It’s important to remember that borrowers can refinance a federal loan to a private loan, but they cannot go the other way or go back once that happens.
The decision may be simpler for potential borrowers since federal loan rates change every year and are based on the high yield of the last 10-year treasury bill auction in May, so potential loan borrowers Federal undergraduates generally receive the lowest rates (currently, 2.75%).
However, undergraduates are not often the ones who rack up massive debt due to federal borrowing limits. We typically see six-figure student debt totals among graduate students and parents.
A popular form of funding for this group is the Federal PLUS loan. This loan, often referred to as a Grad PLUS or Parent PLUS loan, is available to graduate students and parents of undergraduates at higher interest rates – currently 5.30% until June 30, 2021.
These loans also have over 4% origination fees, have virtually no borrowing limits, and require the borrower to not have an “adverse credit history.”
Advisors will need to determine whether it is better to borrow through the PLUS loan system or in the private market by comparing interest rates and other loan costs along with repayment plan options. This requires an understanding of the borrower’s projected future income to assess whether loan cancellation will be a realistic option.
Generally speaking, federal student loans offer more flexibility and benefits than private student loans. President Joe Biden also proposed several new changes that will affect both potential and existing student loan borrowers, including proposed revisions to the IDR plan system and improvements for borrowers working in the public service and seeking a discount. within the framework of the PSLF.
Reimbursement revised based on income
According to Biden’s post-election website, “People earning $ 25,000 or less per year will not owe any payments on their federal undergraduate student loans and will not earn interest on those loans.” Everyone else will pay 5% of their discretionary income (income minus taxes and essential expenses like shelter and food) on $ 25,000 for their loans. ”
While this might sound awesome in theory, several important details are left out.
First, will the $ 25,000 threshold also change based on family size, or will family size only affect the calculation for discretionary income purposes? If no adjustment is made, this proposal favors borrowers without families who are below this threshold.
There is also some ambiguity as to who “everyone” is in this statement regarding being subject to payments based on 5% of their discretionary income. What about parents who have borrowed on behalf of undergraduates? What about graduate students? Are they included in this “everyone” category?
The website also states that new and existing borrowers will automatically be enrolled in the income-based repayment program.
The proposal does not specify whether this applies only to undergraduate loans, which will create even more complications when working with clients who have both federal undergraduate and graduate loans and who are already in the process. a repayment plan.
Will undergraduate loans be subject to the 5% calculation while graduate loans will remain subject to the 10% or 15% discretionary income calculation? What about students who have consolidated their undergraduate and graduate loans together?
The automatic enrollment provision can also create a situation similar to employer-sponsored pension plans where individuals do not realize that they might be better off to pay off loans faster and save on interest. While the auto enrollment feature is useful for most, it can have a grounding effect on other borrowers.
One thing that is likely to happen is to make the remittance of IDR plans tax exempt, in the same way that balances are treated under the PSLF program. Most borrowers who will receive a substantial amount of rebate under the current IDR plan system are unlikely to be able to pay the lump sum tax bills in the year of the rebate.
This tax code provision would also likely apply to borrowers on all IDR plans, and not just those enrolled in the new version of the IBR offered by Biden.
Working in the public service would become even more attractive under Biden’s plan. The existing system would likely be improved to include loans that are not currently eligible, such as FFEL loans.
Additionally, some form of accelerated rebate can be added to the current PSLF program, either the existing 50% after five years and / or up to $ 10,000 per year over five years from recent proposals.
The success rate of the PSLF has been catastrophic. Many borrowers assume they are on track to receive a discount under the PSLF when this has not been the reality.
While greater flexibility is likely in the future, it is always best for advisors to confirm three pieces of information to their clients: that they are making payments on eligible loans, that they have a loan plan. eligible reimbursement and that they are working for an eligible public service. organization.
Making sure borrowers tick these three boxes can only help them, no matter what future proposals are adopted. While other proposals are being considered and designed for lower and middle class borrowers, working towards the PSLF should always remain a viable strategy for borrowers of all wealth levels.
Despite the uncertainty of future education policy, the best thing advisers can do is start developing client profiles. Middle income clients will have a different set of borrowing options than high income clients, and it is important to develop a set of strategies for each group.
Although future policy changes are still pending, it is important to consider taking advantage of legislation that eases certain borrowing, planning for future education spending, and taking advantage of opportunities to refinance certain types of debt at a low cost. lower interest rate.
Ross Riskin is Associate Professor of Taxation at the American College of Financial Services.
Michael Finke is Professor of Wealth Management at the American College of Financial Services.