[00:00:00] Speaker A: In this episode, we talk about times when it actually makes more sense to pay off your loans rather than trying to have them forgiven. Let's get started.
Are your student loan payments or loan balances a major obstacle in your financial life? Then tune in and let's escape student loan debt.
Hello. My name is Brenton Harrison of Escape student loan debt and your host for the escape Student loan debt podcast cast. I'm really excited about this episode because it's going to kind of get into some topics that we really haven't covered in detail in the past, and that is the decision making process between whether or not you should actually pay your loans off in full versus having them forgiven. Now, we've touched on this briefly, and over the past year or so, we've definitely spent far more time talking about ways to have your student loans forgiven by paying the smallest amount towards your loans as possible. So I wanted to give you all some context as to why I push income driven repayment plans so heavily, and some periods where it makes sense to use them, versus some periods where it would be better to try to pay them off in full rather than being forgiven. So what's the rationale you will find amongst student loan experts? Typically a percentage of your household income where if you owe that amount or more, those experts will tell you, hey, you should try to have it forgiven. And that number changes based on the expert. There are those who will say, if you owe more than 135% of your yearly income in federal student loans, then you should try to have them forgiven as opposed to paying them off in full. You have people who will say, if you owe more than 150% of your annual income each year in federal student loans, you should try to have it forgiven instead of paying it off in full. And what they're trying to do and what I'm trying to do when you use these rules of thumb is to quickly give you kind of this marker or this line in the sand where, you know, once you see that amount, you should at least be thinking about x or thinking about y. For example, if 150% is the number, I know that if I owe more than that, hey, I don't have to really worry. If I'm pursuing the right strategy by doing income driven repayment, it's highly likely that I am, because I'm going to pay less towards my loan over time than if I paid it off in full. Conversely, if I owe less than 150%, if that's the number that you're using, then, hey, I should start to think about and run the numbers to figure out if it actually benefits me to pay them off in full. That's why they use those numbers. Now, what's my number? My quick rule of thumb is I just say, hey, if you owe more in federal student loans than you make each year, you at least need to think about income driven repayment plans. So my number, my percentage is a lot lower than most people. But I at least know from experience that that's around the point in time where, depending on the structure of your loans, you start to get into that scenario where you need to actually think through the decision instead of just choosing one plan or the other. So let me put some meat on the bone so you can see what I mean by that. If you're following along with this on screen, you can see this if you are listening, I will describe it to you, and we will put these photos in the show notes so you can see these scenarios. But what we're looking at on screen is a household of two, and that household has $100,000 of adjusted gross income. Now, they also happen to have a $100,000 federal student loan balance. So this is that couple that meets my metric of they owe as much in federal student loans as they make in adjusted gross income. They at least need to run the numbers to figure out whether it makes more sense to pay it off or have it forgiven. Now, on the left side of this equation, we're going to assume that those $100,000 in federal student loans are being repaid at 6.5% interest, and we're going to have them pay this off on the standard plan. The standard plan requires you to pay them off in full, and they're going to do so over the course of 20 years, if that's their objective. The monthly payment for this plan is $746 a month, and they would pay, over the course of 20 years, just under $180,000 in total payments before that loan is repaid in full. Now, on the right side of this, you're looking at this couple choosing to do the pay as you earn plan. So rather than paying it off in full, they're aiming for forgiveness. And the calculation for that pay plan in terms of the monthly payment, is to first find your discretionary income. And under the pay as you earn plan, that's the adjusted gross income from your previous year's tax return, in this case, $100,000. And you get to subtract 150% of the federal poverty level for a family of two. And under the pay plan, it requires you to pay 10% of that discretionary income, this person or this household's monthly payment ends up being $578 a month. Now, over the course of 20 years, that's $138,000 or so of payments, as compared to the $180,000 or so of payments to actually pay it off in full. Now, the interesting thing is, when people created these rules of thumb, 150% of your income, 135%, 100% of your income, it was when we had a pretty standard set of payment plans in terms of how they calculate their discretionary income and also the percentage of that discretionary income that you pay towards your loans. Well, now we have the save plan, the saving on a valuable education plan. And the save plan has kind of turned things on its head in terms of using your rule of thumb for many reasons. The first is, instead of subtracting 150% of the federal poverty level, you get to take away 225% of the federal poverty level before they calculate your discretionary income. That means that most people have a far lower discretionary income in the past. And even if we stayed at 10% of that number, the save plan has just led to lower payments than all of the other plans. You add on to the fact that moving forward, starting in 2024, in midyear, it's not going to just be payments of 10% of discretionary income. There's going to be people on the save plan who only have undergraduate plans, and in those cases, they only have to pay 5% of their discretionary income each year. And for borrowers who have both, they're going to pay the weighted average based on the original loan balance. Now, what type of impact does this have on that percentage of your income before you start to think about actually paying it off in full? Well, in actuality, it makes forgiveness even more appealing for a larger set of people, even if they owe far less than what they make each year in federal student loans. For example, let's go back to that same household where we have a family of two with $100,000 adjusted gross income. But now, instead of having them owe $100,000 in federal student loans, let's cut it in half to $50,000. We are again going to put them on the standard plan on the left side of this equation. But now, because of the lower amount, over the course of 20 years, they're going to pay $373 a month, a little under $90,000 in payments. Now, on the right side of this equation, we have the Save plan. So we take that $100,000 of just a gross income, but we get to subtract a bigger amount. We get to subtract 225% of the federal poverty level, which not only lowers their discretionary income, but we're going to assume that these people only have undergraduate loans. So instead of 10% in a few months, they'll only have to pay 5% towards their loans each year. Well, that means that instead of $373 to pay it off in full each month, they only have to pay on the save plan $225 a month. Comparing that to the $90,000 of total payments under the standard plan, they only have to pay $54,000 in total payments on the save plan until this is forgiven, which leads to a lifetime savings of about $35,000. So you can see this impact on the screen, where because of the Save plan, it's going to incentivize a far greater amount of people to just aim for forgiveness instead of paying it off in full. So there are all these reasons that kind of push you towards these income driven repayment plans if the number is close. But after the break, we're going to talk about some things where, if that number is close, you have to consider as well that might push you towards repaying them in full instead.
This is the Escape Student Loan Debt.
[00:08:16] Speaker B: Podcast, a show for established professionals whose student loan payments or loan balances are impacting their marriage, their business, their credit, or their dream of achieving home ownership.
[00:08:28] Speaker A: We'll be right back.
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[00:09:07] Speaker B: Welcome back.
[00:09:09] Speaker A: All right, so after all those reasons I gave you to not pay your loans off in full, why would you choose to pay them off in full? Well, the reasons have to do a lot with interest rates and also the structure of your employment in the future. You see a lot of people, they choose these income driven repayment plans early in their career, and to be clear, it is the right step early in their career where they're trying to build wealth while also navigating other debts and so on and so forth. But things get a little more complicated as over time, your pay increases, because with these income driven repayment plans, they ask you to recalculate your pay every single year so they can determine your loan payment. So if you're looking at the break even between what makes sense for an income driven repayment plan now versus paying it off in full, you're only looking at a snapshot in time. But that snapshot will change every single year for 20 years. And the standard plan where you pay it off in full doesn't change ever. Whatever is required to pay those loans off in full, you make that same payment every single month. And when it comes to people who have those payment increases that are significant over time, statistically, the people in this country who earn the highest amount of money are those who have graduate degrees. How does that play into the student loan conversation? Well, it plays in because unlike undergraduate loans, where you have multiple options to pay your loans for 20 years before they're forgiven, or under the save plan to pay 5% of your discretionary income towards your loans, if you have graduate loans, and a significant amount of your loans are graduate loans, you're either going to be paying 10% or close to 10%. And many of the plans from which you would choose require you to pay on them for 25 years instead of 20 years. And five years of extra payments is a lot of time. If you're getting to the point in your income creation where that payment is suddenly $500 a month, $1,000 a month, $1,500 a month, you may say, you know what? I would rather pay more to have this done five years sooner than stay on this plan, hoping that it makes sense for me to have them forgiven when you could get to the end of that period. And because of those consistent pay increases over time, it ended up being a wash. And if you're only thinking about your career when it comes to that income increase over time, you can't. If you plan to be married or if you're already married, you have to think about the career projections of your spouse. We have talked about the fact that you can file your taxes married, filing separately, and exclude your spouse's income from the calculation of your loan payments. We have also shared that in many cases, it cost you significantly more in taxes to do so. And I would argue that with the majority of couples that we come across who are pursuing this strategy or considering this strategy, it costs them so much more in taxes that it doesn't benefit them to do it, and instead, they just bite the bullet on the larger loan payments. So if you're married to a person who also has the ability to significantly increase their income over time, thus increasing your household income. Would it have made more sense to bite the bullet now, instead of assuming that my pay would stay pretty level and thus my loan payment would stay pretty level, when in reality, for many people, they get these big jumps in income throughout the course of their career that they didn't expect. And now they look ten years back in the past when they were originally making that student loan decision, and they're making double or triple what they were in those years, and their student loan strategy has shifted entirely. So let's go back to our example to illustrate this. We have the household of two. They earn $100,000 adjusted gross income, and they have $50,000 of student loans at 6.5% interest. We have covered that under the standard plan where they're paying it back over 20 years. That would cost them $373 a month, and they would pay $89,000 in total payments before it's forgiven. But let's now assume that unlike in our original example, where they paid 5% of their discretionary income because they were undergraduate loans, let's make them graduate school loans instead. So they're earning $100,000. The save plan does allow them to have a lower discretionary income, but now they have to pay 10% of it instead of 5%, and that makes their payment $450 a month. Now, not only is that $75 or so more than what it would cost to just pay the loans off in full over 20 years, but because they're paying that extra amount, they actually pay the loan off in full before they reach the 25 years of payments needed to have it forgiven. As a matter of fact, at that amount, they pay the loan off in full in year 14, six years faster than if they had even signed up for the standard plan. This is the impact in action of those pay increases over time, where five years ago, this person might have been making a significantly lower amount. And at that time, it made sense to do the save plan. But as their income increased over the years and their payment increased, they reached a breakeven point where paying it off in full at the lowest interest rate possible would have been the ideal scenario. The reason I referenced the lowest interest rate possible is because another factor to consider is the interest rate that you have on your federal student loan. We cover in this example someone who owes their loans at 6.5%. But there are also people who, based on the rates that Congress said at that time, have federal student loans at 7-8-9. And if your student loans are competitive in the marketplace, meaning that my student loan is at 6.5% and private student loan lenders are offering 6.5%, then I would argue that the flexibility that comes with federal student loan debt would still make it worth staying with the federal government rather than getting maybe a quarter of a percent better on a private student loan. And this hasn't been as relevant in the past year or 18 months as interest rates have increased. But three or four years ago, you had private student loan lenders that were offering rates that were two to 4% lower than what most people had on their federal student loan debt. And if you ran your scenarios of paying it off versus having them forgiven when you had 6.5 to 6.5, well, that has to be completely updated. If the federal student loan is at 6.5, but now you happen to know there's a private loan out there at 4.5 because that could save you tens of thousands of dollars in repayment amounts over the course of 20 years. So when it comes to this decision, and on one side of the equation you have forgiveness, and on the other side you have paying it off in full, you have to keep in mind that strategies change over time, just like your life does. And if your life changes significantly from the scenario that you had in mind when you first ran the equation, then you have to have the knowledge base to evaluate how that's impacted your forgiveness plans in terms of will you even have it forgiven? Or how much will be forgiven versus how much you would pay to have it paid off in full. And figure out which is the best thing for you. Because I can tell you, the answer today may not be the same answer even a year from now, and you have to know what has made that answer change. I hope this has been helpful. We look forward to seeing you in two weeks with more information on how to have your student loans forgiven, reduced, reorganized, or expedited. And I will see you then. Bye.
From escape student loan debt this was the escape student Loan Debt podcast, a show for established professionals whose student loan payments or loan balances are impacting their marriage, their business, their credit, or their dream of achieving homeownership.
