Student loan arrangements can have unforeseen, long-lasting implications for a family's financial future (see the chart "Consequences of $1.4 Trillion in Student Loan Debt"). To illustrate this point, let's look at a nightmare scenario that is based on a real-life situation.
A few months before his eagerly anticipated early retirement, 62-year-old Tom was diagnosed with a terminal disease. Most patients with this disease live two to five years from the date of the diagnosis.
Tom had always carefully planned his family's finances. He prepared a monthly budget and began planning for an early retirement with his wife, Jo, when he was in his early 30s. His four children all went to college, which the family financed primarily through private student loans.
But Tom missed a crucial detail included in the loans' promissory notes. If the student or the co-signer died before the loans were fully paid, the loans became immediately due. At the time of his diagnosis, the loans due totaled almost $150,000.
Tom and Jo were devastated by the news. Tom was already worried that too much would be spent on his care, leaving less for Jo, who was just 60, to live on after his death. Jo was concerned with making Tom as comfortable as possible during the time he had left, no matter the cost. Realizing that $150,000 would now have to be diverted from the insurance proceeds at Tom's death only increased their fears.
Consequences of $1.4 trillion in student loan debt
Percentage of U.S. adults with student loans who said the amount of their loans caused them to:
WHAT YOU NEED TO KNOW ABOUT STUDENT LOANS
This story illustrates what can happen when borrowers do not realize the full implications of the loans they have taken out. Of course, not all repayment situations will be so dramatic. But Tom and Jo's story underscores the importance of knowing the basics about undergraduate student loans. Here are some key things you need to know before you, your children, or your clients take out a student loan.
- There are two types of student loans. Federal student loans (FSLs) are issued directly to students by the federal government. Private student loans are issued by banks or other financial institutions.
- FSL interest rates are either subsidized or unsubsidized. Subsidized FSLs do not accrue interest while the student is in school. Unsubsidized FSLs accrue interest while the student remains in school.
- FSLs and private loans have different repayment terms. The repayment terms for FSLs are more flexible and offer relief if needed. Private student loan terms are set by the lender and offer little flexibility or relief if the student has trouble repaying.
- FSLs are based on the student's financial need, not on the borrower's credit rating, whether the borrower is the student, the parents, or someone else. The only exception among FSLs is the parent PLUS loan. Financial need is calculated as the difference between the cost of attending a school and the student's expected family contribution.
These four points are certainly not exhaustive, but they are a good place to start as you or your clients consider student loan options.
PLAN FOR FINANCING COLLEGE WITH STUDENT LOANS
There are many things for individuals, CPAs, and their clients to consider when financing college with student loans:
- FSLs typically have lower interest rates. The interest rate on an FSL is often lower than on a private student loan. (However, private student loans can have lower interest rates if the student and the co-signer have excellent credit.) Even if a student's or a parent's employer offers special access to private student loans, check out the availability of FSLs before choosing a private student loan.
- Keeping interest under control is important. While in school, students should consider paying the interest that accrues on an unsubsidized loan to minimize the overall interest they will pay on the debt.
- Students do not need to borrow all the money available. If possible, students should borrow only what they need to cover tuition, books, and fees, and pay living expenses with income earned by working part time or applying for a work-study program as part of the Free Application for Federal Student Aid form.
- Details can be costly and shouldn't be overlooked. When applying for a private student loan, ask questions of the lender, read the terms very carefully, and, more importantly, read the promissory note. Consult a CPA or an attorney if you are unclear about any details.
- Whether students apply for an FSL or a private student loan, they should plan the loan backward. In other words, students should think ahead to the loan repayment. What are their job prospects given their major and degree? What will they earn right out of school? High student loan debt—whether for an FSL or a private loan—can limit the choices students have when they look for a job. Recent graduates may have to move back in with their parents until their student loans are paid off (see the sidebar, "3 Tips to Pay for Student Loan Debt").That's why students should have a realistic idea of the amount of their monthly loan payments. This information can help them make more informed decisions about how they want to finance their college education and, in some cases, which major they elect.
INCOME-DRIVEN PLANS: THE DETAILS
If a client's children are struggling to make their monthly student loan payments, they may want to consider income-driven repayment (IDR) plans. These plans are available through the U.S. Department of Education's Office of Student Aid for any borrower with eligible federal student loans. All Direct and FFEL student loans are eligible. Parent PLUS and Perkins loans are eligible if consolidated. IDR plans help borrowers avoid delinquency and default when their monthly debt payment consumes a high proportion of their monthly income. IDR plans do have a downside: Paying back the loan over a longer period means the borrower will pay more interest.
All IDR plans have the following aspects in common:
- They can be used by borrowers who have a financial hardship. This is determined based on the size of the standard student loan payment as a percentage of the borrower's discretionary income. Discretionary income is calculated by a formula that takes into account family size, household income, and the size of the loan compared with 150% of the federal poverty level. It is used to determine qualification for a loan and the size of the monthly loan payments during the 12-month period during which a borrower is qualified. (See questions 16, 17, and 18 of studentaid.ed.gov's Q&A "Income-Driven Repayment Plans: Questions and Answers" for more information, available at studentaid.ed.gov.)
- They require annual recertification. The borrower must reapply every 12 months.
- They offer loan forgiveness of any remaining student loan debt not paid after 20 to 25 years.
- The federal government may provide a subsidy on interest accrual if the monthly IDR payment does not cover the total amount of interest. In most cases, the subsidy is only given for a limited period (e.g., three years).
However, in other respects the types of IDR plans differ. It is difficult to determine which IDR plan is right for your client's child unless he or she carefully considers each.
The chart "The 5 Income-Driven Repayment Options" provides the particular requirements of each plan.
The income-based repayment plan has been the most popular IDR plan because of its simplicity and the flexibility it gives borrowers to decide which loans will be included. The REPAYE plan may become more popular as borrowers learn more about it. It has broader eligibility and lower monthly payments. However, each IDR plan has several pros and cons, and all factors should be considered before choosing a plan.
Before borrowers struggling with making student loan payments consider an IDR, they may want to review their entire financial situation and look at all other options for easing their student loan debt (e.g., cancellation, forgiveness, and postponements). In addition, a certified credit counselor trained in debt management may be able to recommend other ways to free up cash flow to make all monthly payments, such as creating a debt management plan to reduce credit card debt. After other options have been considered, looking at IDR plans may make sense.
A CPA with basic knowledge of student loans can provide real value to clients (and their children) by pointing out how IDRs work and how selecting the right one just may make it affordable for their grown kids to finally move out of the house. If the CPA is uncomfortable getting into much detail, he or she can refer the client to a knowledgeable student loan counselor.
Many not-for-profit credit counseling agencies now provide student loan counseling services. Finding a local agency that is a member of the National Foundation for Credit Counseling (nfcc.org) or the Financial Counseling Association of America (fcaa.org) is a good place to start.
The 5 income-driven repayment options
(For any borrower with eligible federal student loans)
3 tips to pay for student loan debt
Create a budget and follow it.
By Amber Trimble
It's no secret that student loan debt is a huge issue in the United States. In 2016, the average college student graduated with $37,000 in student loan debt—making this year's graduating class the most indebted to date.
But student loans don't have to keep borrowers in debt forever. Whether you have a mountain of debt or several small loans, these tips can help you pay off student loan debt.
1. Create a budget
Susan Bruno, CPA/PFS, founder of College CFO, suggested using free online and financial tools such as the AICPA's Feed the Pig (feedthepig.org) and 360 Degrees of Financial Literacy (360financialliteracy.org). Other options include Mint (mint.com), a free money-tracking tool, and YNAB (You Need a Budget) (youneedabudget.com), a budgeting tool that is free for students. Or track your budget with a simple spreadsheet, Bruno said.
2. Seek assistance
If you're still in college, check out resources—such as financial counseling—that are available on campus. Employers may also offer assistance. Reyna Gobel, author of CliffsNotes: Graduation Debt, said that business assistance for employees in paying for their MBAs or helping them pay off their undergraduate loans is "becoming a trend."
Debt consolidation is another potential option, though it could leave you with one large loan instead of several small loans.
3. Make timely student loan payments to keep your credit score high
In addition to a budget, create a repayment plan. Plan to put any additional income toward your student loan debt. To pay less interest, call your loan provider to ensure that extra payments go to your highest-interest loan.
Failing to make timely payments will result in several negative consequences, including harming your credit score for years.
Editor's note: This sidebar is adapted from the article "6 Tips for Paying Off Your Student Loan Debts," CPA Insider, May 31, 2016.
—Amber Trimble (firstname.lastname@example.org) is a freelance writer based in Durham, N.C.
About the authors
James Sullivan (email@example.com) is a board member of Consumer Debt Counselors Inc., a not-for-profit debt counseling agency. Melissa Towell (firstname.lastname@example.org) is a student loan counselor for Consumer Debt Counselors Inc.
To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at email@example.com or 919-402-2112.
- "Americans See Highest Level of Personal Financial Satisfaction Since 2007," JofA, Oct. 27, 2016
- "Tax Practice Corner: Tax Relief for Federal Student Loan Forgiveness," JofA, Aug. 2016
- "Half of American Families With Student Loan Debt Delay Saving for Retirement," JofA, May 12, 2016
- "Millennials Struggling to Save Money," JofA, March 24, 2016
PFP Member Section and PFS credential
Membership in the Personal Financial Planning (PFP) Section provides access to specialized resources in the area of personal financial planning, including complimentary access to Forefield Advisor. Visit the PFP Center at aicpa.org/PFP. Members with a specialization in personal financial planning may be interested in applying for the Personal Financial Specialist (PFS) credential. Information about the PFS credential is available at aicpa.org/PFS. PFP Section members, inclusive of CPA/PFS credential holders, can access the Millennial Resource Center in Forefield Advisor as a part of their member benefits. This is a collection of videos, FAQs, consumer materials, and interactive calculators addressing student loans and other financial issues of interest for Millennials.