As I researched and wrote Student Loan Solution, it became obvious to me that there are many common misconceptions about student loans.
This wasn’t surprising, though. Any time you have something that is overly complex, you are bound to have misconceptions.
Unfortunately for student loan borrowers those misconceptions about their loans can cost them time and money. Someone who thought they were five years down the path of loan forgiveness could find out that they had the wrong type of federal student loans, or that their employment didn’t qualify.
That’s why it’s so important for student loan borrowers to not be fooled by misconceptions and misleading information. For that reason I wanted to share a few of the common misconceptions around student loan debt, as well as what the truth is.
Misconception #1: You Have to Pay Off Your Student Loans, No Matter What
A disservice is done to student loan borrowers when a personal finance personality makes it seem like a borrower will have to repay their loans regardless of their financial and employment situatoin. This is simply not true.
One reason I wrote Student Loan Solution was because I wanted student loan borrowers to look at and understand all their options. I have read entire books about student loans that do not mention loan forgiveness opportunities. They simply say “if you can’t afford your loans, you need to make more money, spend less money, or both.” For someone making $35,000 a year with $150,000 of student loan debt (which is the reality for some social workers, therapists, and teachers), it’s simply irresponsible to not point out their opportunities for loan forgiveness.
With that being said, in many situations borrowers will eventually pay off all their student loans. But for those who may have opportunities to not have to pay off their loans, it’s important they know their options and are not deceived into thinking they are shit out of luck.
Federal student loans have two primary opportunities for loan forgiveness:
- Public Service Loan Forgiveness – Public Service Loan Forgiveness, or PSLF for short, is what I call “the holy grail” of loan forgiveness. After making 120 qualified monthly payments (equivalent of ten years), borrowers are eligible for tax-free loan forgiveness. That means even if you have $300,000 in federal loans forgiven, you won’t be taxed as if you made $300,000 of income that year.
- Income-Driven Loan Forgiveness – Borrowers who do not qualify for Public Service Loan Forgiveness who have federal student loans likely still qualify for income-driven loan forgiveness. Depending on what income-driven repayment plan you are on, you are eligible for forgiveness after twenty or twenty-five years. The amount forgiven is taxed, though, so you have to prepare yourself over the years for the tax bill you will get when your loans are forgiven.
I touch on all the details of loan forgiveness in Student Loan Solution, but you can also get some more information in this post on Public Service Loan Forgiveness and this post on income-driven repayment plans.
With federal student loans there are even more opportunities beyond PSLF and income-driven loan forgiveness. There is Teacher Loan Forgiveness, Total and Permanent Disability Discharge, and many less common options like if you are a physician practicing in a rural area.
If you have private student loans you are not out of luck. This is a big misconception, partially because there is so much focus on federal student loan forgiveness. With private student loans, depending on your situation, you may be able to negotiate a much lower principal balance. We are talking potentially tens of thousands of dollars and no interest. Again, this varies from situation to situation.
If you are struggling with your private student loans it’s worthwhile to talk to a reputable attorney about your options. The reason you should talk to an attorney is because there is the potential for litigation. I am hesitant to refer people to specific debt counselors and attorneys because I really want to feel good about the referral. With that being said, I have had conversations with Leslie Tayne of Tayne Law Group and I absolutely recommend anyone struggling with student loan debt (or other debt) to discuss your situation with her. Worst case scenario you don’t end up using her services, best case you could have thousands of dollars of debt negotiated on your behalf – including private student loans.
Misconception #2: Student Loans are Similar to Credit Card Debt and Other Debt
There are millions of student loan borrowers who are behind on their payments or in default. This is always difficult for me to hear because I can’t help but think many of those borrowers have a misconception that student loans are similar to other types of debt. The big difference is this: unlike other debt, student loans are incredibly difficult to discharge in bankruptcy.
If you stop making payments on your student loans the government can garnish your wages, withhold your income tax refund, and garnish your social security payments. Put simply, this debt doesn’t just go away and there is no simple way to discharge them in bankruptcy.
With that fact in mind, I always encourage borrowers to prioritize their student loans. And I don’t mean they necessarily have to make the full payment that is calculated under the standard ten-year repayment plan. What I mean is that borrowers should get out of default ASAP and get on an income-driven repayment plan. Even though income-driven repayment is twenty or twenty-five years, it’s still closer than “forever.” And if you have private student loans you can’t afford please consider working with a debt relief attorney.
Misconception #3: Public Service Loan Forgiveness is Impossible So Don’t Pursue It
There have been many headlines about the high percentage of applicants who have been rejected for Public Service Loan Forgiveness. There’s no denying the fact that many have been denied, but does that mean you shouldn’t pursue Public Service Loan Forgiveness?
One of the biggest names in personal finance did a big disservice to student loan borrowers in an Instagram Q&A. Not only did he tell borrowers they absolutely should not pursue PSLF, but he made statements that were simply incorrect that inevitably could scare borrowers.
For some borrowers PSLF could result in $100k+ being forgiven tax free. And if they use certain strategies to maximize PSLF it could be an even bigger financial windfall. They could exit PSLF with their federal loans forgiven, a nice emergency fund built up, and a sizable retirement account. And I’m not talking about someone making a huge salary; PSLF can be maximized no matter what your income is.
With that in mind, it makes sense to look at the reality behind PSLF rejections:
- Around 8,000 of the 28,000 rejected applications (as of end of June, 2018), representing 28% of the total, were denied “due to missing or incomplete information” on their application forms. These could be simple admin errors or a missing piece of information, and realistically we can expect most to be rectified.
- Federal Family Education Loans, or FFEL, are ineligible for PSLF. These loans were issued until 2008, so many borrowers pursuing PSLF who were eligible in the first wave in late 2018 could have had FFEL loans. As of September 2018, approximately 20% of federal loans were FFEL with the vast majority of the remainder being Direct loans (which are the loans that are eligible for PSLF). We can expect the acceptance rate to go up over time from this simple fact.
- Participation in income-driven repayment plans has increased, and the pool of borrowers who would potentially be eligible in 2018 and early 2019 did not have the same options and information ten years ago that borrowers have today. There are now multiple income-driven repayment plans and easier access to information about PSLF.
Don’t get me wrong: PSLF can be a pain in the ass. But for many borrowers it is an excellent option from a financial standpoint and those borrowers should not be discouraged or scared away from participating.
If you plan on participating in PSLF or are already participating, my suggestion is to learn as much as you can about the program’s requirements. You should feel very confident when you submit your final application for forgiveness.
Misconception #4: Refinancing for a Lower Interest Rate is a No-Brainer
One thing that has concerned me is all the social media and other advertising for student loan refinancing. It makes me concerned that many who go through with refinancing are not fully aware of the disadvantages of refinancing.
First, there’s no denying that refinancing student loan debt at a lower interest rate can potentially result in thousands or even tens of thousands of dollars of interest savings. It’s a very simple value proposition.
What concerns me is that many borrowers who refinance their student loans don’t realize what they are giving up. When federal student loans are refinanced with a private bank, they become a private loan. Private loans do not have the same protections and benefits as federal loans, such as opportunities for loan forgiveness and income-driven repayment. Refinancing can’t be done, so if you regret refinancing and wish you could go back to federal student loans, there is nothing you can do.
In some situations it makes sense to refinance federal student loans, but I urge people to take a step back before going through with it. Are you certain you won’t need the federal student loan benefits in the future? Can you easily afford the payments? Have you built up an emergency fund in case you hit hard times? These are all things you should think about before refinancing federal student loans.
If you already have private student loans, that’s a different story. With private student loans you don’t have the benefits of federal student loans in the first place, so it makes sense to shop around and refinance at a lower interest rate. And something I always tell people is that you can always shop around for a lower rate again in six or twelve months. Just because you refinanced today doesn’t mean you can’t do it again down the road if you find a lower interest rate.
Misconception #5: Consolidating your Loans Saves You Money
Loan consolidation doesn’t save you money.
I repeat: loan consolidation doesn’t save you money.
As I explain in my post on the difference between student loan consolidation and refinance, consolidation simplifies your payments but ultimately you get a weighted average interest rate so there is no interest savings.
Let’s take the following loans as an example:
- $20,000 at 8.0%
- $20,000 at 8.5%
- $10,000 at 3.0%
Your consolidation loan would be $50,000 at 7.5%, which is a weighted average of the loans and corresponding interest rates.
The benefit of loan consolidation is you can simplify your repayment. For example instead of having twelve loans across three different loan servicers, you can consolidate so that you have one loan, with one interest rate, with one servicer.
You should be a little careful with consolidation, though, because just like refinancing it creates a brand new loan. If you had 60 of your 120 required eligible payments for PSLF completed and you went ahead and refinanced, you would be back at 0 eligible payments for PSLF. Reason being that the loans you were previously making payments towards no longer exist; instead you have a brand new loan.
Don’t Be Fooled! Know Your Loans
Student loans are complicated, and misconceptions can potentially cost you thousands of dollars. So what is a borrower to do?
Because student loan debt can be such a big part of someone’s financial life, I highly recommend borrowers spend time learning and understanding their loans and repayment options, as well as how they fit into and impact their greater financial life. Simply put, those with student loans need to work harder at improving their financial life than those who
A good place to start is by getting my book Student Loan Solution from Amazon or your local library, as well as downloading our free student loan spreadsheet. If you don’t feel 100% confident about your student loan strategy, you owe it to yourself to make sure you are on the best path for your personal situation.
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