Student loan forgiveness, especially Public Service Loan Forgiveness, is a really sweet deal.
Borrowers are required to work for the government or a non-profit for 10 years. During that time, they pay a small portion of their monthly income towards the loans. At the end, all federal loans — no matter how large the balance — are forgiven.
Public Service Loan Forgiveness was created to encourage young college graduates to take lesser paying jobs in order to help others. Many Americans answered the call.
Unfortunately, actually getting the loans forgiven has proven to be very difficult. Department of Education statistics indicate that 99% of applicants are rejected.
Other federal programs also provide student loan forgiveness, including the various income-driven repayment plans. However, most income-driven plans have not been around long enough for students to be eligible for loan forgiveness, so no statistics are available.
The troubling recent history of student loan forgiveness, combined with a desire by some in government to eliminate the programs, should have borrowers nervous. The good news is that there are ways to reduce the risk of not qualifying for forgiveness while still maximizing the potential benefit.
Avoiding the Forgiveness Risks
If student loan forgiveness is Plan A, it is critical that borrowers have a Plan B.
An ideal Plan B would be to create a savings account to set aside extra money for student loan payments in case forgiveness falls though.
Plan B would look something like this:
A borrower is required to pay $200 per month towards their student loans. The borrower is careful with his or her money, so there is an extra $100 per month that could also be used towards the debt.
If the borrower pays the extra $100 towards the loans each month and gets forgiveness, the amount forgiven will just be smaller and the borrower loses out on that extra money.
Instead, the borrower puts that $100 into a Plan B savings account. The money accumulates in the account. If forgiveness works out, the borrower has a large cash reserve to use on a down payment for a house or to invest for retirement. If forgiveness is a bust, the borrower has money set aside to attack the debt.
The cost of going with Plan B is the difference in interest between what the savings account earns and what the loan charges. If the student loan interest rate is 6% and the savings account earns 2%, the borrower is behind by 4%. A Plan B account with a balance of $1,000 would “cost” the borrower $40 per year. (Using that $1,000 in savings the borrower earns $20 per year, but because the loan balance is $1,000 higher than what it would have otherwise been, the student loan will generate an extra $60 of interest, hence a $40 cost to Plan B.)
A borrower could get aggressive and invest some or all of the Plan B funds. If the borrower is able to earn an a return equal to the student loan interest rates, then the borrower breaks even. However, any investment comes with risk, so the borrower could end up much worse off.
A side benefit of having a Plan B account is that the funds are available in case of an emergency.
Who Should Have a Forgiveness Backup Plan?
Ideally, any borrower hoping for forgiveness should also be preparing for the possibility that it won’t happen. The current numbers from the Department of Education are just too bad to ignore.
That being said, it is the opinion of The Student Loan Sherpa that the numbers will improve with time. Loan servicers should get better at handling applications and advising borrowers. Similarly, borrowers will learn from the mistakes of others and take steps like submitting a yearly employer certification form to help their chances of success.
It is also worth noting that Public Service Loan Forgiveness and Income Driven Repayment Plan Forgiveness are programs that are written into the Master Promissory Note (MPN) that most borrowers sign. The MPN is the student loan contract between the government and the student. The MPN language is part of the reason why proposals to eliminate or reduce forgiveness programs usually don’t apply to current borrowers.
Ultimately, there is a reasonable hope for the continued existence of student loans forgiveness, but there is also enough reason to be concerned and have a backup plan.
Some borrowers may also end up making too much money for forgiveness to be a viable route, or they may leave public service before becoming eligible. Thus, even if the programs were certain to continue, borrowers should still account for the possibility that they may not qualify.
When to Stop Chasing Forgiveness
There is no specific equation or line in the sand that will apply to every borrower.
If chasing forgiveness is Plan A, then Plan B is using the money set aside to pay down the balance and beginning aggressive repayment.
The time to shift to Plan B would be when a borrower concludes the following:
- I am going to pay off my loans in full before I qualify for forgiveness, or
- By chasing after forgiveness, I’m going to spend so much on interest that I would have been better off aggressively repaying the loan.
At the point forgiveness stops being the best option, either for financial reasons or for eligibility reasons, it is time to make the shift to aggressive repayment. The strategies required for aggressive repayment of student loans will require a new borrower mindset, but can save significant amounts of money.
Qualifying for student loan forgiveness can be done, but it is far from a sure thing.
Having a smart backup plan in place allows borrowers to maximize forgiveness if they qualify, but to minimize the damage if they fall short.