• Nate Baim, MBA, CFP®

Understanding Federal Student Loans


Enjoy this week's edition of the Planner's Beta


Beta (n) - climber's jargon that designates information about a climb This digest's purpose is to share observations, ideas, and treasures found this week which you may also find insightful. Sharing does not mean it's an endorsement. I am endorsing the pursuit of knowledge and exploration.




Mastering Student Loans

Part 2 of a Multipart Series

Basics of the Federal Student Loan System

If you have student loans, now is the time to begin planning your next steps. Administrative forbearance is likely going to end this September, which means that you should reassess your loans. You should also reevaluate the strategy that you're deploying to reduce your student loan debt. Federal student loans are complicated. Before we dive into all the details of federal student loans, let's start with a basic federal loan overview.


An Overview

There are two primary programs that we see impacting people's lives. There is a legacy loan program called the Federal Family Education Loan (FFEL) Program. These loans will primarily affect people who were students and took out federally insured loans before 2010. Private loan providers originated these loans, but the federal government insured them. Because FFELs are from a legacy program, they are becoming less and less common. However, it is crucial for people who consider going for public service loan forgiveness (PSLF) to understand that these FFE loans are not eligible for public service loan forgiveness. Borrowers can consolidate FFELs into the new program via a Direct Consolidation loan.


The new program is the William D. Ford Direct Loan Program. These loans are provided directly by the U.S. Department of Education. And the servicing of these loans is outsourced to select companies such as Navient, Fed Loans, and Great Lakes. These Direct loans are eligible for public service loan forgiveness. The loans provided by the Direct Federal Loan Program are Direct Unsubsidized, Subsidized, PLUS, and Consolidated loans. Each of these loan types has its unique benefits and characteristics.


Direct Loans Types

Direct Subsidized loans are available and offered to undergrads who meet a needs-based test. The interest does not accrue on these loans while the student is in school, during their grace period, or while they're in deferment. These benefits are what give Subsidized loans their name.


Direct Unsubsidized loans are available to undergrad, graduate, and professional students. The government treats interest differently on these unsubsidized loans. The interest begins to accrue from an unsubsidized loan's origination date (the beginning of the loan's life).

With Direct PLUS loans, these loans provide funds to graduate students or parents of undergraduate students. A credit check is required to attain PLUS loans. With PLUS loans, the fees and interest are higher than the Direct Unsubsidized loans. Like unsubsidized loans, a PLUS loan's interest accrues from the origination date.

Next, let's discuss Direct Consolidation Loans. A Direct Consolidation Loan is a loan used to combine multiple loans into one loan. Using consolidation loans makes it easier for the student to pay off those loans by reducing the number of loans they need to track. These are available to undergrad and grad students. Much like the unsubsidized loans, the interest accrues from the origination date. Now, an essential thing to understand here is that a consolidation loan is not a refinance loan. The interest rate is not going to change to reduce your total monthly payments materially. The consolidated loan's interest rate will be the weighted average of the loans used for that consolidation.


Additionally, if you consolidate your loans, you will likely have two (or more) consolidation loans. One consolidation loan will include all your subsidized loans. And all of your unsubsidized loans will consolidate into another loan. This should be done to preserve the benefits of subsidized loans. There are some unique circumstances with parent PLUS loans borrowers should consider. Again, direct consolidation loans are not a refinance. The interest is just the weighted average of those loans used in the consolidation (this is a place many folks get confused).


Student Loan Statuses

Understanding your loan status is informative and essential.


The most common status is repayment. Repayment is when you're out of school and paying off your loans on time to the terms laid out by your loan.

Forbearance occurs when the borrower needs temporary assistance. With forbearance status, payments are reduced or not required, and the interest accrues while under this status. A borrower may attain Forbearance status by contacting the loan's servicer.

Deferment is a loan status, which occurs when you're facing difficulty in repayment, or you may be back in school. Loans in deferment may not require a payment, but the interest might accrue. To understand if interest will accrue on your loans while in deferment, you need to review your loan types. If you have a subsidized loan and you're in deferment, the interest will not accrue. If you have unsubsidized loans and you're in deferment, the interest will accrue. So it's essential to know the loans you possess.


It is crucial to understand the difference between forbearance and deferment (it's okay to be confused on this; many folks are confused). A loan in forbearance means interest will accrue on that loan. Loans in deferment mean interest may accrue on your loans (it just depends on your loans).

Loans in forbearance or deferment will not impact your credit score. Whereas if you find yourself in default (when you have payments that are more than 270 days past due), this status will impact your credit score.


The grace period lasts six months after leaving school. Loan payments are not required during the grace period. And again, depending on if you have unsubsidized or subsidized loans, that will impact whether or not you have any interest accruing on those loans during the grace period.

Programs for Paying Back Your Loans

So there are two primary buckets for people to pay back their loans. The first is the balanced-based repayment plans. Balance payment plans include level payment plans or graduated payment plans. Balance-based programs are driven by the amount outstanding, the interest rate, and the payment schedule. The level ten-year payment plan is the default option for borrowers. But there are other options such as the 25 and 30-year level payment plan. Generally speaking, a level payment will be the least expensive, especially if you pay off the loans quickly. If you provide extra installments to a 10-year level payment plan, this will reduce the loan's total cost and help you pay off that loan quicker.


A graduated payment is when the monthly installment starts low, and then it increases with time. Graduate payment plans may make sense for individuals who expect their income to grow over time. Before using a graduated payment plan, the borrower should give careful consideration to this plan. We rarely know what our income is going to be in the future. So signing up for a graduated program may make sense for specific individuals. It's not something that I would immediately suggest folks go to without carefully considering the pros and cons of a graduated scheme.


The second primary bucket for paying back federal loans is the income-driven repayment (IDR) plan. And IDRs are confusing for many borrowers (rightfully so; they are very complex). There is extra work for borrowers who decide to deploy an income-driven repayment plan. Four plans fall underneath the income-driven repayment plan umbrella. Those plans are income-contingent repayment (ICR), income-based repayment (IBR), pay as you earn (PAYE), and revised pay as you earn (REPAYE). Each of those plans has a formula that determines what the payment is going to be each month. The income of the borrower is the key input into the payment formula. Each program may look only at the borrowers' income or look at the household's income. IDRs are for those who cannot afford payments or are pursuing PSLF.


Next Steps

The next segment will focus on helping you understand income-driven repayment plans. In the meantime, feel free to download these two resources. The first resource is a checklist used to evaluate what issues you should consider when paying off your student loans. The following resource is a decision tree that will help you understand if you're eligible for income-driven repayment plans.



This Month's Financial Planning Item - Reviewing How to Maximize Your Savings

The K Shape Recovery led some household's savings rates to skyrocket. The personal savings rate is the highest it has been since the 1970s. Now, families may be struggling to optimize their savings strategies because of the assets they accrued.


You may have extra cash on hand, and you want to save for the future. But you may need help identifying all of the different account types to consider for your savings. This 17 point checklist provides a structured outline to guide your thoughts regarding available and appropriate saving strategies. It covers accounts across the following categories:

  • Foundational Savings

  • Healthcare Savings

  • Retirement Savings

  • Employer-provided Benefits

  • Business Owner Savings

  • Accounts To Help Future Generations

  • Tax-Deferred Insurance Options

  • Other Account Considerations



If you need independent advice on managing income and savings, please review the services I offer and place an introductory appointment on my calendar.


If you are a current Pursuit Planning and Investments client, securely upload any documents needing review to PreciseFP. I am happy to help proofread any resumes, conduct mock interviews, or support you with any career decisions you face. We can discuss this in our next scheduled check-in meeting, or feel free to place an appointment on my calendar.



Quote of the Week

"The job of the central bank is to worry." - Alice Rivlin

 

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