Posted by Abundant Wealth Planning LLC

How to Protect Your Financial Health If You Have Student Loans

How to Protect Your Financial Health If You Have Student Loans

Student loans have become a main concern on the 2020 Presidential campaign track and these loans are a huge part of the discussion about Millennials and Gen Z’s financial possibilities. In fact, for 44 million Americans who owed a combined of $1.6 trillion, student debt is a reality of life.

However, out of all the discussion and concerns, there are some student debt variations that are only slightly perceived which could affect your whole financial health. Here are five essential ones.

1. Student loans appear on credit report and can influence credit score

Credit report displays any form of loaned money including student loans.

When you get them out, both private and federal student debts will become apparent on your credit report (except the Parent PLUS loans which will be tackled next).

Credit score is a number which is a result of your credit report. Here are a couple of ways in which it can be impacted by your student loans.

Length of account: Creditors appreciate seeing lengthy, positive credit accounts as they indicate that a person can loan money responsibly over a long term. Regular student loan balance is a debt account that most persons will have for 10-25 years depending on their payment policies as it reaches to $35,359.

Payment history: A FICO credit score is the score commonly used by lenders and your payment account covers up to 35% of a FICO credit score. Student loan payments are conveyed to credit bureaus. Borrowers who pay on time will have an advantage from the reports, and those who fail to pay or have their loans end up in default will have their credit scores suffer as a result.

A distinct section of your credit report was made by some credit bureaus for student loans. A credit report from Experian for instance wherein the student loan appears in a division entitled “student account.” This segment includes the balance, the monthly dues, the total payments made on-time, and also the progress made for the account to be fully paid.

For a customer who possess a FICO 780 score and have always paid on time on any accounts, a month of delayed payment could have an effect of as much as 90 to 110 points drop on their credit score. The longer you go without paying your student loan, the more it will upset your credit score. The damage will differ depending on your history and your starting score, but generally, as the late period increases, so does the damage.

Nonetheless, always bear in mind that not paying throughout the six-month grace interval that lenders award to new graduates would not affect a credit score negatively.

Credit mix: As most FICO scores, your mix of credit is counted as 10% of your total score. It appears good to lenders when you have a combination of credit card and loan accounts, and you were able to handle them responsibly. Creditors will perceive you as a liable debtor if you’re able to manage different kinds of credit.

2. Defaulted student loans will shoot up because of collection fees

Based on the records from the Federal Office for Student Aid, approximately 10% of student loans that have started repayment in 2016 have finished up in default since then. Defaulting on student loans does occur although it should be refrained from.

After a balance has exceeded its due for 270 days, federal student loans are proclaimed in default. The Department of Education will then give the loans over to a private collections agency (about 361 days) to recover the balance owed, this is if the balance remains past due. In addition to owed balance and accumulated interest, the debtor also becomes responsible for the costs acquired during the collection process (denoted as collection costs).

As to the question of how much is the cost of those collection? The answer is complicated.

The charges can differ depending on the kind of federal loan a borrower has. The Higher Education Act of 1965 obliges debtors who have defaulted on federal student loans to pay “reasonable collection costs.” Collection costs can only be charged if the debtor has not go into a repayment arrangement within 60 days of notice that their debt is in collection.

If fully paid, the collection charges for federal loans may range from 24.34% of the remaining dues, or 19.58% of the paid amount. The limit was put in place after the Department of Education was prosecuted in 1995 for charging up to 43% collection costs on borrowers whose promissory notes stated 25% collection fees.

Here is what it means: If a student has a loan of $10,000 and it goes into default and finishes up in collections, the storyline could go in two ways:

1. Pay monthly and have a percentage go to the collection costs

Take for instance, if you pay $100 of a loan, $19.58 will proceed to the collection fees and the rest ($80.42) will head to your actual loan.

2. Pay the loan fully and pay a percentage of the balance to the collecting agency

For instance: If you choose to fully pay a $10,000 defaulted loan, it will cost a total of $12,434—$10,000 for the full compensation of the loan, and $2,434 for the collection fees.

Remember that there are exclusions to these percentage limits.

    •    Private student loans in collections, for instance, commonly have court-designated collection charges based on the loan’s note of hand and state law.

    •    Perkins loans are subject to collection expenses of 30% of the primary balance on first collection efforts, and 40% for any collection efforts decided afterwards. These loans were no longer accessible to borrowers after September 30, 2017.

    •    Consolidated loans are restricted to 18.5% collection charges.

Nevertheless, there is a way to reduce the setback of collection fees if a borrower’s loans enter default and this is through Rehabilitation.

Defaulted loans are permitted to go into rehabilitation by the Department of Education. In this platform, a borrower is obliged to make nine out of 10 monthly payments on time to eliminate the loan from default status. Collection costs will not be greater than 16% of payments made throughout the rehabilitation; if the borrower successfully completes the program, only the principal and interest of the loan will be moved to a new servicer, and no additional collection costs will be acquired.

Rehabilitating loans in default can save a debtor thousands in extra, unnecessary collection charges, this is of course aside from paying their loan fully which is an unlikely choice for somebody incapable of paying their monthly dues. Rehabilitating loans can also save their credit score.

Loan rehabilitation totally take away defaulted loans from credit reports, it’s as if the default never took place. While delinquencies before the default will remain on the report, they have less negative effects on a credit score than the default. Debtors only have one opportunity to put a loan into rehabilitation, except if they formerly finished the program on the same loan earlier than August 2008.

After your loans are already in default, the Department of Education has the prerogative to come after you and collect your unsettled debt. This can be through wage garnishment in which up to 15% of your income can be withheld and goes directly to your loan repayment, or through a seizure of your federal tax refunds (in certain cases, the DOE can also seize your state income tax refunds and invalidate your driver’s license). The DOE is mandated by law to send advance notice of these actions, and debtors have plenty of actions to take to avoid them from occurring. Thus aside from wrecked credit and rising costs, defaulting on your student loans doesn’t mean you’re free of the balance.

Avoid defaulting by all means through communicating with your loan servicer as soon as possible to deliberate appropriate choices when you’re incapable to afford a payment.

3. Benefits on credit report will not be seen by students repaying Parent PLUS loans

There are two kinds of PLUS loans—first is for the graduate students and second is the one taken out by the parents of undergraduates which is usually referred to as Parent PLUS loans.

Parent PLUS credits only appears on the parent’s credit account. The positive or negative payment history will only help or upset the parent’s credit score and not of the child’s, even though the student and parent have agreed for the student to be financially liable for the repayments.

Parents are blocked by the Department of Education from officially transferring the responsibility of the loan to the child, setting parents on the hook for their child’s financial activities in the coming years.

The loan is not transferred to the student even if a parent with Parent PLUS loans dies, it is discharged instead. The loan is also discharged if the child on whose behalf the parent obtained the loan dies.

4. The remaining interest will capitalize if you are late in rectifying an income-driven repayment plan

For federal student loan borrowers, being on an income-driven repayment strategy can make monthly payments more convenient. But they come with a firm warning (which is not applicable to income-contingent compensation plans).

Subsidized loans on income-driven compensation plans come with support for capitalization, or owed interest being added to the whole amount required to pay back the loan. Debtors with monthly payments lesser than the amount needed to cover the full amount of interest have that interest covered by the government for up to three years, under REPAY, PAYE and IBR plans. Nonetheless, persons on REPAY with subsidized loans remain to have capitalization support after those initial three years, with only half of the owed interest capitalized.

Unsubsidized loans on income-driven compensation plans comes with a less generous support for capitalization of loan on REPAYE plans. The government covers half of any interest that isn’t covered by monthly payments and capitalizes the other half but there is no special three year period. For as long as a borrower is on the REPAYE plan, this concession is accessible.

Participants under REPAYE, PAYE and IBR need to revalidate their plans each year. This means that it is necessary for the borrowers to comply the documentations about their income (including tax returns) and family size to the Department of Education by its yearly deadline. The information obtained is then used to compute capability for income-driven compensation and calculate the new monthly payment.

However, the outstanding interest on the debtor’s loans will capitalize if they fail to revalidate their income-driven repayment plan on time, probably adding thousands to their loan balance.

Be sure to recertify on-time each year if you are in an income-driven repayment plan. In order to avoid any interruptions on the student loan services part, it might be beneficial to complete the paperwork far in advance.

5. Student loans that are forgiven might serve as taxable income

Student loan “tax bomb” denotes to the huge tax bill debtors will have to face once their federal student loans are forgiven.

Debtors who sign up in income-driven compensation plans (Income-Contingent Repayment (ICR), Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Revised Pay As You Earn (RePAYE) have their monthly dues capped at a definite percentage and then their outstanding loan balance are forgiven after 20-25 years of payments.

Although it sounds like a good deal, the forgiven amount will be taxed as income by the Internal Revenue Service (IRS) which means that the borrower will be left with a bill to the US government. The only method that the forgiven debt would not be treated as taxable income is if the borrower accomplished the requirements for public service loan forgiveness (PSLF.)  

You can steer clear of the tax bomb if you can attest that you are insolvent (this means that your liabilities which includes your forgiven debt, go beyond your assets).

The thought of paying major taxes in the future should not hinder you to sign up in income-driven repayment plans. Some states like California are already addressing the issue for debtors by suggesting legislation to keep them from state taxes on the forgiven debt.  Nonetheless, you would still be accountable for any federal taxes due on the loan forgiveness.

It doesn’t matter in what way you choose to repay your student loans, just ensure that you continue to pay and avoid them to end in default.

Abundant Wealth Planning LLC
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