The college funding world is going through one of its biggest shake-ups in decades and could have an impact on your financial plans. The new SAVE student loan repayment plan has been making headlines so we pulled together a list of important changes and planning opportunities for those who may be impacted by the resumption of student loan payments.
With student loan payments resuming in October after a period of forbearance which began in March 2020, what will the impact be for borrowers, consumers, and the overall health of the economy? Find out more here.
The New SAVE Program
After a 3 ½ year hiatus, student loan payments are set to restart in October. The Supreme Court struck down the Biden administration’s direct loan forgiveness program but left their ‘Saving on A Valuable Education’ (SAVE) income-driven repayment plan untouched. Some of the main changes have been highlighted below:
Out with the old, in with the new.
SAVE replaces the existing Revised Pay As You Earn (REPAYE) income-driven repayment plan. Those already enrolled in REPAYE will be automatically switched to the SAVE program. Besides the Income-Based Repayment (IBR) plan, all of the other income-driven repayment plans will eventually be phased out [Pay As You Earn (PAYE), Income-Contingent Repayment (ICR), Income-Sensitive Repayment (ISR)], making the SAVE plan the most sensible choice for most borrowers going forward.
A little something for (almost) everyone.
The program is open to everyone with undergraduate and graduate Federal Direct student loans (besides Parent PLUS loans, which must use the Income-Contingent Repayment plan if payments are too onerous).
Lower monthly payments.
For those with undergraduate loans, payments will be limited to 5% of discretionary income, and to 10% for those with graduate loans. If a borrower has both, a weighted payment is calculated based on the initial balances. Note: This part of the program will take effect July 1, 2024.
What is discretionary income?
The government considers your Adjusted Gross Income over 225% of the Federal poverty line to be discretionary income (i.e., $32,805 for single households and $67,500 for a family of four in 2023). Excess income is considered available to use towards repaying Federal Direct student loans. Those making under the line will have monthly payments of $0. Under the old REPAYE plan, the cut-off was 150%. Finally, those enrolled in the new plan will be required to re-certify their income and household size each year, however, there is an IRS Data Retrieval Tool available to make the process a bit smoother.
All is forgiven.
There are two elements of forgiveness within the new plan that applies to the loan balance and interest. For those with an original total loan balance of $12,000 or less, the remaining balance is forgiven after 10 years of consecutive payments. For every $1,000 over this limit, one year is added to the payment schedule to qualify for forgiveness, up to a maximum of 20 years for undergraduate loans and 25 years for graduate. In addition, any interest not covered by the minimum monthly payment is forgiven and no longer added to the total balance. After 2025, student loan debt forgiveness will likely be treated as taxable income again, so avoiding the negative amortization of unpaid interest will be even more meaningful.
Time is money.
The program offers a one-year grace period or “on-ramp” from October 1, 2023, to September 30, 2024. It is recommended that borrowers begin making payments as soon as they are able, but if for some reason they need more time making payments, it will not impact credit scores or risk default for one year. However, interest will accrue. It’s important to note that the last 3 ½ years of forbearance will only count towards those already enrolled in an income-driven repayment plan or Public Service Loan Forgiveness program. However, for those keen to realize loan forgiveness sooner, beginning July 2024, borrowers can make “catch-up” payments to make up for the lost 3 ½ years.
A new tax filing wrinkle.
Only in rare cases does it make sense for a married couple to file separate tax returns. However, with the new SAVE program, borrowers can choose to exclude their spouse’s income in calculating their payment but only if they file taxes separately (i.e., Married Filing Separately). If the spouse’s income is substantially higher than the borrowers, it may be worth revisiting their filing status and rerunning the numbers. While they will likely pay more in taxes, they can potentially save a substantial amount in total loan payments.
What’s the Best Option for Me?
Like any planning discussion around debt, this one is no different. Not all debt is created equal so holding on to “good” debt and putting together a plan to eliminate “bad” debt as quickly as possible should be the focus. A useful rule of thumb is to pay down debt that has an interest rate higher than what one can earn on their investments. Or, for example, if one would be reasonably satisfied with a 6% return on your investments, focus on paying down debt with an interest rate higher than 6%.
There is no one-size-fits-all approach to paying off your student loans and the final decision will likely involve crunching the numbers based on the following factors:
Student loans mostly fall into two buckets: Federal and private (though some states have loan programs similar to the Federal program). Federal loans typically have more repayment options and flexibility than private loans. For borrowers that have some private loans, which most people do, paying those off as quickly as possible, especially those with a high interest rate, should be a primary focus.
For those with Federal loans, current and expected future income will play the largest role in which plan is right for them. Depending on what the borrower is comfortable paying each month, here are a couple options to consider:
- Standard Repayment Plans
Those with stable income and the ability to pay off their loans in full over 10 years, without drastically altering their lifestyle, would be best suited by the standard plan. Extended and Graduated repayment plans, modified versions of the standard plan, are also available for those who want a bit more time and control over their payments, with the tradeoff of paying more over the life of the loan.
- Income-Driven Plans
These plans make the most sense for those with lower earning potential, or who may anticipate financial hardships or frequent job changes. The idea with all these plans (SAVE, PAYE, IBR, ICR, ISR, & PSLF) is to make manageable payments for a certain amount of time with the goal of eventual loan forgiveness.
If the interest isn’t forgivable, higher interest rate loans should be prioritized and paid off first. Loan consolidation or refinancing can also be an option, but borrowers should make sure they don’t give up other, more valuable benefits and protections to lock in a lower interest rate (i.e., going from Federal loans to private loans, since it cannot be undone).
Borrowers should check to see if their employer offers any kind of assistance with student loan debt. The two most common benefits are matching payments up to a certain amount or a retirement contribution match. These benefits are expected to become much more common as employers look to attract new talent who will likely have student loan debt.
Unused 529 Plan assets
Thanks to the SECURE Act, up to $10,000 (per person) can be used towards student loan debt, so a parent or grandparent with unused 529 plan assets can reallocate them to help with student loan debt.
The goal of every financial decision, including paying off debt, is to keep as many dollars as possible working for you. Understanding the best way to coordinate all of the above can help you keep the most dollars in your pocket and work towards your other financial goals.
Source: Department of Education
Please consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. The information in this article is not intended as legal or tax advice.