With the recent turmoil driven by the coronavirus pandemic, people across the country are faced with tremendous uncertainty about their financial situations. In response to the crisis, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a $2 trillion emergency fiscal stimulus package, in order to offer much-needed relief for both individuals and business owners to meet their short-term cashflow demands. For borrowers of Federal student loans, in particular, Section 3513 of the CARES Act offers a full suspension of Federal student loan payments with no interest accrual on those loans through September 30, 2020.
In this guest post, Ryan Frailich – Founder of Deliberate Finances, a fee-only financial planning firm in New Orleans, Louisiana – breaks down the key features of this relief provision and how the suspension of payments plays into forgiveness plans. Additionally, he offers strategies that advisors can use to help their clients leverage available CARES Act relief benefits as they relate to their student loans.
For instance, clients with direct student loans and Federal Family Education Loans (FFELs) owned by the U.S. Education Department can take advantage of suspended payments during the relief period, with no action required from the borrower. Importantly, though, FFELs that are not owned by the Education Department do not qualify for relief under the CARES Act, nor do other types of privately serviced student loans. Additionally, borrowers can confirm that the interest rates on their eligible loan accounts are set at 0% throughout the relief period, during which time any unpaid interest on loans will not be capitalized.
Meanwhile, for borrowers in forgiveness programs in which the forgiven amounts will be considered tax-free income, such as the Public Service Loan Forgiveness (PSLF) program, the relief period during which payments are suspended will count for payment periods; accordingly, borrowers in such forgiveness programs should be encouraged to stop payments during the relief period. Some forgiveness-eligible loans that don’t offer tax-free forgiveness, like Income-Driven Repayment (IDR) plans, may pose more complex challenges about whether to pay during the relief payment period, and the best choices will largely depend on anticipated future income levels and whether any forgiveness will actually be pursued.
Other clients with unique student loan situations may also benefit from relief efforts. For example, borrowers with FFEL or Perkins Loans that are not owned by the U.S. Department of Education, which will not qualify for CARES Act relief, may be able to consolidate their loans into a Direct Loan, which will qualify for CARES Act relief. Clients who may be expecting a reduction in income might benefit from entering into an IDR plan, which, after the relief period, may potentially reduce their payments by substantial amounts. And finally, clients who have stable income levels not impacted by the crisis and with no high-interest debt might be better off not taking advantage of the option to suspend payments, and may instead benefit more by making regular payments as usual in order to reduce their principal loan balances as quickly as possible (still taking advantage of interest rates while they are set at 0% during the relief period).
Ultimately, the key point is that the relief provided by the CARES Act for student loan borrowers is yet another way advisors can help their clients cope with the current crisis. Especially in light of the rapidly changing legislation, clients will need their advisors to help them determine if their loan payments are eligible for suspension, how loans that do not qualify for relief can best be managed, and how the rules may impact those in more complex financial circumstances.
The CARES Act Offers Relief For Some Student Loan Borrowers
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed last month to provide economic relief in the face of the current pandemic crisis, provides Federal student loan borrowers with a variety of forms of relief.
In particular, the biggest impact on student loans is outlined in Section 3513 of the Act, which provides for the full suspension of most Federal student loan payments and interest accrual on those loans through September 30, 2020. Servicers of student loans indicate that relief measures were implemented automatically for all borrowers by April 10, 2020, and that no action by the borrower is needed.
The United States Education Department (USED) has released a helpful FAQ that provides clarity to section 3513, but the information is changing rapidly, and it is likely that there will continue to be changes and more questions as servicers work to implement all these changes in a very brief period of time.
Because the CARES Act suspends all involuntary collection (including wage garnishments, seizure of tax refunds, and seizures of Social Security benefits) during this 6-month period, even student loan borrowers whose wages are garnished will now be entitled to receive a refund for garnishments made after March 13, 2020 (although the mechanism for receiving refunds is yet unclear).
Given the economic hardship currently facing so many individuals, financial advisors are in a prime position to help their clients who have student loan debt to determine if, and how, CARES Act relief provisions may benefit them.
All Direct Student Loan Borrowers (And Some FFEL Borrowers) Are Eligible For CARES Act Relief
All borrowers of Direct Student Loans and Federal Family Education Loans (FFELs) owned by the U.S. Education Department (USED) are eligible for relief under Section 3513 of the CARES Act. Borrowers can tell what type of loan they have in the name of the loan, which will say whether it is a “Direct” or “FFEL” loan. For borrowers who took out their debt before 2010, when most lending was consolidated under the Direct Loan program, they are more likely to have FFEL loans.
It is important to note that not all FFELs are owned by the Federal Government, because loans that are not owned by the Federal government will not qualify for relief provided by the CARES Act. The easiest way to confirm whether loans qualify is for the borrower to log into their loan servicer’s website and to check if the loans have had their interest rates set to 0%. If so, their FFEL loans are owned by the Federal government. If the borrower’s loans still show that payments are due and do not see a 0% interest rate, their loans are owned by a third party and do not qualify for the relief in the CARES act.
Also not eligible are most Perkins loans, which are disbursed directly from colleges and universities, and HRSA Loans, which are administered through the Bureau of Health Workforce, a government department separate from the Department of Education.
While private loans are not included in the CARES Act, many individual lenders are responding to the situation, offering a wide variety of their own relief efforts. To get an idea of the range of options for borrowers, here are just a few ways this is being handled by different companies:
- Earnest asks borrowers to contact them to “review your options.” LendKey and Education LoanFinance (ELFI) have similar messages about getting in touch.
- SoFi has a form on their website to apply for 60 days of forbearance.
- CommonBond offers natural disaster forbearance, so borrowers can pause payments throughout the duration of the declared national emergency, but interest will accrue throughout.
- Citizens Bank does not appear to have any information for current borrowers but does have a prominent message on their website warning prospective new borrowers about the potential downside risk of refinancing private student loans with them during this uncertain time.
Continuing (And Restarting) Loan Payments And The Impact Of Relief On Loan Forgiveness Programs
The CARES Act states that the suspension of Federal student loan payments will end on September 30, 2020. This means that borrowers will need to begin paying again in October, after the nationwide forbearance ends.
During the 6-month relief period, interest will not accrue on any eligible loans and student loan borrowers will also have their principal balances frozen. Starting August 1, 2020, servicers will begin notifying borrowers via email, mail, and phone when the borrower’s normal repayment schedule will resume.
Fortunately for borrowers pursuing loan forgiveness via a Federal program (such as PSLF, Teacher Loan Forgiveness Program, and long term forgiveness via Income Driven Repayment Plans ), the payment periods suspended by the CARES Act relief provision will be included as if payments were made when counting the number of payments made for determining forgiveness. The text of Section 3513(c) of the CARES Act reads as follows:
The Secretary shall deem each month for which a loan payment was suspended under this section as if the borrower of the loan had made a payment for the purpose of any loan forgiveness program or loan rehabilitation program authorized.
Notably, while it seems clear that the 6-month period will count for borrowers working towards forgiveness programs, servicers have been known to make errors crediting months of service to borrowers, so advisors should still encourage their clients with covered loans to confirm that they received credit for payments for each of these months for each individual loan they have in any forgiveness programs.
Nerd Note: There was a proposal for the government to effectively make payments on behalf of borrowers during this time, thereby reducing principal balances, but it doesn’t seem that language made it into the final bill.
Unpaid, Outstanding Interest On Loans With Deferred Payments Through The CARES Act Will Not Be Capitalized
In other words, because the borrower’s payments do not cover the entire amount of interest accrued each month, the amount of accrued interest that is not paid remains as an outstanding interest amount, thus making the total debt grow over time.
While negative amortization has always been a potential drawback of IDR plans, it is notable that when a borrower enters forbearance under normal circumstances (say, due to a job loss or other temporary need to relieve monthly payment obligations) , their unpaid interest would capitalize, such that their principal balance grows even faster, and they end up paying even more interest on interest.
The potential for negative interest to compound faster due to CARES Act forbearance has been a major point of confusion during this legislation, with different servicers providing different explanations.
The main Q & A page on studentaid.gov does not definitively answer the question at this time (as of April 20, 2020). However, Ron Lieber from The New York Times has confirmed with the Department of Education that they don’t intend for any borrower to have interest capitalization due to this period of no payments.
How Advisors Can Help Their Clients With Student Loans Benefit From CARES Act Relief
Relief from the CARES Act may impact all borrowers differently, so it’s imperative that advisors help their clients understand how relief provisions can benefit them.
First, advisors should encourage all clients with Federal student loans to ensure that their payments have been suspended for any loans which qualify. Borrowers can also log in to their student loan servicer’s account portal to verify that their interest rates are now set to 0%. I’ve verified this for multiple borrowers at different servicers, such as Navient and FedLoan, but each borrower should confirm with each of their lenders for themselves. Any borrower who had a loan payment processed after March 13, 2020, may also request a refund from their servicer.
For clients who have private student loan debt, even though they won’t benefit from relief provided by the CARES Act, they should still be encouraged to contact their individual lenders to determine what, if any, relief is being provided at this time. Information is changing daily, so borrowers may get different answers next week than they did this week.
Depending on the client’s particular situation, advisors will find different strategies that will benefit their clients the most. Here are some of the most common scenarios advisors can expect to encounter.
CARES Act Relief Can Help Clients Working Towards Public Student Loan Forgiveness (PSLF)
For advisors who have clients on track for Public Service Loan Forgiveness (PSLF), they should absolutely recommend that their clients not pay anything during the 6-month relief period. Borrowers will get credit for these 6 months regardless of whether they make payments during this time, and since there is no taxation on their eventual loan forgiveness, any dollars spent during this time will be entirely wasted.
One point the Education Department has clarified is that borrowers must have been on a qualifying repayment plan prior to March 13, 2020, to get credit for these 6 months. So a borrower who is currently in the 6-month grace period provided to all borrowers post-graduation cannot take their loans out of the grace period into ‘repayment’ now and get the PSLF (or longer-term forgiveness) monthly credits. This would only apply to borrowers who recently finished their education and have not yet started repaying their loans.
Notably, there are some borrowers who are enrolled in programs where a third party gives them money to pay their forgivable loans, such as a law school or employer. Each borrower should check with that third party to see if it’s possible to redirect those payments to other student loan debts, if applicable. After all, the third-party also shouldn’t want to spend money making payments that ultimately will not have any impact on the borrower.
Income-Driven Repayment (IDR) Plan Loan Borrowers May Benefit From CARES Act Relief Depending On Forgiveness Goals
For clients who make payments for either 20 or 25 years on an IDR Income-Driven Repayment (IDR) Plan (depending on the repayment plan chosen), any remaining debt balance at the end of the time period will be forgiven. However, amounts forgiven under IDR plans will be considered taxable income. This typically only makes sense if a borrower has far more debt than annual income and is not eligible for any other loan forgiveness programs. By determining payment amounts based on income, borrowers can often have a far more affordable payment than their loan terms would otherwise dictate, and even with the tax due on eventual forgiveness, reduce their total repayment cost over the life of the loan.
Under the CARES Act, though, because interest accrual is set at 0% and outstanding interest before March 13, 2020 will not capitalize, there is no immediate cost to a borrower in this situation to take advantage of the forbearance. They get the credits for paying during those months even if they do not make a payment. Thus, they will simply resume paying in October 2020, but will have been able to use the money typically allocated to student loan payments for other purposes during these months.
As while a borrower going for long-term forgiveness typically owes far more in debt than their annual salary, it’s likely they will have multiple financial obligations that may be more pressing.
For borrowers on IDR plans who will eventually pay off their debt in full (e.g., borrowers who expect their income levels to increase dramatically from the time they established their loan, and who will pay off their loans before the 20- or 25-year forgiveness period), taking advantage of forbearance may still be appealing and the non-capitalization of loan interest is the key why.
Take, for example, a medical resident who earns $55,000 annually, and has upwards of $300,000 of student loan debt. They are likely on an IDR plan while in residency, and then if not going for PSLF, they would enter a standard repayment plan or privately refinance their debt once they secure their physician role. If the Education Department were to capitalize their outstanding interest from residency, it could cost them thousands of dollars down the line, as they’ll now pay interest on that interest.
By not having their interest capitalized, though, no harm is done taking advantage of this forbearance, and borrowers will still have options to refinance and repay their debt balance later, while building up cash now they may need for other purposes.
A borrower who makes no payments from April-September should owe the exact same amount in October that they did at the start of the forbearance. Financial advisors and clients with IDR Plans should watch carefully in October, though, as servicers gave very different answers when asked about this scenario and seemed to be confused about whether or not pre-March 13, 2020 interest would capitalize come October.
Direct Consolidation Can Benefit Borrowers With Federal Family Education Loans (FFEL) or Perkins Loans, Not Already Owned by the Federal Government
For borrowers with FFEL or Perkins loans that don’t qualify for CARES Act relief, advisors may want to consider recommending that they consolidate their loans into a Direct Consolidation Loan. Doing so would turn the student loan(s) into one owned by the Federal Government, thereby allowing the borrower to take advantage of the 0% interest and no payments in the coming 6 months. It also would set up the borrower with the loan type most likely to get further relief, if any additional relief comes in future legislation.
The process for consolidation is relatively easy, starting with this website. Borrowers elect the loans they wish to consolidate, elect their repayment plan and new loan servicer, and submit some information regarding income. Within 1-2 months, all of the selected loans will be paid off in full, and the borrower will have a Direct Consolidation loan instead.
Notably, though, if any unpaid interest is outstanding on the original loan, that interest capitalizes during the consolidation. Which wouldn’t necessarily create any problems during the forbearance period – as interest on the principal is still 0% - but would implicitly result in compounding capitalization of interest after the forbearance period ends. Given the cost, this likely only makes sense for borrowers who are already paying their loans down, and have little or no outstanding interest at time of consolidation.
Additionally, when loans are consolidated, the new interest rate (which will go into effect after this relief period) will be the weighted average of the interest rates of the loans being consolidated, then rounded up to the nearest ⅛%, which is standard on all federal loan consolidation. This would also preclude borrowers from targeting payments strategically at their highest interest rate loans, thus leading to slightly higher overall repayment costs for some borrowers who have been paying more than the minimum monthly amounts due.
CARES Act Forbearance To Manage Lost Income, Unemployment, Or Other Debts
Advisors with clients whose income has been reduced or eliminated should clearly encourage them to stop paying any student loans eligible for CARES Act relief during this time, especially given the favorable provisions not only of the suspended payments themselves (relieving cash flow) but also of the forbearance and non-capitalization of interest.
In addition, any borrowers who have higher-interest debt, such as credit card or private student loan debt, can use the additional cash flow freed up to reduce those balances during this time.
For borrowers experiencing a drop in income, an Income-Driven Repayment (IDR) plan may be beneficial. Any borrower is allowed to file for recertification of their income if they’ve experienced a change in circumstances, such as job loss or reduced income. IDR may result in lower payments, even as low as $0 per month (e.g., based on their reduced income level, and independent from the suspension of loan payments), while keeping loans in good standing even beyond the September 30 expiration of the payment suspension. Even after income goes back to previous levels, this would give a borrower flexibility to pay less than they were for a period of time if they need to focus on other financial obligations.
Given the current level of economic uncertainty, though, borrowers considering an IDR loan should wait until August to make the decision. This can provide the borrower with time to assess their personal situation, and, if they choose to move into an IDR plan, they would maximize the months of the reduced or $0 payments.
For example, let’s consider a borrower who just lost their job and now has an income of $0.
If that borrower recertifies income in May 2020, based on their job loss, and gets a required student loan payment of $0, they would have to recertify their income again in May of 2021. Since they already have a $0 payment for May - September, they’d not be changing their required payment amount at all right now.
If that same borrower waits until September 2020 to recertify, and is still unemployed, they would get to keep the $0 payment on their loans until September of 2021, which is the next time they’d be required to recertify. This gives them more time to rebuild financially before resuming student loan payments, though it should also be weighed against the negative amortization impact of making a $0 payment once the relief from the CARES ACT expires.
CARES Act Relief May Not Be Necessary When Income Is Stable With Sufficient Cash Reserves And No High-Interest Debt
Advisors may recommend that clients who are not seeking loan forgiveness and who have stable income, cash reserves, and no high-interest debt, simply continue paying their loans and forgo the relief offered by the CARES Act provision to reduce their loan principal as quickly as possible.
The repayment of principal now – especially when the full payment (or partial payment, as there are no minimum amounts required during the relief period) can go towards principal since no interest is accruing – can save significantly on interest expense later, once interest rates return back to normal after the SECURE Act Relief period ends.
And because there are no minimum required payment amounts or due dates during the relief period, borrowers also have the freedom to selectively target payment amounts towards specific loans (e.g., those with higher interest rates), as they aren’t required to make a minimum payment on each separate loan.
With other core financial obligations in order, these clients can speed up their timeline to being free from student-loan debt.
Married Couples With Multiple Student Loans May Have More Complex Planning Needs
Clients who are married may have situations that pose additional complexity, with some combination of any of the types of clients described above.
If one spouse is working towards PSLF while the other is working to pay off their debt and the couple otherwise has stable income, they could redirect all of the cashflow that had been going towards making qualifying PSLF payments and instead make payments to the loans they are working to pay off.
More specifically, the couple could target all payments towards whichever individual loan has the highest interest rate and use this time to significantly reduce their highest-interest student loans.
A couple that owes both Federal and private student loans could use the reprieve from the federal loan payments to more rapidly pay off private student loans that are still charging interest and requiring monthly payments.
How CARES Act Forbearance May (Or May Not) Help Borrowers Thinking About Refinancing Non-Forgivable Federal Student Loan Debt
Borrowers who have Federal student loans that are not in forgiveness programs may benefit by refinancing their loans to private student loans with lower interest rates. For these borrowers, choosing whether to take advantage of CARES Act forbearance benefits can be a tough call. On the one hand, refinancing can mitigate the interest expense at higher rates that would have otherwise amassed significantly over the life of the loan; on the other hand, though, doing so would preclude the borrower from taking advantage of the current CARES Act forbearance benefits (and any other benefits available for Federal student loan borrowers).
For example, a borrower with $90,000 of Federal student loan debt at an average interest rate of 6.8% can expect to pay over $34,000 of interest if paying the debt off in 10 years.
Prior to the CARES Act, a borrower with good credit and income may have been able to refinance this debt with a private student loan at 4.5% for 10 years. This would have cut their interest to just under $22,000, saving $12,000 in the process. But now they would have missed out the 6-month relief period to pay with no interest at all.
For clients who are considering a private loan refinance, they should first take as much time as possible before confirming or denying the offer. I have a client currently who has an offer to refinance, and the offer expires in late April. Given how fast things have moved in the past few weeks, it’s prudent to at least take the time to continue payments on their Federal student loan at 0% interest now, and see if any additional information comes out that may dissuade them from completing their refinance.
The security of the borrower’s income should also be considered when deciding whether to refinance their Federal student loan. If they foresee a possible reduction in income or job loss, it’s wise for borrowers to forego any savings from refinancing to maintain the generous provisions of Income-Driven Repayment plans and Federal forbearance rules. If their income is relatively secure and they have cash reserves to tide them through any job loss, it may still be worth refinancing, but with the knowledge that they may kick themselves if further student loan relief comes down the line for Federal loan borrowers.
What’s On The Horizon For Student Loan Relief?
While it’s always best to advise clients based on current law and not speculation about the future, it’s also important to recognize that clients carrying significant student loan debt are seeing a lot of headlines that may influence their decision-making process during this time.
In fact, during the negotiations for the CARES Act, four Democratic senators proposed having loan payments effectively made on borrowers’ behalves, rather than simply frozen. Their proposal also included $10,000 of student loan forgiveness. Both proposals would have made those benefits tax-free as well.
Another proposal in the House of Representatives included similar provisions, but with $30,000 of debt cancellation. These provisions seem not to have been included in the most recent conversations regarding a second round of the CARES Act but call for forgiveness have expanded to politicians who as recently as last year opposed the idea.
Presumptive Democratic nominee Joe Biden announced on April 10 an expansion of his student loan forgiveness vision. This plan includes Elizabeth Warren’s call for immediate forgiveness of $10,000 for all borrowers, but expands on that to include the following:
- Immediate cancellation of a minimum of $10,000 of student debt per person, as proposed by Senator Warren in the midst of the coronavirus crisis;
- Those earning less than $25,000 per year will not have to make monthly payments and will accrue no interest;
- Those earning more than $25,000 per year will pay no more than 5% of discretionary income toward payments; and
- After 20 years, the remainder of federal student loans will be forgiven without any tax burden.
Those who participate in public service will be eligible for additional Federal loan forgiveness, including $10,000 per year of forgiveness for up to five years.
These proposals would probably have seemed far-fetched several months ago, but several months ago no one would have seen a 6-month, 0%-interest, $0-payment period either.
As while clients should generally not be advised to make decisions based on prospective law rather than actual current law, the speed at which legislation has recently been proposed, and passed, leaves open the possibility that additional forms of loan forgiveness may happen.
Despite the fact there is no certainty that additional loan forgiveness benefits will be made available, advisors should be aware that clients are seeing headlines and news stories about these issues and are wondering how they could be impacted personally.
Accordingly, it is important for advisors to stay abreast of legislative activity so that they will be prepared to respond to questions about previous and future proposals, as Congress continues to find ways to provide relief to those impacted during these difficult times.