Should You Pay Off Student Loans or Hold Out for Forgiveness?

Should I pay off my student loans or pursue long-term forgiveness?

This is one of the most common questions Student Loan Planner consultants get from borrowers. Maybe your income is going up, or you’ve just gotten married, and are curious if that changes the plan.

Twenty or 25 years is a long time to pursue forgiveness, and something about it still doesn’t feel real.

The fast and furious approach to student loan repayment

To be honest, when I finished graduate school in 2013, I didn’t even research the long-term forgiveness options for my student loans. I felt like my future was so uncertain, and that my income potential was completely up in the air.

I also feel allergic to debt like many of you do — my dad taught me from a young age not to carry debt. So I attacked my student loans with vigor.

I started by making a standard 10-year payment of $1,400 per month, despite my $60,000 salary at the time. My loan payment cost more than my rent.

Then, at the end of every year, I received some form of bonus from my job, and pretended that it didn’t belong to me — it belonged to the Department of Education. So I paid a rent payment monthly, then all of my bonus money went to my loans.

The emotional side to paying student loans quickly

Using my method, I paid my loans off in six years. I’m not going to lie, it felt really good. My husband and I paid off $225,000 of debt that way. I would also like to point out that Student Loan Planner wasn’t around yet.

I tell you this for two reasons:

1. I understand the desire to pay student loans quickly.
2. I understand that student loan repayment is an emotional decision, not just a mathematical one.

We spend our calls walking you through many student loan repayment options, but our goal is to find the best option for you. Carrying this debt isn’t easy, so we want to ensure your comfort with whatever we decide, even if it means paying a little bit more.

Active vs. passive approach to repayment

At the start of many consultations, I talk about the active vs. passive approach to student loan repayment. I took the active approach. Any form of overpayment or private refinancing are also considered the active approach. The idea is to get rid of the debt as quickly and efficiently as possible.

We spend a lot of our time in consultations talking about the passive approach, also known as income-driven repayment. Income-driven repayment can be a true gift if it fits your situation.

The passive approach to student loan debt

The idea behind the passive approach is that you pay the least amount possible and potentially spread those payments over the longest amount of time. You can see how that feels counterintuitive to how we typically learn about debt. Why would anyone consider that?

The Department of Education’s income-driven repayment options aren’t perfect, but in some cases, they’re life-changing.

Income-driven repayment (IDR) plan options

You’ve likely read about these plans, they have odd names like PAYE, REPAYE and IBR. These plans calculate 10% to 15% of your discretionary income, which can result in payments that are significantly less than what you’d pay under a Standard 10-Year plan.

As a reminder, the Standard 10-Year plan is the repayment plan that we’re all placed on after leaving school. If you think of the Standard 10-Year plan as your baseline, the goal with IDR is to lower that standard plan payment.

As an illustration, my standard repayment plan means I made payments that were a little over $1,400 per month for a $125,000 loan balance. It’s usually pretty high. IDR plans can reduce your payment significantly.

IDR plans last 20 years for PAYE and 25 years for REPAYE and IBR. That’s the crux of this article — it’s a long time to pay small payments and watch your balance grow. That can be anxiety-provoking.

The tax bomb

So what happens when you follow this plan? After 20 or 25 years, your loans are forgiven by the federal government. However, the balance forgiven counts as taxable income during the year you received forgiveness.

Related: Student Loan Forgiveness Tax Bomb: What to Know Today

Depending on the level of borrowing you’ve done and your choice of repayment strategy, this could be calculated as hundreds of thousands of income in your year of forgiveness. You won’t have to pay that total balance, but the forgiveness amount typically puts borrowers in a higher tax bracket than usual.

For example, if you have $250,000 of loans forgiven after a 20-year period, you could be looking at a $100,000 tax bill.

Public Service Loan Forgiveness

If the idea of a huge tax bill is terrifying, the Department of Education currently offers the Public Service Loan Forgiveness (PSLF) program. This program might not be around forever, but it’s available now. Here are the rules:

1. You need to have Direct Loans, as opposed to FFEL loans.
2. You need to be on an IDR plan.
3. You need to work full-time for a qualifying employer (nonprofit or government).
4. You need to make 120 qualifying payments.

In other words, if you are able to work 10 years for a nonprofit or government organization, your loans can be forgiven tax-free. This is the most generous plan currently available.

Questions to ask yourself about forgiveness

Here are some things to think about when considering whether to pay off your loans quickly or pursue forgiveness:

• What’s your plan after graduation?
• Will your income start small and grow over time? Or will your income stay approximately the same?
• Will you get married? Have kids?
• What IDR plans are you eligible for?
• Can you find a nonprofit or government job for 10 years? Do you have a passion for that type of work?
• How are you feeling mentally about the loans? Are they causing you stress or keeping you up at night?
• What does your budget look like? Can you afford large payments, or do you live in an expensive area where it’s hard to come up with the extra cash?

Consider the PSLF Waiver and IDR Waiver

If you follow our blog posts or listen to the SLP podcast, you’ve heard about the two waivers the Department of Education announced in the past year. The PSLF waiver and the IDR waiver made the forgiveness rules much more lax. These waivers are truly unheard of in the student loan space.

While the PSLF waiver expired in October 22, you can get credit for payments on any repayment plan and might be eligible for credit during periods of forbearance or deferment under the IDR waiver. We think of these waivers as a once-in-a-lifetime opportunity.

Sample scenarios: Pay off your loans vs. wait for forgiveness

High-earning lawyer with student loans

The PSLF opportunities for lawyers are somewhat limited. We most typically talk to lawyers working for government employers, like the DA’s office.

Let’s start with Ella. She finished law school 11 years ago and made an income of $75,000 with a student loan balance of $200,000. She called her servicer and they recommended an IDR plan. She made the required payments but became overwhelmed as the balance continued to grow.

Fast forward 11 years and Ella is now married with two kids, and her total household income is closer to $400,000. She feels stressed about filing taxes separately to reduce her student loan payment, but she wants to stay in the federal system just in case there’s any sweeping forgiveness.

With 14 years remaining, if she files her taxes jointly with her spouse, she’ll actually pay the loans off before she achieves any kind of forgiveness. She’ll also be looking at payments of $2,000 to $4,000 per month based on her joint income. With two kids, that’s really tough.

Although this is a typical refinancing case because her income is so much higher than her student loan balance, we have to remember she wants to stay federal. So in this case, I would find a payment that worked well for her, then suggest overpaying in big chunks when she can (during bonus time).

Physician with student loans who hates their job

Jack has worked for the VA for five years and has been pursuing PSLF, but finds his job grueling and is ready to look at other opportunities.

The first thing we would do in this case is look at the PSLF and IDR waivers. Many physicians were in deferment or forbearance during residency and or fellowship. As a result of these waivers, we might be able to go back and grab three to five more years!

Jack might be able to join a private practice and double his income, so even if we can get three prior years of credit with the IDR waiver, it might be too stressful to stay at his current job for two more years.

Student loan strategy is complicated!

We talk to people about complicated situations like these every day. In a student loan world where there’s a large amount of uncertainty, we want to help you choose the most straightforward money-saving plan. However, we understand that what’s right for you might not be what our calculator says.

Let us take a look at your case by booking a consultation with us!