Understanding Recent Student Loan Repayment Developments and Their Potential Impact on Your Financial Plans
By Anna Hays, Vice President, Senior Wealth Management Officer
The spring of 2022 offers federal student loan borrowers the opportunity to assess how pandemic relief and new remedies from the United States Department of Education (Department) may impact their overall financial health. To understand the recent developments, rewind to March 2020.
On March 13, 2020, the federal government suspended the repayment of federal student loans, including those in default, through administrative forbearance. Federal student loans that are eligible for administrative forbearance include Direct and other loans held by the Department. Loans from private lenders are not under the federal government’s jurisdiction, and those loans were not eligible for administrative forbearance. Administrative forbearance “paused” loan repayments, stopped the collection of defaulted loans and set loan interest rate to 0%. The 0% rate effectively means that the interest on outstanding student debt has not been capitalized and added to the total principal balance during the last two years.
On April 6, 2022, the Department announced an extension of the administrative forbearance period to August 31, 2022. This gives borrowers time to plan for the changes in their cash flow when loan payments resume in September. Borrowers can also use the next four months to confirm whether they may benefit from three new remedies included in the Department’s April 6th announcement.
First, borrowers who defaulted on loans before the onset the pandemic will be restored to good standing. Often borrowers default because their income is not enough to cover rent, living expenses and the loan payment. The reset to good standing gives borrowers the opportunity to request an income-driven repayment (IDR) plan through StudentAid.gov and to consider the Public Service Loan Forgiveness (PSLF) program. Because the second and third remedies announced by the Department specifically relate to IDR plans and PSLF, it’s important to understand that each offers distinct paths for managing and repaying federal student loans.
IDR plans are based upon the borrower’s monthly discretionary income and family size. There are four types of IDR plans: (1) Revised Pay As You Earn (REPAYE Plan); (2) Pay As You Earn Repayment Plan (PAYE Plan); (3) Income-Based Repayment Plan (IBR Plan) and (4) Income Contingent Repayment Plan (ICR Plan). For borrowers who have large student debt balances relative to their monthly income, IDR plans can result in lower monthly payments over a 20- or 25-year period depending on the plan. At the end of the 20- or 25-year repayment period, the remaining balance is forgiven. Prior to the pandemic, the balance of the forgiven debt would be taxable income to the borrower. Under the American Rescue Plan, one of the federal statutes that provided pandemic relief, balances forgiven under an IDR plan before December 31, 2025 will not be taxable income for the borrower.
The PSLF is not based on the borrower’s income. The program offers loan forgiveness to borrowers such as first responders, military personnel and teachers who work for government or non-profit employers. To be eligible for PSLF, borrowers must certify their employment each year and make 120 qualifying payments on a Direct or Direct PLUS loan. The 120 payments do not have to be consecutive. The balance of the debt forgiven through PSLF is not taxable income.
The second and third remedies announced by the Department involve a one-time adjustment to correct tracking errors and violations of forbearance rules by student loan servicers. Here’s why the one-time adjustment may be significant for borrowers in an IDR plan or seeking PSLF.
Following an extensive review, the Department found that student loan servicers did not track payments accurately. To correct the tracking errors, the Department will credit borrowers for all loan payments, even if the borrower was not in an IDR when they made the payment. The credited months will count toward the IDR and PSLF repayment periods.
The Department will issue guidance to loan servicers with the goal of creating a uniform tracking system. It is also creating its own tracking system and anticipates that it will be ready in 2023. Borrowers will be able to see their progress through this new tracking system on StudentAid.gov.
The same review found violations of the Department’s forbearance rules. Borrowers can seek forbearance for limited time periods if they cannot repay their loans. The Department’s rules limit forbearance to no more than 12 consecutive months and no more than 36 months in total. Borrowers who are granted forbearance do not have to make payments during the forbearance period. However, in contrast to the pandemic pause, interest is capitalized and added to the outstanding principle during the forbearance period. The net result is a higher loan balance and a greater potential for default.
The Department’s internal review found that student loan servicers directed borrowers to forbearance when they qualified for reduced payment under an IDR. The review also found that student loan servicers let borrowers stay in forbearance past the 12-consecutive-month or the total 36-month limits allowed by the Department’s rules. The Department’s one-time adjustment will count forbearance periods that exceed the 12-month or 36-month limits toward an IDR or PSLF payment periods.
While the Department’s April 6, 2022 announcement brings helpful news to student loan borrowers, like all budget matters, the details are complicated. Borrowers are encouraged to review their loan information, particularly the number payments that they have made, before September 1, 2022.
Anna Hays is an attorney, Certified Financial Planner (CFP®) and Senior Wealth Management Officer with Cape Cod 5. She has over 25 years of experience developing estate and trust plans that integrate financial goals.