There has been a lot of talk in recent years about the growing student loan crisis and with good cause. According to the Federal Reserve, Americans now carry more than $1.7 trillion in student loan debt making it the largest source of household indebtedness next to home mortgages. That number is staggering, but when you consider that 34 percent of that debt — $574 billion — is carried by young adults in their 20s, the scope of the problem becomes clearer.
The rising generation plays a critical role in our financial ecosystem. We rely on them to get educated, become productive in the workforce, start families, raise kids, buy homes, build communities and do all the other things that fuel long-term economic growth. When saddled with high levels of debt, young-adults can lose their ability to do these important tasks. A 2012 study by the Federal Reserve showed that 30-year-olds are more likely to own a home and a car if they have no student debt. It isn’t rocket science: student loans appear to crowd out these other purchases and delay household formation.
If you are carrying a heavy student loan burden, there is no need to wait for the folks in Washington to develop a plan. There are several things you can do now to help lighten the load. I’ll discuss a few ideas in this column, but if you want to learn more, check out the website www.studentloanhero.com.
A word to the wise: the world of student loans can be pretty complex, so consult with a knowledgeable advisor before you commit to anything. Note, also, that today’s column deals with federal student loans. Private student loans are a completely different animal and will not qualify for what I will talk about here.
The CARES Act enacted last March granted a temporary moratorium on federal student loan payments. President Biden recently extended the moratorium until at least Sept. 30. This is a great opportunity to get ahead. Because no interest is currently accruing on those loans, every dollar you pay reduces your principal. So, keep paying if you can and if you can, pay even more.
If you are carrying a large student loan balance, it might make sense to use this moratorium period to enter into an income-driven payment plan. There are four types of plans to choose from, but they all set your monthly payment somewhere between 10 and 20 percent of your disposable income.
Disposable income is calculated as the difference between your adjusted gross income and 150 percent of the federal poverty guideline for your family size and state. For 2021, the poverty guideline for a single resident in California is $12,880 so the threshold for an income-driven payment plan would be $19,320. If your adjusted gross income is $35,000 per year, a 10 percent income-driven payment would be somewhere in the neighborhood of $130 per month regardless of the loan balance you are carrying. In comparison, someone with $45,000 in student loans would likely be making monthly payments more than twice that amount.
You might also consider working toward one of the 13 existing loan forgiveness programs that are available. Not all of these programs will fit everyone. In fact, most are very closely targeted at specific audiences, but if you can find one that works for you, it can save you a lot of money.
One such program is known as Public Service Loan Forgiveness. PSLF can lead to complete forgiveness of your loan balance after 120 qualifying payments, but qualifying is tricky. To qualify, you must work full-time at a federal, state or local government agency or a 501(c)(3) non-profit organization AND you must be under an income-driven payment plan like we talked about earlier.
The Department of Education reports that the average loan balance forgiven with PSLF is $75,090. However, they also report that only 3 percent of PSLF applicants were deemed eligible. What caused applicants to fail? According to the DOE, 56 percent did not make all 120 qualifying payments. Others failed because they weren’t working for a qualifying organization. The bottom line: if you are going to do this program, make sure you understand how it works, develop a plan, and then stick with the plan.
Steven C. Merrell is a partner at Monterey Private Wealth Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.
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