Federal Employees News Digest

Informed Investor: Beware of private loans when refinancing to consolidate student loan debt

There is no doubt that in recent years the cost of a college education has skyrocketed. It is getting increasingly harder for students to graduate from college without taking on student loan debt. In 2016, nearly 70 percent of undergraduates who will graduate with bachelor degrees will leave school with debt, a fact that could have major consequences for the national economy. Recent research indicates that the current $1.2 trillion in student loan debt exceeds the $0.70 trillion in credit card/revolving debt. Student loan debt is the second-highest level of consumer debt behind mortgage debt.

To make matters worse, many college graduates have multiple student loans, a result of taking out loans at different stages of their undergraduate, graduate, medical school or law school education. Refinancing debt to consolidate multiple student loans is becoming a favorite way of handling student loan debt. This column discusses what student loan holders should and should not do with respect to consolidating their student loans.

There is much to be said about the advantages of consolidating student loan debt. A large number of loans with a variety of loan services to pay, with varying interest rates and loan terms, can be unmanageable and spiral out of control, possibly leading to default and bankruptcy. Refinancing multiple loans into a single consolidated loan with one interest rate can also be appealing if the new loan has a longer repayment period and a lower interest rate. Consolidation into one loan may save money in the long run, as well as minimize the chance of loan default. But consolidating college loans can be a challenge because today’s student loans consist of both federal and privately sponsored loan programs.

To help alleviate explosive levels of college debt, federal government-sponsored student loans have access to multiple forms of flexible repayment programs. These flexible loan repayment programs are available only for federal student loans. In fact, those students or graduates who refinance federal student loans into a private loan lose access to the flexible repayment and potential forgiveness loan programs. Refinancing a group of federal government student loans to a private loan with a lower interest rate and smaller monthly payment—while enticing, at least initially—will prevent any future flexibility to refinance—and cut off access to several repayment programs only available for federal student loans.

Under the Federal Direct Consolidation Loan program, multiple federal student loans are combined into a single loan. The loan program can also render the student loan borrowers eligible for several repayment programs, including:

Income-Based Repayment (IBR). With IBR, payments are capped at 15 percent of the borrower’s discretionary income and can be as low as zero for those below 150 percent of the federal poverty level. A student loan borrower must qualify for IBR.

Pay As You Earn (PAYE). Under PAYE, a student loan borrower’s monthly payment is capped at 10 percent of the borrower’s discretionary income.

Revised Pay As You Earn (REPAYE). REPAYE has terms similar to PAYE in which monthly payments are capped at 10 percent of discretionary income, it also allows forgiveness after 20 years.

A disadvantage to IBR, PAYE and REPAYE is that any loan balance that is forgiven is considered taxable income to the borrower in the year of forgiveness. But the Public Student Loan Forgiveness (PSLF) program, which can be used instead of IBR, PAYE and REPAYE, turns the forgiven loan from being taxable to nontaxable.  But PSFL is available only to those who work full-time in the public sector. This means working for the federal, state or local government, a 501(c)(3) charity or certain other qualifying nonprofit organizations.

The Treasury Department took over the entire federal student loan program in July 2010. Prior to 2010, federal student loans were administered by a combination of the federal government and the Federal Family Education Loan (FFEL) program. Starting after July 1, 2010, all federal student loans were administered by the Treasury Department. That means all federal student loans—those taken out before and after July 1, 2010—are eligible for the IBR, PAYE, REPAYE and PSLF programs. But if a student loan borrower goes through the process of refinancing his or her federal loans into a private loan, then he or she will irrevocably lose access to these programs.

Many students may not be aware of whether their loans are federal government-sponsored loans or privately sponsored loans. To find out, students can request their federal government-sponsored loan information through the National Student Loan Data System (NSLDS) at https://www.nslds.ed.gov. To identify all other loans, students should also get a copy of their credit reports to determine all student loans outstanding. Any loans that are shown on a credit report and not listed in NSLDS are considered privately sponsored loans.

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