In a perfect world, the government would allow students to refinance their public and private student loans into one loan at a low rate while the borrowers continue to receive government loan protections and forgiveness programs. Until then, borrow wisely, and refinance cautiously.
Harvard Law School recently invited me to talk with some students about their personal financial planning. During those meetings, I learned that students have a combination of government and private student loans.
I wasn’t able to offer them much guidance, as I didn’t know a lot about the student loan repayment process. So, I figured, if I’m ever invited back, I’d better read up on how this $1.23 trillion of student loans is going to get paid.
To Consolidate, or to Refinance?
The federal government allows students to combine their government student loans. This provides the student with one monthly payment. But their interest rates remain the same, so the total amounts paid back also remain the same.
To pay less back, the interest rate on the new loan must be lower than what students are paying on their current loans. Some private lenders allow students to combine their government and private loans into a new loan with a new interest rate.
The new rate is based on the student’s credit history, salary, and earnings potential. So even with today’s record low interest rates there is no guarantee that the refinancing rate will be lower than the student’s current one.
Government loans provide protection, as well as forgiveness options, that private loans don’t:
- Income-driven Plans. For example, the government offers four types of plans that allow borrowers with government student loans to cap their monthly payments to a percentage of their discretionary income. Usually no more than 10% to 20% of their discretionary income is required for payments.
- If you fall on severe financial hardship, postponing your payments through deferment or forbearance can help. However, if you refinance, you may have limited options for payment postponement.
- Loan forgiveness. Borrowers who work for an eligible employer can get a certain percentage of their federal loans forgiven.
Loan Forgiveness For Public School Teachers
There are two programs:
Federal Teacher Cancellation (Perkins Loans):
- You can have up to 100% of your Perkins Loan forgiven years
- The teacher must teach in either:
- a low-income school;
- a special-ed program
- math, science, or a foreign language;
- or a field that your state considers to be in short supply
Teacher Loan Forgiveness (Direct or loans)
- Up to $17,500 in loans can be forgiven.
- the teacher must teach in a low-income school
- for five full-time consecutive years.
Public Service Loan Forgiveness (PSLF)
Teachers and individuals who work full-time in the public sector or for an eligible not-for-profit can get a percentage of their federal loans forgiven. The amount of forgiveness varies based on the balance left after a borrower has made loan payments for ten years.
Loan forgiveness works well with one of the Income-Driven Plans—that way, a borrower pays as little as possible for ten years, thus leaving the biggest possible balance for forgiveness.
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These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.
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