Student Loan Debt Relief
Borrowers who are struggling to repay their student loans have options for both short-term and long-term financial difficulty. Solutions for short-term financial difficulty, such as job loss and medical/maternity leave, include deferments and forbearances. Solutions for long-term financial difficulty include alternate repayment plans, such as extended repayment and income-driven repayment, as well as student loan forgiveness.
Face your problem directly. Ignoring the problem will not make it go away. It will get worse if you avoid it. Your student loan debt will continue to grow with interest and collection charges, even after you default.
Read the mail you get from the lender. While it will certainly demand payment on your debt, it may also discuss solutions. Call the lender as soon as you encounter financial difficulty. Explain the situation and ask about your options for financial relief.
You will have fewer options if you default first. If you default on your federal student loans, you will lose eligibility for deferments and forbearances and you will be unable to consolidate your loans.
Get help. Borrowers who are struggling to repay their student loans often have problems in other areas of their finances. Talk to an accountant (CPA), financial planner (CFP) or a non-profit credit counselor. You can find non-profit credit counselors at the National Foundation for Credit Counseling (NFCC) or the Association of Independent Consumer Credit Counseling Agencies (AICCCA). Friends and family may have suggestions or be willing to help financially.
If you are experiencing a short-term financial difficulty, you may be able to suspend payments through a deferment or forbearance. During a deferment, the federal government pays the interest on subsidized federal loans, such as the Federal Perkins Loan and the subsidized Federal Stafford Loan. The interest on all other loans remains the borrower’s responsibility and will be capitalized (added to the loan balance) if unpaid by the borrower as it accrues. During a forbearance, interest on both subsidized and unsubsidized loans must be paid by the borrower or capitalized.
Deferments and forbearances are not a good long-term solution, since the interest may continue to accrue and, if unpaid, will be added to the loan balance. Interest capitalization just digs you into a deeper hole, making it more difficult to repay the debt after the forbearance ends. An extended period of non-payment for a decade or more can cause the loan balance to double or even triple. But, deferments and forbearances are better than default.
If you are going back to college or are about to be deployed, tell the lender. The lender will provide you with an in-school or military service deferment, as appropriate.
If you must get a forbearance, consider a partial forbearance, where you make interest-only payments for a period of time. This will prevent your loans from getting bigger as the interest accumulates. It doesn’t reduce the monthly payment as much as a full forbearance, but it may provide some financial relief. Partial forbearances are more likely to be offered on private student loans than federal student loans.
If you are approaching default, making a full monthly payment can put off the default for a month. You don’t need to be current on your student loans, so long as you are not 270 days delinquent on the federal student loans and 120 days delinquent on private student loans.
If you are experiencing a long-term financial difficulty, there are three main options: increasing your income, decreasing your expenses and decreasing the monthly loan payments. If you have a job, but don’t earn enough money to repay your student loans, consider ways you can increase your income, such as asking for a raise or working a second job in the evenings and weekends. An added benefit from a second job is that you’ll have less time available to spend money. Try to cut your expenses, by eliminating discretionary expenses and substituting lower-cost options for mandatory expenses.
For example, eliminate the money you are spending on cable TV, gym membership, cell phone service, vacations, eating out and paid entertainment. To cut mandatory expenses, get a roommate to split the rent or move back in with your parents. Sell your car and use public transportation instead. Increase the deductible on your insurance. Sell excess belongings, which you haven’t used in over a year, on eBay or Craigslist. Start a small business selling crafts on Etsy and eBay. Consider alternative repayment plans, such as extended repayment or income-driven repayment. These repayment plans reduce the monthly payment by increasing the term of the loans. Refinance private student loans to get a lower interest rate.
Income-driven repayment bases the monthly payment on your discretionary income, as opposed to the amount you owe. Discretionary income is the amount by which income exceeds a multiple of the poverty line, typically 150 percent. The remaining balance will be forgiven after 20 or 25 years of payments. This forgiveness is taxable under current law. If you are pursuing an income-driven repayment plan, consider working full time in a public service job. Public service loan forgiveness will cancel the remaining debt, tax-free, after 10 years of payments.
If your financial difficulty is caused by a severe long-term disability, you may be able to qualify for a total and permanent disability discharge on your student loans. Visit www.disabilitydischarge.com for federal student loans. But, the cancelled debt is treated as though it were income to you, resulting in an IRS Form 1099-C. This can yield a big tax bill, albeit smaller than the student loan debt. If you are insolvent (total debts exceed total assets), you may be able to convince the IRS to ignore all or part of the cancelled debt (at least the part that exceeds total assets). Read IRS Publication 4681 and file IRS Form 982. Even if you aren’t insolvent, you may be able to negotiate the settlement with the IRS by submitting an offer in compromise using IRS Form 656.
Refinancing does not yield as much financial relief as most borrowers expect. Even if your interest rates are drastically reduced, you still have to repay the principal balance, which is a big part of the monthly payment. Reducing the interest rate by one percentage point will cut the monthly payment by about 4\% to 6\%, depending on the term of the loan. For example, suppose the interest rate on a $10,000, 10-year loan were cut from 6.8\% to 3.4\%. This reduces the monthly payment by from $115.08 to $98.42. The $16.66 reduction in the monthly loan payment is small, only about 14\%, although it does save about $2,000 in interest over the life of the loan. Cutting the interest rate in half does not cut the monthly payment in half.