Written by: Saki Kurose | Omega Wealth Management, LLC
From the way that news and issues about student loans are covered in the media, whether it is about loan cancellation or the borrowers who are struggling to navigate through the complex repayment programs, it is easy to assume that the types of people who take out student loans and can benefit from federal student loan programs are limited to young adults who borrow to finance their own education. However, parents are a group of borrowers who are rarely talked about.
Federal Parent PLUS loans come with higher interest rates and some parents choose to borrow private loans with lower interest. However, many of the repayment plans and forgiveness programs that are available to student borrowers are also available for parent borrowers of federal Parent PLUS loans. Before parents default to either using their own funds to pay for their children’s education or taking out private loans with lower rates, borrowing federal loans and pursuing forgiveness should be part of the college planning conversation and analysis.
When a family has savings earmarked for their children's college expenses, when would it make sense to borrow money instead? What is the advantage of taking out high interest federal loans over low interest private loans? It is important to understand that federal student and parent loans are not traditional types of debt. Traditional debts require a borrower to pay back the full balance over time, but federal loans do not always have to be paid back in full. The Income-Driven Repayment (IDR) plans are repayment options that are available for federal student and parent loans that allow borrowers to pay monthly payments based on their income for a certain number of years and get the remaining balance forgiven. There are two main paths to forgiveness. First, borrowers who work for a public sector employer and non-profit organizations can pursue forgiveness in 10 years under the Public Service Loan Forgiveness (PSLF) program; and second, other borrowers whose employment does not qualify for PSLF can pursue long-term forgiveness by simply staying on an IDR plan for 20 or 25 years.
Again, just like student borrowers, parent borrowers can qualify for both types of forgiveness paths, although the Parent PLUS loans may need to be consolidated in certain ways to be eligible for some repayment plans. It is also important to understand that the total payment and the forgiveness amounts in IDR plans are be based on the parent borrower’s income and not the loan amount. This is the potential foundation for creative planning.
In all of the IDR plans except the REPAYE plan, the income used to calculate the monthly payments depends on your tax filing status. If the borrower is filing as Single or Married Filing Separately, only the borrower’s income is used for the calculation; but the couple’s joint income is used as the borrower income when taxes are filed jointly. Because of this rule, the best option may be to have one spouse take on all the federal loan balance and file taxes separately. The determination of which spouse should take out the loan is based on many factors. These factors include the potential eligibility for PSLF that based on employment, which spouse’s income is lower (both currently and in retirement), and whether one spouse is old enough to potentially have the loans discharged at death. It is very typical for the higher income spouse to take out the loans in his or her name, but it could be a great strategy for either the PSLF-eligible spouse or the spouse with the lower income to take out all of the family’s federal Parent PLUS loans to minimize the monthly payments and maximize the forgiveness amount.
Under the right circumstances, when parents can use the right strategies to maximize loan forgiveness, intentionally borrowing federal loans instead of borrowing lower interest private loans or spending down their savings can cost less.
The repayment analysis for federal student loans can be very complex. There are a lot of risks and factors to consider, such as the tax consequences of filing taxes separately, the uncertainty of taxation on forgiveness, potential rule changes, and the monthly payment calculations and repayment plan options that are particularly complex for married couples who are both enrolled in IDR plans. However, taking a deeper look into student and parent loan repayment strategies and understanding the pros and cons could make a huge difference in some situations. If you have clients who are helping their kids pay for college, it is important not to rule out federal Parent PLUS loans. If you are not sure, consult a student loan expert to find the most appropriate course of action and repayment strategy!
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