution servicing the loan)

*Regardless of disbursement date, Perkins loans have a fixed interest rate of 5%.

Repayment Options

As mentioned previously, federal student loans offer more flexible repayment options which can play an important role when deciding the best course of action for your loans. Please note the repayment options listed below are for federal student loans and do not apply to private loans or Federal Perkins loans. Your private or Perkins loans will have their own conditions outlined by the servicing provider in the loan agreement.

  • Standard Repayment Plan – under the Standard Repayment Plan you will pay a fixed amount of at least $50 per month for up to 10 years. Under this repayment plan you will pay less interest for the life of the loan than you would under other plans which have a longer repayment term.
  • Graduated Repayment Plan – Payments start out lower and increase (usually every two years) over the course of 10 years. Under this plan, you’ll pay more interest than under the standard repayment plan.
  • Extended Repayment Plan – This plan allows the term of the loan to be extended for up to 25 years. Payments may be fixed or graduated. Under this plan you will pay more in interest over the life of the loan, but the extended option may prove necessary if the total amount of your debt causes an excessively high monthly payment over a shorter period of time if you don’t qualify for an income driven repayment option.
  • Income Driven Repayment Options
    • Income Based Repayment Plan (IBR) and Income Contingent Repayment Plan (ICR) – In order to be eligible for IBR you must demonstrate a partial financial hardship. Under both IBR and ICR, your payments will change as your income changes and the term of the loan may last up to 25 years. You will pay more under these plans than you would in a standard repayment plan. However, if you have not repaid your loan after making 25 years of qualifying payments, any outstanding balance on your loan will be forgiven. Loan forgiveness is a great benefit of income driven repayment plans, but be aware the amount forgiven may be subject to income tax, so make sure you’re prepared to pay the tax out of pocket at the end of the 25 years! IBR and ICR plans are similar, but have a different formula for calculating your monthly payment. Refer to studentloan.gov for more information.
    • Pay As You Earn Repayment Plan – As with IBR, the Pay As You Earn repayment plan also requires a partial financial hardship and your payments will change as your income changes. Unlike IBR and ICR, the term of this loan repayment plan is up to 20 years. If you have not repaid your loan after making 20 years of qualifying payments, the outstanding loan balance will be forgiven. Again, keep in mind this amount may be subject to income tax.

Loan Forgiveness

Depending on your career and the repayment plan you choose, you may eligible for a loan forgiveness program. These are special programs usually offered to borrowers who work in public service jobs. The most well-known of these is the Public Service Loan Forgiveness (PSLF) program.

Under PSLF, borrowers may qualify for forgiveness of the remaining balance of their Direct Federal Loans after making 120 qualifying payments (10 years of monthly payments) while employed full time by certain public service sectors. There are a number of qualifications you must meet in order to be eligible for this type of program, such as working full time for a qualified institution (government agency, non-for-profit organization, a private organization that provides services such as public health, public safety, public education, etc.) and repaying your loan under a qualifying repayment plan (10 year standard repayment plan, or income driven plans).

You will benefit the most if you are under an income driven repayment plan, as the amount forgiven at the end of the loan will be greater. What’s even more attractive, the amount forgiven under a qualifying PSLF program is not subject to income tax, potentially saving borrowers thousands of dollars not only in forgiven loan balances, but also in taxes owed on the forgiven balance!

What to consider when choosing a repayment option

  • Income – ability to pay back the loan in the desired amount of time
  • Interest – the longer the time period, the more you’ll pay in interest. However, a longer time period also means more affordable monthly payments.
  • Other goals and priorities – how to juggle paying down your debt while saving room in your budget for savings towards goals like buying a house, getting married, traveling, etc.. According to JPMorgan, 75% of student borrowers said their student loans made it harder to buy a home and 43% delayed starting a family.
  • Emotional burden of carrying large amounts of debt – depending on your interest rate, the math may show that it’s “smarter” to pay off your student debt slowly over the course of 30 years with the assumption (or the hope) that your investments (savings that you’ve put into the market) will grow at a higher rate than your student loan interest rate. However, you should also factor in how your debt makes you feel because the emotional burden of carrying large amounts of student debt may outweigh what the math is telling you.

If you’d like to compare your expected monthly payment under each repayment plan, studentloans.gov offers a great repayment estimator. Click here to compare plans for your loan(s).

Whether you are a student or parent seeking out financial aid for an upcoming college expense, or a graduate faced with the reality of repaying what you’ve accrued over the years, make sure you do your research and know your options. Seek guidance from a trusted financial professional or contact the Federal Student Aid Information Center (FSAIC) at 1-800-4-FED-AID (1-800-433-3243). They have a number of helpful resources and tools on their website at www.studentaid.ed.gov.

If you’d like to talk through your situation with a Clearview advisor, you can schedule an appointment here.