Student loan payments, interest are back in January for the unforgiven

For many federal student loan borrowers, repayment strategy is critical as payments, interest and collections — paused since March 2020 — are expected to resume after December 31.

That’s true even if, by early estimates, nearly 45% of borrowers, or nearly 20 million people, would have their debt forgiven entirely under President Biden’s federal student loan forgiveness plan, though recent policy developments have narrowed the eligibility of some borrowers.

If you have student debt that won’t be forgiven under the Biden plan, the next steps depend on a borrower’s specific circumstances, according to experts who advise on student loan matters.

Here are six considerations:

Understanding your eligibility for forgiveness is paramount

The application for the Biden administration’s forgiveness plan is expected to open in early October, and borrowers are advised to apply before Nov. 15 to receive relief before loan payments resume, according to Federal Student Aid.

Borrowers with US Department of Education loans are eligible for relief if their individual income is less than $125,000 ($250,000 for households). Eligible borrowers who were Pell Grant recipients can receive up to $20,000 of debt relief; otherwise, the maximum relief is up to $10,000. Borrowers whose outstanding loan balance is less than their maximum debt relief amount receive a reduction equal to their full loan balance, according to Federal Student Aid.

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Don’t try to make repayment decisions based on the expectation of additional broad-based forgiveness, because that’s unlikely, said Michele Streeter, senior director of college affordability at the Institute for College Access & Success. However, there are other relief programs, such as government loan forgiveness or income-tested reimbursement forgiveness, that need to be included in the financial analysis.

Get a grip on your balance after forgiveness

Loan balances remaining after the relief is applied will be written off again, according to Federal Student Aid. This means that borrowers’ monthly payments are based on their new account balance. Credit servicers should communicate the new, possibly lower, amount.

Some borrowers may want to make a down payment or pay off their balance just before payments resume to take advantage of the zero interest rate environment. “In some cases, turning off the remaining balance before restarting is a great strategy,” said Michael Lux, attorney and founder of a website dedicated to student loan borrower education, strategy and advocacy. “It’s a great way to take advantage of the 0% interest rate and reduce future interest expense on the debt.”

However, this may not be a suitable strategy for everyone.

Explore other student loan forgiveness options

Some borrowers with larger balances might be better off sticking to minimum payments once they resume in January while they work towards other forgiveness.

If they have not already done so, borrowers should see if they are eligible for additional forgiveness under time-limited changes to the Government Loan Forgiveness Program, available through October 31. You can visit the Federal Student Aid website to learn more.

Borrowers could also benefit from a new income-based repayment plan proposed by President Biden. Among other things, borrowers would not have to pay more than 5% of their discretionary income on student loans each month, said Lindsay Clark, principal borrower attorney at Savi, which provides student loan counseling to borrowers. “This is less than the 10% available under the latest income-based repayment plan,” she said.

This could be particularly beneficial for low- and middle-income borrowers who are left with high balances after the government’s broad-based decree. The proposal has yet to work its way through the procedural lanes, however, and some experts expect the new plan won’t be available until at least the summer.

Crack the debt numbers

How to handle the repayment is a personal decision based on a person’s overall financial picture.

Lauryn Williams, a certified financial planner who is a member of the CNBC Advisor Council and senior student loan advisor at Student Loan Planner, offered the hypothetical example of a borrower making $75,000 a year, having $170,000 in student loan debt and receiving $20,000 of that forgiveness . This borrower, whose debt after forgiveness is still double what he earns, is a good candidate for income-contingent repayment.

Instead of paying off the student loan debt, the borrower should consider putting that money into their 401(k) or 403(b). Because student loan payments are based on adjusted gross income, you can get a lower student loan payment by saving for retirement in a pre-tax retirement account, Williams said.

However, if a borrower who makes $75,000 and owes $30,000 after Biden’s exemption might consider paying down the loans more aggressively. The borrower could set aside money in a savings account for the next few months and then pay a large lump sum before the end of the year to lower the loan balance before interest rates start up again, Williams said.

Borrowers with relatively small balances who are in good financial standing and do not expect to need the various protections that federal loans offer, including income-contingent repayment and forbearance, might also consider refinancing at a lower rate with a private lender, he said williams .

The tax factor

Borrowers who received debt forgiveness under the Biden plan do not owe federal taxes. But many could be responsible for state taxes. Indiana, for example, recently said the ordinance will trigger state income taxes and some borrowers may owe county taxes in addition to state income taxes. Mississippi and North Carolina have made similar announcements, and state-level taxation may be possible in Arkansas, California, Minnesota and Wisconsin.

Borrowers whose government will or is likely to levy taxes should ensure that they have sufficient reserves to meet this obligation when considering repayment decisions.

The big picture

Borrowers considering a voluntary payment should also ask their service provider how much outstanding interest they owe before they can begin paying down the principal, Clark said. When the payment pause is lifted, any outstanding interest will be capitalized and offset against your existing balance. “You may want to pay back the outstanding interest to avoid having a larger overall balance at the end of the break,” Clark said.

It’s important for borrowers to think about the bigger financial picture when making student loan repayment decisions, Lux said. “Borrowers may find it more beneficial to save for retirement or a home, depending on their student loan rate,” he said.

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