getting the most student debt forgiven

Ten Tips to Maximize Student Loan Forgiveness

Michael Lux Blog 0 Comments

Student Loan Forgiveness Programs are a primary reason that federal student loans are the best student loans.  Even though qualifying for loan forgiveness can be complicated, the potential savings make it worth the effort.

Borrowers looking to have their student loans forgiven should be focused on two goals:
1) Getting their loans forgiven as soon as possible, and
2) Paying as little as possible until the loans are forgiven.

The following strategies should help borrowers achieve these goals…

#1: Get on the Right Repayment Plan Right Away

The standard repayment plan for most borrowers is the 10-year plan.  This plan has the highest monthly payments and only qualifies for some forms of forgiveness.  Borrowers who plan on having their debt forgiven would be wise to get on the appropriate income-driven plan as soon as possible.

It is also worth noting that the processing times for income-driven repayment plans can take several months.  While a few months may not seem like much time in the big picture, a few months here and there can add up to years in the long run.

While the number of federal student loan repayment plans can make things seem complicated, it is important to not procrastinate on this step.  Months missed early in repayment mean extra months added to the end.  Most borrowers would be much better off paying 10% of their current income rather than 10% of their income 10 or 20 years from now.

#2: Save Some Money for Retirement

Borrowers don’t have to make a choice between saving for retirement or paying off student loans.  In fact, doing both at the same time can be an excellent strategy.

Pursuing student loan forgiveness, means enrollment in an income-driven repayment plan and month payments based upon a borrower’s discretionary income.  The discretionary income calculation starts with the Adjusted Gross Income or AGI of the borrower.  Borrower’s who find ways to lower their AGI will also lower their monthly student loan payments.

One of the best ways to significantly lower AGI is to contribute to a tax advantaged retirement plan such as a 401(k) or Traditional IRA.  Not only do these funds go into the retirement account on a pre-tax basis, but they also result in lower monthly student loan payments.

Retirement contributions are a great way to build for the future and maximize the student debt forgiven.

#3: Max Out Health Savings Accounts

Borrowers on an HSA eligible insurance plan would be wise to max out HSA contributions each year.  Health Savings Accounts (HSAs) are considered to be “triple tax advantaged” because HSA savers do not have to pay taxes on the money that goes into the account, they don’t pay taxes on the growth of the account, and they don’t pay taxes when the money comes out of the account.

HSA contributions also work like retirement contributions when calculating AGI.  This means a borrower can shield additional income from monthly payment calculations by putting money in their health savings account.

#4: Avoid Forbearances/Deferments

A student loan forbearance or a deferment may seem like a nice break in payments, but these moves can be very expensive.

The first problem with a deferment or a forbearance is that they do not count towards any federal student loan forgiveness plan.  Borrowers who are in dire financial circumstances can often avoid a deferment or forbearance simply by enrolling in an income-driven repayment plan.  While a $0 monthly payment may not seem any different than a forbearance or deferment, that $0 monthly payment counts towards the forgiveness programs.

Another issue with the deferments and forbearances is that they cause student loan interest capitalization.  This can cause balances to grow out of control quickly.  Borrower’s pursuing loan forgiveness may not worry about their balance, but some forgiveness programs impose an income tax on the balance forgiven, so all borrowers should be careful to minimize balance growth.  Additionally, borrowers who eventually decide not to pursue forgiveness or have issues qualifying will be glad they keep their balance low.

In short, a forbearance or a deferment is normally an expensive unnecessary break from student loan payments.

#5: Send in Employer Certifications Yearly

Public Service Loan Forgiveness (PSLF) is perhaps the holy grail of the federal forgiveness programs.  It happens after just 10 years and the debt is forgiven tax-free.

One of the key requirements is that a borrower work for at least 10 years for an eligible employer.  In order to make sure an employer is eligible for the program, borrowers have the option of submitting an employer certification form (ECF).

Submitting an ECF will do more than just verify that an employer is eligible.  It also triggers a review of the borrowers account to make sure their loans are eligible and that they are on an eligible repayment plan.  This is the single best way to track progress towards PSLF.

#6: Don’t Get Married

This tip probably isn’t the most romantic advice, but single borrowers will find pursuing student loan forgiveness much easier and less expensive.  This is especially true for borrowers with spouses who do not have student loans but earn an income.

While filing taxes separately does allow some borrowers to exclude their spouse’s income, it isn’t a perfect solution as it doesn’t work on all income-driven repayment plans, and it means a higher tax bill each April.

The vast majority of borrowers hoping to qualify for any form of student loan forgiveness will find that there is a very real marriage penalty.

#7: Don’t Miss an Income Certification

Continued enrollment in an income-driven repayment plan requires borrowers to submit proof of income on a yearly basis.

Missing this deadline will result in the borrower being kicked off the income-driven repayment plan until income certification can be submitted.

In addition to getting kicked off of the desired IDR plan, borrowers will see their balance grow due to interest capitalization and it will cause a delay in reaching the number of months required for loan forgiveness.

#8: Keep Detailed Records

Federal student loan servicing is notoriously terrible.  This can include giving bad or conflicting advice or making mistakes processing documents.

Because the loan services and the government don’t benefit from borrowers successfully getting their loans forgiven, they have little incentive to be helpful or to avoid mistakes in processing.

It falls on the shoulders of borrowers to keep copies off documents submitted to their loan servicer as well as copies of all documents received from their loan servicer.  In the event of an issue, these records could be incredibly valuable.

#9: Start Saving for the Tax Bill

The IRS treats debt forgiven to be the same as income.  If $10,000 worth of credit card debt is forgiven, the government treats it as though the taxpayer earned an additional $10,000.  This means a larger tax bill.

Most student loans receive this same treatment, with PSLF forgiveness being a notable exception.

All borrowers, even those pursing PSLF, would be wise to set aside extra money each month for the big tax bill, some call it the tax bomb.

If forgiveness ends up not working out for the borrower, this extra money can be a huge boost to paying off the debt.

If the tax rules change and there is no massive bill at the end, the money can be used towards retirement.

#10: Certify Income Strategically

Income certification is done in one of two ways.  Either a borrower submits their most recent tax return or they document two recent paychecks.

There is no rule for what method a borrower must use.  Because the two methods can result in dramatically different payments, it is important for borrowers to carefully select the manner in which they certify their income.

Borrowers who just finished school will have tax returns that show they made very little money prior to starting their new job.  On the other hand, borrowers who recently moved to a job with lower pay will have tax returns that show they earn far more than what they actually make.

It is also important to understand how a lender defines a “significant” change in income and to discuss options with your loan servicer.  These conversation can result in much lower payments for an entire year.

Final Thought: Forgiveness isn’t always the best route…

Getting student loans forgiven is great, but the primary objective for all borrowers should be to minimize total spending.

For many borrowers going after loan forgiveness, the path of least expense is clear.

Others may find that by paying the minimum over a long period of time, they spend a great deal on interest.   Combine that with a tax bill at the end, and paying off the student debt as fast as possible may be the best route.

The most important aspect of student loan forgiveness is to plan ahead and have a sound strategy.  Some may learn that means forgiveness isn’t the best path.  Others will find ways to save thousands.