What to Do If You Fall Behind on Your Student Loans

Q. I read your article “When student loans break the bank.” My student loans are past due because I suffered an injury and lost my job. My lender listed alternative repayment plans as you listed in the article, but I’m wondering if they would ever consider a settlement option to pay in full for a lesser amount. I did that with a couple of my credit cards.
— Falling behind

A. When considering repayment plans, the choices will be different depending on whether the loans are federal or private.

The Basics on Federal Student Loan Repayment

Your federal loans provide more flexibility in repayment options than private loans, said John Crosby, a certified financial planner with Individual Financial Services in Middletown, N.J.

“You cannot renegotiate a reduced payoff amount of the federal loan balance like you did with your credit cards,” Crosby said.

Steven Sirot of College Benefits Research Group (CBRG) in Roseland, N.J., said you can ask your loan servicer for the specifics on alternative payment plans, as well as deferment, forbearance and forgiveness options.

“Deferment allows you to delay payment for a period of time, but is only offered under very specific circumstances and interest will accrue during this period,” Sirot said. “If you don’t qualify for deferment, you can look to forbearance options, where you may be able to stop making payments or reduce your monthly payments for up to 12 months.”

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Special Circumstances

Let’s take it a step further.

Crosby said if you’re unemployed, you can defer payments. Federal subsidized loans will have the interest paid by the government while in forbearance, he said, while unsubsidized loans will have the unpaid principal and interest capitalized and added to your loan balance.

You also mentioned an injury.

“If you are disabled from your injury or illness, you will have to be totally and permanently disabled in order to qualify for full loan forgiveness,” Crosby said.

To determine your best repayment option, some basic information is needed on your college loans before making a sound decision.

He recommends you consider the following.

Who is the loan servicer of your federal loans?
Separate the federal loans from the private loans. Then separate the federal subsidized from un-subsidized loans.
What type of federal loans do you have?
Who is the loan servicer of your private loans? You can refinance your private loans if you qualify.
Is there a co-signer/co-borrower on your private loans?
What are the terms of your loans: years, interest rate, payment, current loan balances.

Ways to Lower Your Federal Loan Payments

Crosby said your federal loans may qualify for PAYE, (Pay As You Earn), IBR (Income Based Repayment) or ICR (Income Contingent Repayment).

These programs can limit your monthly federal loan payments to 10%, 15% or 20% of your adjusted gross income (AGI).

Crosby offered an example of the IBR program.

“The qualifying formula for adjusted federal loan repayment looks at your family size,” he said.

If we assume you are a family of one person, you’d multiply the 2016 poverty level of $11,880 by 150%, which equals $17,820. Subtract $17,820 from your adjusted gross income (AGI).

So if, for example, your AGI is $25,000: $25,000- $17,655 = $7,180.

The IBR plan limits your monthly payment to 15% of the $7,180, Crosby said. Here’s the math: $7,180 x 15% = $1,077 / 12 = $89.75 per month.

“If your payment is $350 per month, you only pay $89.75,” Crosby said. “The $260.25 difference is forgiven if you stay in the program. The accumulated balance may be forgiven, pending your current employer.”

If you qualify for one of the repayment programs and have made payments on time, after 20 short years, the unpaid balance is forgiven, Crosby said.

“If you paid back $60,000 of your $100,000 of principal and interest, you will receive a 1099-C for the cancellation of debt of the unpaid $40,000,” he said. “In other words, in 20 years, you have to recognize the $40,000 as income and pay income tax in your current tax bracket.”

One exception is PSLF, or Public Service Loan Forgiveness, if you work for a non-profit, a hospital, a university or the government, Crosby said. Your repayment period is limited to 10 years and just 10% of AGI, and the $40,000 of unpaid balance is forgiven and there is no 1099-C or tax liability.

The loan servicer monitors the program each year. As your income and family size changes, the repayment amounts change, he said.

“We don’t know what the laws will be in 10 or 20 years, and if our legislators make changes to these programs, anything is possible,” Crosby said. “Hopefully you’ll be very successful, make a lot of money and pay off your loans early.”

Private Student Loans

Now, private loans.

Crosby said there are several lenders available to refinance your private loans.

“The refinancing requires you to have a good credit score, be employed and you still may need a co-signer if you’re a recent graduate with limited work history,” he said. “Some lenders will remove the co-signer after 3 years of payments.”

Crosby recommends you speak to your loan servicer, which should be able to direct you to a viable payment program that best meets your current needs. Before applying for refinancing, you’ll want to check your credit scores — you can get two free credit scores each month on Credit.com.

He said you should be sure to stay current on your monthly payments, and consider speaking to a certified financial planner who works in the area of college planning and understands how these programs work today and in the future.

“Your CFP can help you understand how your college loans affect your credit rating, and your monthly cash flow,” Crosby said. “Not understanding or managing your college loans may prevent you from buying a car, getting a credit card, renting an apartment, getting a job, buying a home and saving for an emergency fund and retirement.”

You’ve invested a great deal of time, energy, and money into your college education. Using the tips and tools mentioned above will help to ensure that your education is a good investment, Crosby said.

Good luck.