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Dealing with crippling student debt is (thankfully) something I’ve never had to experience myself, since in Canada our universities aren’t nearly as expensive and we did a co-op program that allowed us to work while we were studying to pay for our education. But student debt is something that many of our readers have to deal with, especially our American readers who regularly write into us with a ball and chain worth over $100k hanging on their necks. So I thought I’d take today’s article to address those people.
I first met Travis Hornsby at Fincon last year, and was impressed by how much he seemed to know about navigating the labyrinth student loan in the US. He runs a website called StudentLoanPlanner.com where he helps people navigate their own student debt situations, and he was gracious enough to talk to us about this problem so many people have.
Travis, thanks for doing this. First of all, what the Hell is going on with the US educational system? Why is student debt in the US so damned high?
The US has always made citizens carry most postsecondary educational costs. Of course, you also get to keep more of the returns in the form of lower taxes.
That isn’t the main contributor in the massive explosion of debt in the past decade though. In 2006, the Grad Plus program passed. Limits on borrowing disappeared. Since the Federal Government is the lender, no underwriting criteria are used to determine if the loan should be made.
At the same time, students could now pay based on their incomes and not the total debt borrowed.
University administrators are really smart people. They figured these new rules out and started raising prices even faster. With no borrowing limits, students just had to agree to sign their names. All of a sudden, there’s $1.5 trillion of student debt.
At Fincon, you told me you ran a site called StudentLoanPlanner.com? What are you hoping to do with it?
I want to stop people from tossing piles of cash in a furnace and setting it on fire. Most Americans with student loans are wasting thousands of dollars with a sub-optimal repayment strategy. The complexity of the student loan world invites mistakes.
I want borrowers to use the money for better things like getting to financial independence more quickly. So far, we’ve been able to identify about $44 million in projected savings for about 730 clients we’ve worked with 1 on 1.
I don’t track how much money our readers have saved, but I bet it’s a couple hundred million. We give away our best calculator away for free intentionally.
I want to get that savings number to $1 billion, then I think I’ll be pretty happy.
Yeah, *just* $1 billion. No problem.
OK enough beating around the bush. Let’s get down to brass tacks. When it comes to student loans, there are basically 3 different weapons you can use to take a whack at it: Refinancing, Payment Reductions, and Loan Forgiveness. Let’s talk about the first one. When does it make sense to refinance a federal government loan with a private lender?
Refinancing can make a ton of sense for folks at for profit employers who owe a reasonable amount compared to their income.
Look at how much you owe and divide it by your income. If you’re married include your spouse in that calculation. If that number is below 1.5, why keep your loans on the federal system at 5% to 8% interest when you could move it to a private lender that’ll charge you less.
If your “debt to income ratio” is more than 1.5, you need to think twice before refinancing student loans. Also, avoid refinancing if you work at a not for profit employer or might in the future.
These are rules of thumb, but you just want to make sure the benefits you get from a lower interest rate are better than the opportunity for loan forgiveness you give up.
Are there any downsides to refinancing? Why do you only advise people do it if their loan-to-income ratio is 1.5x?
There are a bunch of downsides to refinancing if you ever need the protections that federal student loans offer (or if you just owe a bunch of debt relative to income).
When you refinance, you lose income based repayment, forbearance, and loan forgiveness. That’s a lot to lose out on for a 1% to 2% lower interest rate.
Refinancing can be an outstanding way to get out of debt sooner. That said, it’s oversold in my opinion because there’s a lot of money behind ad campaigns with these well funded startups. Doesn’t help that most personal finance blogs get referral bonuses when people refinance but $0 bonus when they stay on a government repayment plan.
I don’t want to say that refinancing doesn’t help people. It can help tremendously. You just need to be smart in using it. That means 1.5 debt to income ratio at a private sector employer. Couldn’t hurt to have a solid emergency fund too.
Can you use 0-interest-rate balance transfer cards to do this?
You could, but the best 5-year variable rates right now are about 2.5%. When you do balance transfers, you usually get hit with a 3% transfer charge. That’s pretty close to the same result.
Pretend you lose your job and can’t move the debt to a new 0% card. Now that intro teaser rate resets to double digits.
Someone who owes less than $50,000 who doesn’t really care about getting a mortgage or a car loan might try this approach. It’s just like playing financial roulette with a loaded gun, so I don’t think I’d ever recommend that.
OK let’s talk about the second weapon. How do you reduce your monthly payments if you don’t make enough?
If you have federal loans, it’s easy. Just call up your loan servicer (the people who send you statements in the mail) and tell them you need to make an update to your income.
If minimizing the payment is the goal, I usually tell people ask for either Pay As You Earn (PAYE) or Revised Pay As You Earn (REPAYE) depending on what you’re eligible for. Your payment can literally be $0 a month.
Does it make sense to do this? If your new lower payment is less than the interest rate, won’t the loan just grow into infinity?
The interest doesn’t compound. Rather it grows at a simple rate. That does a lot to limit the balance in the most extreme circumstances where someone borrowed $300,000 but only earns $50,000 a year.
Maybe you’re just broke temporarily, so you game the system to get interest rate subsidies. If your goal is forgiveness, then eventually you’ll hit the 20-25 years of payments and be done.
OK that dovetails nicely into the third weapon. How does loan forgiveness work?
There are two systems depending if you work for a not for profit or for profit employer. The public servant one forgives all your debt tax free after 10 years of income based payments.
“Private sector forgiveness” requires 20 to 25 years of income based payments. At the end of that, the forgiven balance goes on your tax return as income. You’d owe as much as 40% of a very large number.
Who knows what politicians will do when this “tax bomb” they created starts coming home to roost. I just make sure people know that they’re going to owe a lot, and they need to prepare for it by saving a few hundred a month in index funds.
If you earn a lot of money relative to your debt, you’ll just pay it all back and get almost nothing forgiven while paying a lot in unnecessary interest. That’s the reason for that 1.5 debt to income rule for when you’d refinance or go for forgiveness.
OK yeah, you touched on a very strange aspect of the American student loan system. When students have their loans forgiven (and they aren’t eligible for the Public Service Loan Forgiveness Program), it gets added as taxable income which turns it into an IRS debt. Why is it done this way when other countries just forgive the loan outright?
Because when laws are made in America, they start with the goal of making it as incomprehensible and ridiculous as possible. Gold star if you kill a small forest while printing out the bill.
One point is that the taxable income event only happens for borrowers working in the private sector. If you’re in the government, academic, or not for profit world, you’re probably ok.
I think the real reason they did it this way is because it sounded good at the time and nobody properly thought through it. By the time the IRS issued their interpretation, Congress had already moved on to the next topic.
Expect future reforms to the system to address this. Eventually the IRS will send out a bunch of bills that can’t be paid, and they’ll be forced to address it.
For a new or current student thinking about taking on student debt, how much do you think is reasonable?
If you have wanted to be a dentist, doctor, lawyer, (fill in the blank) since you were 2, then I’m cool with borrowing less than double your expected first year income with the expectation that you’re gonna live really frugally for the first 5 years of your career to pay all the debt back in full.
Lots of professionals borrow more than that, and they’re on track to work til 65 or later. So just realize if you go to grad school and borrow a ton of money, the earliest you’ll be retiring is in a couple decades.
For people who just go to undergrad, the high cost private schools don’t seem to be worth it. If you’re going to an Ivy League they’re probably helping you out with tuition if you can’t already afford it.
But if you’re gonna go to a top 30 school and take on 50k in debt instead of a top 100 school that’s public (and leave with no debt) then I just don’t see the ROI in that decision.
The Republicans are trying to make changes to the federal student loan system. What are they, and will they make the situation better or worse?
They want to cap the total principal and interest paid and create a single income based payment program. The borrowing caps for grad school would be way lower than they are today. The bill would also get rid of the tax bomb problem while eliminating loan forgiveness.
If you’re a high cost private university (think Georgetown, NYU, USC, etc), this bill should terrify you. In fact, half of your tuition revenue might go up in smoke.
On the margins, grad school enrollment would have to fall if this thing passed. I think tuition would also drop at many of the most expensive programs without access to unlimited federal loans. That might be bad or good depending on your views.
Any other tips that you’d like to talk about that we haven’t already?
If you want to pay your debt off quickly, drive a clunker and live like a broke minimum wage worker and get rid of it really fast as long as the math supports payoff.
If you owe more than you could ever hope to pay back (double your income or more), you need to take a strategic approach and optimize the government programs for your benefit.
Pay back debt as aggressively as possible like your hair is on fire, or pay it back strategically and slow, taking max advantage of the government income driven options that promise forgiveness.
Most people make the mistake of taking an in between option and it’s really toxic for your finances.
Why do you care so much about helping people with their student debt problems?
I was really into the financial independence movement after spending three years in corporate America, but then life happened. I met my wife in Philly, and she revealed she had six figures of med school debt.
We spent a while trying to figure out the best way to pay it back, and I remember getting so frustrated navigating everything.
I didn’t see anybody out there giving math based help to borrowers who owed more than $100,000 but not a lot of time to spend figuring it out.
What should our readers do who have read all this info and are still struggling with student debt?
If you’re the kind of person that likes reading investment blogs and managing their own investments at Vanguard, then the Student Loan Eraser course I created will tell you everything you need to know in about 3 hours.
If you’d rather have us figure it out for you, email me at travis@studentloanplanner.com and tell me what you’re dealing with.
Awesome. Thanks Travis!
Are you struggling with student debt? Sound off in the comments!
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I know well the burden of paying off student loan debt. When I graduated college, I had over $50k in student loans.
It felt like a crushing debt, but you know what? I sucked it up, and paid off every penny as quick as I could. Today our net worth just broke $3 million dollars.
It’s definitely possible to climb out of that student debt hole!
Any tips or tricks? Or did you just power through it?
Thank you for this interview! I am at almost 200k, and make around 30k a year. I had been working at finding a PSLF qualified job this past fall, but am I misunderstanding the comments that even though it will be around for those that have already taken out the loans that it won’t actually work because they are defunding it?
My understanding is that people currently eligible for the PSLF will remain eligible for the PSLF. But contact your student loan office to be sure.
Unfortunately, we know the crush of student loan debt. We are on the public service loan forgiveness plan, but I hope you get to $1 billion quickly.
Yeah, me too.
A Canadian taxpayer advantage for sure when it comes to the cost of post-secondary education! Oh Canada…. When I graduated I had some government student loans (not a lot as my parents were too “rich” for us to qualify) and some larger bank loans.
The gov’t used to provide a 6 month interest and payment grace period – but it’s not actually a grace period, the interest during that time gets added to your principal.
In Canada there are also a range of forgiveness (or loan remission) programs depending on the province. Some you actually have to apply for. Others are automatic. The other thing my husband (who once worked for a provincial student loans said) was that he wished he had MAXED OUT his gov’t student loan each semester and saved it (cause when you are in school it really is interest free) particularly when he later realized he would have qualified for loan remission and had the gov’t pay off some of that – lost free money 🙁
Heck he could have shoved it in a high interest savings account and repaid it back immediately upon graduation and pocketed the interest even if he didn’t qualify for remission. So, particularly for those of us achieving FI through cost of living reductions and lower taxable incomes – consider maximizing your student loans.
Education can pay off!!!
That is horrible advice. Take out student debt to shove into a HISA in the hopes that the government wouldn’t catch on and disqualify you from forgiveness? Nobody listen to this guy.
Respectfully it is not horrible – your concern of “Take out student debt to shove into a HISA in the hopes that the government wouldn’t catch on and disqualify you from forgiveness” – the rules (and programs) around forgiveness/remission vary from province to province, but the rule in place at that time for that province was they looked at your total student loan, compared it to a cap calculation based upon years in school x so many $/week, and just forgave/remised the difference (provided the graduate actually applied for it – the gov’t wasn’t just giving it away without a tiny bit of work in this case back then).
Also – say you didn’t qualify for forgiveness after doing this – assuming you followed the FI principle of not spending money you didn’t need to (as I said he wished he’d taken the loans he qualified for and SAVED IT) – that sweet cash is sitting in an account somewhere at a minimum earning you high interest savings rate or whatever in which case you make the repayment at graduation once you find out the gov’t isn’t giving you any remission – no harm no foul whatsoever plus you got a little bit of free interest earnings while in school. Now, if the student is going to spend it needlessly, then wait till they realize they also can get (absent any “qualification” requirements) an abundance of credit cards that they can also max out and waste their money to really screw up their FI potential!!!
I encourage my fellow Canadians to look at the rules where they qualify for gov’t student loans to determine how to make them benefit you the most. For example, doctors and nurses in Canada can get forgiveness by basically just moving to certain rural areas and serving there (and I assume once more actually applying) after they graduate. Other provinces have education type specific grants for certain types of jobs (daycare workers stand out from memory). Some provinces offer no additional benefits (remission/forgiveness/grants) other than Canada’s repayment assistance plan. Rules change all the time and so educating yourself to determine whether there is a possible way to benefit yourself further is key. You either qualify for a loan or you don’t each semester, then when you graduate, you are either eligible for grant / remission / forgiveness or you are not. Knowing how eligibility for both is determined (i.e. income, assets) prior to graduating from high school and monitoring for changes throughout will allow for better decision making.
Cheers!
This is yet another reason I’m so glad to be Canadian 🙂 I’m pretty sure I attended the same university as Wanderer and FIRECracker, and the co-op education system was a game saver! I’m happy with how it turned out, although certainly I had classmates and friends who scored supremely lucrative co-op jobs in Silicon Valley…
Which actually leads nicely to my favourite part of this article: The entire subsection under “For a new or current student thinking about taking on student debt, how much do you think is reasonable?”
The whole point of that section is to be deliberate and make a conscious decision about your future, and to weigh the pro’s and con’s. What do you want to do as a career? How long do you want to do it for? And how much are you willing to pay for that privilege? (Or should I say “privilege” in quotes?)
Even if you don’t know the answers to half of those questions, any students who are evening considering them will likely be so much closer to achieving the life they desire!
I hope students will read that and take note (our youngest reader’s age is 12!) but I’m not hopeful. Who among us at 17 knew how money worked? Again, hope they read this blog.
My kids are 17 and 19, one is in University taking Software Engineering, and the other is close behind. I have forced them to read the blog, especially the Student debt part.
For parents out there, the RESP is the best thing going, we started when they were born, and now are drawing from it. Canadian Government tops up 20%, not a bad investment.
70K saved, and we have already used some for kid #1. University is 2 bus rides from home, so they save money on accommodation, and will have 4 COOP’s to work and save.
I drill into them how money works, how to invest, how to budget. I think they are getting tired of it, but I do believe they will be immensely more successful than i ever was. This is my legacy, and I try to coach and encourage any kid that will listen. (most don’t)
Hm, just went to the website and saw the $450 fee for a personal phone consultation or $200 for a 3 hour course. Seems a bit steep to me. I’m never comfortable with people who hide behind the guise of helping others while charging pretty astronomical fees to people in (often) dire financial situations.
That’s why I love the financial freedom community. Most of them are providing life changing knowledge for nothing at all. Some of them (such is MR) even provide bespoke advice for free also.
Only if I like you.
Which I do, VB, despite our many many disagreements on pretty much everything.
Good advice with the 1.5 rule! Yes, beyond 1.5x your income, it gets progressively more difficult to manage other financial goals with the student debt repayment.
I’d say the only case where you could go above 1.5x is if you know you will be at the top of your class in a desireable field. If you are a desireable candidate in an in demand field, you have the possibility of negotiating your own terms. Higher salary, better benefits, etc.
Biggest thing with student loans: try to do the math before you get the debt. If it’s too late for you, take a high schol student under your wing and educate them. Stop the cycle, or at least try.
Yeah I actually like the 1.5x rule myself. I might have to steal it.
I was struck by the irony of the student debt post only a few inches (scrolling down the page inches) above the “Arbeit Macht Frei” death camp picture…
Hey man, I don’t control that shit. WordPress has a mind of it’s own sometimes!
Bahaha! I love this! Our lawmakers enjoy making everything as difficult as possible.
We paid off my $25k student loans this past year and just slammed $15k onto Mr. Picky Pincher’s loans this month. Woohoo!
Mr. Picky Pincher put his loans into forbearance for years. In hindsight it wasn’t a great idea, but at the time we weren’t able to afford the payments at all. After really cutting costs and increasing our income, we were able to pay extra on our student loans. After getting rid of credit card debt, it was much easier to pay these suckers down.
here’s a link with a list of really good american schools with no student loans in the financial aid calculation. http://time.com/money/5058767/colleges-no-student-loan-policies/
this a relatively new phenomenon and you may still be on the hook for some debt with a high family income. grad school and professional school will still likely be cumbersome but the point i’m making is that many people don’t even know the possibility exists if you have enough credentials to get admitted.
big point number 2: only borrow what you absolutely must to get through the program. i remember living with 4 people in a 2 bedroom apartment in norfolk, VA with no air conditioning and spending about 20 bucks a week on groceries. if you’re so inclined then go ahead and finance a wardrobe and some spring break trips and a few luxuries on the back of a bigger loan balance. the borrow less side of the equation is under-discussed in my humble opinion.
I paid off 135k in US student loans (due to poor private university decisions before mathing that shit up). Rates were 6.8%-8.6% for 2/3rds of them and 3% or less for the remainder. I did it by barely buying anything, including a car for the first two years. The only nice thing I splurged on was an apartment in the city (Portland, OR) because the suburbs are the worst. My income out of college was 80k, so I was about 1.7x at graduation. I didn’t even put anything in my 401k until I paid off the last 6.8% loan (though in hindsight I regret that due to the tax savings). I also started a side gig after about 1 year that brought in 1k/month and shoved everything at that dumpster fire of debt. I tried to refinance at one point with SoFi, but those pricks wouldn’t oblige due to one missed payment on my credit report from 3 years earlier, but screw them I didn’t need their help.
The new Robert Kiyosaki book, “Why the righ are getting richer”, talks a lot about the american student debt problem. By the way, it’s a very good book, as much as Rich Dad Poor Dad.
It is concerning that the author is advocating to rely on the Federal Loan Forgiveness program as a way to get out of this debt crush. With the US already trillions in debt and and there is over 1.5 trillion in student loans out there what is the likely hood that the rules of student loan forgiveness will remain the same when the US already l has such a high National debt. I think that this way of thinking is recklass as the rules could easily change and now the individual is facing not only the principal but also the interest that is accumulated. Paying off student loans takes a lot of sacrifice as I have been contining to pay off an initial $210k student loan for the past 8.5 years and now have the principal down to only 17k. Sacrifices that I have had to made is taking a job away from my family and young children in order and being gone from them 159 days a year and working 12-18 hour days when I do work inorder to double my salary and dig out of the student loan mess that I have created for myself and am responsible for.
Very timely article. I’m 38 and looking into switching careers, which of course requires going back to school. I’ve never had student loan debt, which has given me a great head start on the savings route. I know people my age who still owe tens of thousands. But the more I research, the more I question if its even worth it. Tech schools charging 50k for a 2 year program, community colleges 30k. Not only that, but schools are becoming more selective about who they let it. I hear some programs get hundreds of applicants but may take only 15 students a year. Its insane! Furthering ones education should be a right, not a privilege. The price of education has gotten out of hand.
I think one of the other major issues when it comes to student debt–and it’s a consequence of the same “EVERYONE GETS A LOAN” approach we take here in the US–is that wages and career opportunities just don’t match the debt levels anymore.
Even though we aren’t in a job crisis like we were back in, say, 2010, how many people graduate with $50,000+ of debt and can’t find a job that doesn’t involve waiting tables or flipping burgers? Having six figures of student debt makes sense if you have a six figure income right off the bat (or at least within the first three years). But a college degree doesn’t do much to bring you those large incomes anymore.
Sincerely,
ARB–Angry Retail Banker
Since this was written, I stumbled across a movement that’s gaining steam to cancel student loan debts. Alan, the Point of Contact and leader, is well informed and articulate. Here’s a link to the petition: https://www.change.org/p/pandemic-economic-stimulus-cancel-student-loans-by-executive-order?recruiter=1644046&utm_source=share_petition&utm_medium=copylink&utm_campaign=share_petition
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