The purpose of this article is to help borrowers identify and avoid student loan scams. Much of the advice contained below comes directly from the Federal Trade Commission (FTC) or the Consumer Financial Protection Bureau (CFPB). I’ve also included details on some of the types of scams I’ve seen over the years.

Calling Out Scammers by Name: I’d love to make a list of known scammers as a resource for borrowers. Sadly, a scary experience dealing with a scam company makes going that route especially difficult.

What Does a Student Loan Scam Look Like?

The most effective scams that I have seen create a sense of urgency with borrowers. Act now before the opportunity disappears.

For many responsible borrowers, a limited offer is worth investigating. If there is even a chance that the offer is legitimate, the potential savings would be enormous.

While the rules for student loans do change, it never happens quickly, and it never costs any money to benefit. All federal student loan programs are free to enroll. Additionally, paying for expert help just to fill out paperwork is almost always a mistake.

This graphic from the FTC best summarizes some of the telltale signs of a scam:

Lower Student Loan Interest Rates: Real or Scam?

The good guys and the bad guys both promise lower interest rates.

What is Legitimate – There are many student loan refinance companies that can actually lower your interest rates. Most of them work with both federal and private student loans.

The legitimate companies make money by offering lower interest rates to borrowers who are highly likely to pay back their student loans. These lenders pay off your existing debt with your old lenders. Then, you pay back the new company at, what is hopefully, a lower interest rate. The aggressive advertising, lower interest rates, and sign-up bonuses often trigger the “too good to be true” alarm for many consumers.

The best way to know you are dealing with a legitimate company is that good credit will be required. They will need your credit report to determine if you are a borrower who pays back your debt and can afford the loan.

This service is normally advertised as student loan refinancing, and there are many lenders in the refinance business. I’ve ranked and reviewed the nationwide companies offering student loan refinancing. Note that although some lenders received negative reviews, they are still legitimate companies. They just provide rates and terms I think could be better.

When a Lower Rate is a Scam – One of the biggest red flags to be aware of is when a company promises you lower interest rates and student loan forgiveness. You can get lower rates by refinancing your federal loans. However, those loans become private loans and lose eligibility for federal forgiveness programs. Alternatively, you can pursue federal forgiveness, but the government won’t be cutting your interest rate.

If everybody gets a lower interest rate, it is also probably a scam. Refinance companies only make money if they are smart in choosing their customers. If they pay off the loans for people who won’t pay back their debt, they will lose money.

Obama, Trump, or Biden Student Loan Forgiveness

Scammers love to advertise forgiveness programs associated with the current president. They try to benefit from the harsh political climate by appealing to a particular point of view.

However, it isn’t fair to say that all federal forgiveness programs are a scam. It has just been my experience that if somebody attaches the President’s name to the program, it is more likely to be fraudulent in some way.

What is Legitimate – Many student loan forgiveness programs exist for federal student loans. The most common are the forgiveness programs offered through income-driven repayment plans and Public Service Loan Forgiveness. There are also programs for borrowers in certain occupations, such as teachers and military personnel.

You can enroll in the legitimate programs directly through your federal student loan servicer. No special expertise is required. Although, researching and understanding the programs is very helpful for preventing errors. Furthermore, there is no cost to signing up for any of the student loan forgiveness programs. Federal law created these programs and are often a term in your student loan contract with the government.

Legitimate student loan forgiveness does not immediately wipe away all of your debt. It takes years to reach. It is a good idea for some borrowers, while others are better off aggressively paying off their debt.

Student Loan Forgiveness Scams – One of the biggest giveaways to a student loan forgiveness scam is a high-pressure sales environment. If somebody is aggressively trying to push you into a program that will erase your debt, it should be a red flag. Another huge red flag is any fees associated with the program. Again, student loan forgiveness is federal law, and signing up costs nothing. There should be no enrollment fees or monthly costs.

Another common red flag is when a company advertises a special relationship with the Department of Education. Such a relationship doesn’t exist. Student loan programs are open to all federal borrowers. No outside company can change your eligibility.

Finally, if you are working with a company that requires your FSA PIN, now known as the FSA ID, you are likely getting scammed. The Department of Education makes it clear that the borrower is the only person who should have access to this number.

You can achieve enrollment in any student loan forgiveness program through your federal student loan servicer. Any third party that tries to enroll on your behalf likely has bad intentions. At best, they are charging you money to fill out forms that you could submit on your own. At worst, they are flat-out stealing your money or your identity.

Student Loan Consolidation Scams

Student loans are consolidated when multiple existing loans are combined into one new larger loan. There are two types of consolidation. One is federal student loan consolidation, and the other is private loan consolidation. For many borrowers, student loan consolidation is a helpful or even necessary step. Unfortunately, there are also scammers advertising student loan consolidation services.

Legitimate Student Loan Consolidation – Many borrowers elect to consolidate their federal loans to gain eligibility for certain programs. For example, FFEL loans are not eligible for public service loan forgiveness, but they can be included in a federal direct consolidation loan and gain public service forgiveness eligibility. You can consolidate your federal student loans only directly through the federal government. This process can only take place using the Department of Education’s consolidation site.

Student Loan Consolidation Scams – If you are paying for this service, it is almost definitely a scam. Whether you are consolidating your federal loans for program eligibility or consolidating on the private market for a lower interest rate, the cost to you should be $0. Another red flag is if the company you are working for asks for your FSA ID or FSA PIN.

$0 Per Month Student Loan Payments

Like many other scams, the $0 per month payment scams start with a legitimate federal program and use it to take advantage of borrowers.

What is Legitimate – Federal student loans do have income-driven repayment plans. If you don’t have any income or your income is below a certain level, your monthly payment could actually be $0. It is also possible that the government could eventually forgive your loan. This is something you can do directly with your student loan servicer and requires no expertise or special knowledge.

When $0 Payments are a Scam – If you see advertising for income-driven payments, the odds are pretty good that it isn’t legitimate. Loan servicers and the federal government don’t spend money advertising these options. They have no incentive to promote these programs. They simply make it available for the borrowers who need help. If you are seeing aggressive advertising from a company offering $0 payments, it is a huge red flag.

Private lenders don’t have income-driven repayment plans. If you see an advertisement for this, somebody is probably trying to sell you something, and you probably don’t want to buy it.

Personalized Student Loan Consultations 

There are numerous self-described student loan specialists offering personalized advice for individual student loan circumstances. This is a gray area in the world of student debt.

For the sake of transparancy, I should disclose that I am someone who falls into this category of self-described specialists offering individual guidance.

As such it probably isn’t fair for me to say who or what is legitimate and what might be a scam. What I will say is that when shopping for a service like this be wary of ongoing fees and lofty promises.

Paying someone for an hour of their time and insight is reasonable. There isn’t any reason for monthly charges, or charges based upon the amount of debt forgiven. Likewise, nobody can promise loan forgiveness or a specific outcome. Anyone engaging in either practice should be viewed with some skepticism.

Red Flags to Avoid

If the specific details covered so far don’t apply directly to your situation, the Consumer Financial Protection Bureau has some excellent general guidelines for identifying and avoiding student loan scams.

According to the CFPB, the following are all signs of a scam:

Pressure to pay high up-front fees. It can be a sign of a scam when a debt relief company requires you to pay a fee up-front or tries to make you sign a contract on the spot. These companies may even make you give your credit card number online or over the phone before explaining how they’ll help you. Avoid companies that require payment before they actually do anything, especially if they try to get your credit card number or bank account information.

Promises of immediate loan forgiveness or debt cancellation. Debt relief companies cannot negotiate with your creditors for a “special deal.” Federal law sets payment levels under income-driven payment plans. For most borrowers, loan forgiveness is only available through programs that require many years of qualifying payments.

Demands that you sign a “third party authorization.” You should be wary if a company asks you to sign a “third party authorization” or a “power of attorney.” These are written agreements giving them legal permission to talk directly to your student loan servicer and make decisions on your behalf. In some cases, they may even step in and ask you to pay them directly, promising to pay your servicer each month when your bill comes due.

Requests for your Federal Student Aid ID. Be cautious about companies that ask for your Federal Student Aid ID. Your FSA ID — the unique ID issued by the U.S. Department of Education to allow access to information about your federal student loans — is the equivalent of your signature on any documents related to your student loan. If you give that number away, you are giving a company the power to perform actions on your student loan on your behalf. Honest companies will work with you to develop a plan. Further, they will never use your FSA ID to access your student loan information.

A Couple Final Tips from the Sherpa

I once received a call from a student loan company that was going to fix my student loans. The glaring red flag was the fact that they didn’t even know my name. If you call me to offer a service and don’t even know my name, I know you are a spammer. Enough Americans have student loan debt that some scammers just call every phone number they can.

However, I’ve received mail from companies that had detailed information about my student debt situation. After some investigation, I determined that they were scams attempting to charge me for free federal student loan programs. The lesson: companies that have your loan information on file may not be legit. To this day, I have no idea how the scammers knew about my debt balance.

Finally, calls, texts, emails, letters, and ads about brand new laws and special programs from Congress are almost always scams. Any new student loan program from the government gets a ton of attention. These programs are easy to verify via a quick Google search. Don’t ever assume that some company has special access or information.

The post Student Loan Forgiveness Scams vs. Legit Programs – How to Tell the Difference appeared first on The Student Loan Sherpa.

Harris’ Past Positions on Student Loans

Kamala Harris’ 2020 presidential campaign and her Senate tenure provide some insight into her views on higher education:

• Free Public College: Harris previously supported making public universities free for most Americans, a bold but expensive step toward addressing the root problem of student debt. Though this idea hasn’t resurfaced in the current race, it remains a potential cornerstone of her platform.
• Lower Interest Rates: During her 2020 campaign, Harris proposed slashing interest rates to 1.88%, a significant reduction that could save borrowers thousands over the life of their loans.
• Targeted Loan Forgiveness: Harris suggested $20,000 in forgiveness for Pell Grant recipients who start businesses in disadvantaged communities. This complicated plan was criticized for its narrow applicability, making it less likely to return in its original form.

Likely Policy Directions

A Harris administration would likely focus on defending and expanding Biden’s student loan initiatives:

• Defending the SAVE Plan: If Trump is re-elected, he might end legal challenges to the SAVE Plan, jeopardizing the program’s future. Harris would likely fight to preserve it.
• Pursuing Forgiveness 2.0: The White House has already announced plans for a Forgiveness 2.0, and it still might happen before the election. Even if it does, litigation before it happens is likely. A Harris administration could defend the plan, which has a much greater chance at surviving a legal challenge.
• Expanding Bankruptcy Relief: Biden’s administration made strides in allowing more borrowers to discharge their loans in bankruptcy. Harris could continue this underutilized program.

Challenges and Opportunities

The biggest lesson from Biden’s presidency is that major changes are difficult without significant congressional support. Without finding 60 votes in the Senate, massive changes are unlikely. That said, Harris could continue fixing broken programs like IDR, PSLF, and Borrower Defense to Repayment rather than pushing for sweeping reforms.

However, there are areas of potential bipartisan support:

• Employer Contributions: Expanding the ability of employers to help with student loan repayments could gain traction.
• Tax Relief: Harris might push to extend or permanently eliminate taxes on forgiven student loans.

Accountability and Enforcement

Harris has a track record of holding for-profit colleges and big banks accountable. She has made it a cornerstone of her pitch to the American people. As President, she could intensify oversight of loan servicers and continue fighting against predatory schools.

The Future of Free College

Though her free college proposal hasn’t reemerged, making public education free could be a first step toward addressing the student debt crisis. Right now, any forgiveness is treating a symptom of a much larger problem: college is too expensive.

If we address the root issue, a one-time fix to help the millions of Americans with student debt becomes far more likely to succeed.

Final Thoughts

A Harris presidency would likely continue Biden’s work by protecting existing student loan programs, pushing for gradual improvements, and finding common ground for bipartisan support. Additionally, she could prioritize holding loan servicers and predatory institutions accountable.

While the Presidential election will be crucial for borrowers, it’s not the only vote that matters. The makeup of Congress, especially considering recent Supreme Court rulings, will significantly influence the future of student loan policies and how the next four years unfold for borrowers.

The post What a Harris Presidency Might Mean for Student Loan Borrowers appeared first on The Student Loan Sherpa.

It’s true that missing payments or delinquencies on your student loans can negatively affect credit scores. However, the connection between student loans and credit scores is only a small part of the equation.

For most borrowers, the biggest impact of student debt is felt in the form of Debt-to-Income ratio analysis. Essentially, the larger your monthly student loan bills, the more difficult it can be to get approved for a mortgage.

This guide will cover how student loans can impact the Debt-To-Income ratio and explore the tools and strategies that borrowers can use to reduce or eliminate the impact of student loans on mortgage applications.

Student Loans and the Debt-to-Income Ratio

The debt-to-income ratio (DTI) is one of the most critical numbers in the mortgage application process. DTI is a calculation that compares how much you owe with how much you earn every month. Lenders use it to evaluate if you can afford to pay back a mortgage.

Lenders consider two DTI numbers. The first one is called the front-end ratio. The front-end ratio looks at how the mortgage payment you’re applying for compares to your monthly income.

Calculating the front-end ratio is relatively straightforward. Lenders will look at your expected monthly housing costs – this includes the anticipated principal, interest, property taxes, and insurance – and then divide that number by your monthly income before taxes. Tools such as the FHA Mortgage Calculator are excellent for estimating housing costs.

Here’s an example of the front-end ratio at work: Suppose the total expected housing costs are $1,000 per month and the applicant earns $5,000 per month. The front-end ratio would be .20 or 20% ($1,000/$5,000). Most mortgage companies prefer a front-end ratio below 28%, though some may accept up to 31% or slightly more under certain circumstances. It’s important to note that student loans don’t impact the front-end ratio.

The second DTI number that mortgage lenders look at is called the back-end ratio. This number is the one that causes headaches for student loan borrowers. Unlike the front-end ratio that considers only the expected housing costs, the back-end ratio calculates all monthly expenses compared to monthly income. Lenders typically want this ratio to be below 41%. That said, the highest acceptable back-end ratio can vary based on your credit profile. In some cases, lenders may approve ratios even above 50%.

The back-end ratio includes the following monthly bills:

• current housing expenses
• car payments
• student loan bills
• minimum monthly payments on credit cards
• any other debt that appears on a credit report

The back-end ratio DOES NOT include the following monthly bills:

• utility bills
• food and groceries
• cell phone bill
• cable bills
• retirement plan contributions to 401(k), IRA, and Roth accounts
• most subscriptions

One final note on back-end DTI calculations: Lenders usually take yearly income and divide it by 12. If you get paid every two weeks, take your paycheck, multiply it by 26 and then divide by 12 for your monthly income.

Strategies to Improve Debt-to-Income Ratios

Fixing the back-end DTI isn’t an easy task. Most borrowers can’t just snap their fingers and have less debt. However, there are ways to tweak the DTI to lower your ratio.

Pay Down Credit Card Balances – For most types of debt, paying down the balance doesn’t change your Debt-to-Income (DTI) ratio. For instance, even if you pay more than needed on your car loan, your monthly car payment doesn’t decrease. Accordingly, your DTI remains the same. However, paying down your credit card balance lowers your minimum monthly payment. The lower your credit card balance, the less you have to pay each month. The less you’re required to pay monthly, the better your back-end DTI becomes.

Change Repayment Plans – One of the perks of federal student loans is the variety of available repayment plans. By changing to a plan like SAVE or PAYE, borrowers can potentially lower their monthly payments. Suppose a borrower has $35,000 in federal student loans and they are on the standard repayment plan. According to the federal loan repayment simulator, the monthly payment used in the DTI calculation would be $389. If that borrower switches to the graduated repayment plan, the payment lowers to $222 per month. Even though the student loan balance hasn’t changed, by switching repayment plans, the borrower can improve their back-end DTI. Many borrowers will find the lowest monthly payment using the SAVE plan.

Eliminate Smaller Balances – We’ve established that lowering the balance on most loans won’t reduce your monthly expenses. But, paying off an entire balance can make a huge difference. Typically, we suggest that borrowers pay down their highest-interest debts first. However, one notable exception is when borrowers are trying to improve their DTI for a mortgage application. By paying off a smaller loan in full, even if it is a low-interest loan, the monthly payment disappears from the credit report. Thus, one less debt means a smaller back-end DTI.

Refinancing Student Loans for Mortgage Applications

Another way to better your Debt-to-Income (DTI) ratio is by refinancing your student loans. Refinancing means finding a new lender who agrees to pay off some or all of your current student loans. You then pay back this new lender based on the terms of your new loan agreement.

People usually refinance to get a lower interest rate on their student loans. But, if you’re refinancing to help you qualify for a mortgage, the main goal is to lower your monthly payments. For example, while securing a lower interest rate is beneficial, extending the length of your loan can have a much bigger impact on reducing your monthly payments.

Please note that refinancing student loans is different than temporarily picking a new repayment plan. Before refinancing, borrowers should consider several factors:

Be Extra Careful with Federal Loans – Federal student loans have excellent borrower perks, like income-driven repayment plans and student loan forgiveness. If you refinance your federal loans with a private lender, you’ll lose access to these benefits forever. You should only refinance federal loans if you’re confident you can pay back the entire loan without needing those federal programs.

Shop Around – It’s important to compare options. Talk to several lenders because each one has their own way of evaluating loan applications. To make sure you’re getting the best deal, it’s a good idea to check rates with different lenders. We recommend applying with at least five different lenders to see what offers you can get.

Don’t Delay – The entire refinance process can easily take longer than a month. Getting approved takes time. Having your new lender pay off the old debts takes time. Waiting for your credit report to show the old loans as paid off takes time. If you are going to refinance your student loans to help your chances at a successful mortgage application, be sure to do it long before applying for the mortgage.

Find the Best Long-Term Rate – If your goal in refinancing is to lower your monthly payments for a mortgage application, opting for a longer repayment term is a smart move. For example, choosing a 20-year loan term will give you significantly lower monthly payments compared to a 10-year term. Though the interest rate might be a bit higher, your monthly payments will be much more affordable. Keep in mind that the companies advertising the lowest rates are usually promoting their shortest-term loans. Focus on the lenders who have the best 20-year refinance rates.

Multiple Refinances – As you plan your strategy, remember that there is nothing wrong with refinancing your student loans multiple times. You might start with a long-term loan to reduce your payments before applying for a mortgage, then refinance again after buying your home to lock in a better interest rate. This approach can be creative way to work within the system, but it does involve some risks. You’re counting on being approved again and lower interest rates being offered in the future.

Mortgage Applications, Student Loans, and Credit Scores

Thus far, we have focused primarily on the DTI because this is typically how student loans make the biggest impact on a mortgage application. However, student loans can also affect credit scores (which can have an effect on mortgage applications). For example, longer credit histories typically help credit scores, and a student loan might be a borrower’s oldest line of credit. Additionally, making on-time payments can improve a credit score, while late payments and other student loan issues can damage it.

The process of refinancing has the ability to either help or hurt your credit score. In the vast majority of cases, the impact on credit score is minimal in either direction. It usually is difficult to predict the exact nature of the score change. Paying off multiple loans and consolidating them into one new loan can lead to an increase in your score. But, if your student loan is one of your oldest accounts, closing it and opening a new one can shorten your credit history and might lower your score a bit.

Refinancing applications can also cause a slight dip in the credit score. Fortunately, credit agencies generally count shopping around as a single application.

For these reasons, it is crucial to make any student loan moves well in advance of your mortgage application. This will ensure that any potential negative impacts are minimal while allowing you to take advantage of the positive consequences.

There are a couple of additional items to be aware of. First, for borrowers with excellent credit scores, the minor variations from the refinance process are unlikely to impact the amount offered or the interest rate on their mortgage. Second, if your lender has mistakenly reported any negative information to the credit agencies, be sure to get this adverse reporting fixed as soon as possible.

Working with Mortgage Brokers and Lenders

Because credit scores can be complicated, it is often a good idea to consult an expert. Mortgage brokers earn their living by helping people find mortgages. Some are better than others, and some are more reputable than others. Working with someone who is not only skilled but also trustworthy can greatly improve your chances of getting approved.

A knowledgeable mortgage expert can assist most student loan borrowers in understanding their financial position and what steps they might need to take to improve their chances of mortgage approval. They can help mortgage applicants answer the following questions:

• What size mortgage will I qualify for?
• Is my credit score going to be an issue?
• What ways can I improve my DTI?
• What price range should I be considering?

Where the mortgage brokers and lenders can fall short is in helping borrowers make a responsible decision. Determining how big a mortgage someone can qualify for is one thing, but determining whether it is a good idea is another matter. Just because you can qualify for the mortgage doesn’t mean you can afford it or that it’s a good idea. Brokers get paid when new loans are created, so they don’t have an incentive to tell you when a mortgage is a bad idea.

Another area where mortgage experts can often lack expertise is with student loans. Many mortgage lenders don’t fully understand how federal repayment plans work. This knowledge deficiency can make the underwriting process more difficult.

Underwriting Issues – Can I Use IBR, PAYE, or SAVE Payments?

Mortgage underwriting is the process by which lenders evaluate an applicant’s finances to determine whether or not they should offer a mortgage loan. This process also determines the interest rate and loan size.

Borrowers who use income-driven repayment plans for their federal student loans have historically found their plans to be a hurdle in qualifying for a mortgage. In the past, lenders would not accept income-driven payments for DTI calculations because the borrower’s payments could increase. Therefore, they concluded that the payments weren’t an accurate representation of that monthly expense.

Student loan borrowers and advocates argued that the only reason these payments would go up is if the borrower was earning more money. Borrowers making more money would be in a better position to repay their mortgage.

Nonetheless, for years, borrowers weren’t able to use income-driven payments for DTI calculations. Instead, lenders would replace the actual monthly payment with 1% of the loan balance. For borrowers with enormous debts, this would often shatter the DTI and lead to application rejections.

The good news is that most lenders are becoming more knowledgeable on this issue.

Mortgage giants like Freddie Mac and Fannie Mae have finally seen the light. They have updated their approach and are now more open to considering payments under income-driven repayment plans (like IBR, PAYE, or SAVE) when calculating your DTI. This new approach has also been adopted by many smaller lenders, like local credit unions and regional banks. However, not every lender is on board with including these types of payments into DTI calculations. For this reason, it is critical to communicate with your lender to determine how they evaluate income-driven payments on student loan applications.

To safeguard your home buying journey, we recommend applying for a mortgage with multiple lenders. This way, if one lender gets cold feet about your student debt close to the final decision, you’ll have another option already in progress.

Sherpa Tip: For many borrowers, the plan with the lowest monthly payment is the best plan to use if you are going to apply for a mortgage.

Special Rules for $0 Payments on Mortgage Applications

When applying for a mortgage, it’s important to understand that mortgage lenders typically do not consider $0 payments when calculating debt-to-income (DTI) ratios. Instead, they use a percentage of the existing loan balance. Historically, lenders used a flat 1% of the loan balance for these calculations. However, many lenders now use a more favorable 0.5% rate.

If you qualify for a $0 per month payment on your student loans, it may be beneficial to switch to a repayment plan that offers the lowest non-zero monthly payment. This strategy can present a more favorable DTI ratio to lenders, potentially improving your mortgage approval chances.

However, there are significant drawbacks to consider. Switching to a plan with a higher payment means spending more money on your student loans. Additionally, if you move away from an income-driven repayment (IDR) plan, you could lose valuable time toward student loan forgiveness. The process of changing repayment plans can also be cumbersome and time-consuming.

If you decide to change repayment plans for mortgage purposes, it is advisable to make the switch a few months before applying for the mortgage. This timing ensures that the new monthly payment appears on your credit report. Maintaining this mortgage-friendly payment plan until the loan closes is wise, as lenders may conduct another credit check at that point. After closing on the house, you can switch back to the plan offering a $0 per month payment, assuming you still qualify.

Given the complexities involved in tweaking repayment plans and mortgage eligibility, consulting with several mortgage professionals is a prudent step. Explain your available repayment plans and discuss your options. While the extra steps of changing repayment plans may not be necessary in every case, for those with substantial student loan balances, it could be the key to securing the mortgage you want.

Co-Signer Issues on Mortgage Applications

Being a co-signer on a student loan can also impact your mortgage application. Co-signed student loans appear on your credit report, along with monthly payments. Consequently, most lenders include the co-signed loan payment in DTI calculations, even if you aren’t the one who makes the student loan payments.

Many lenders will remove the co-signed loan from the DTI calculation if you can show that the student loan borrower has been making payments independently for a while, usually 12 to 24 months. However, since many mortgage applications are initially reviewed by a computer algorithm, co-signed loans could still trigger a rejection, regardless of the primary borrower’s payment history.

Things get further complicated for co-signers of borrowers still in school. We have heard of lenders going so far as to initiate a three-way call between the mortgage applicant, the mortgage company, and the student loan company. The mortgage company essentially asks the student loan company to determine the maximum potential payment once the borrower graduates and enters repayment. This maximum payment is then used in the DTI calculations, potentially affecting the co-signer’s mortgage application significantly.

Accordingly, if you’re thinking about buying a house in the future, you should probably avoid co-signing on student loans if possible.

Next Steps to Fix Student Loan Debt on Your Mortgage Application and Buy a Home

The following steps could help you qualify for a home loan. Because student loan changes can take months to be reflected in your credit report, you should plan ahead.

Visit the Federal Repayment Simulator – Review the repayment plan options to get the lowest monthly payment.

Refinance Private Loans – The best way to improve debt-to-income ratios for private loan debt is to pick a 20-year loan at the lowest interest rate possible. Borrowers can probably refinance again after securing a mortgage.

Try to get a Co-Signer Release – If you have co-signed a student loan for someone else, getting removed from that loan should be a priority.

The post Student Loans and Mortgages: The Impacts and Strategies for Homebuyers appeared first on The Student Loan Sherpa.

At first glance, the companies that sent these letters seemed legitimate. They knew exactly how much I owed in federal student loans and had my name and address correct. Everything appeared to be the usual stuff you get about student loans. However, when I looked closer, I noticed several warning signs that something wasn’t right.

Sherpa Tip: Sometimes it is challenging to separate a scam from legitimate information.

For example, an expansion of PSLF that requires some borrowers to consolidate might seem like a scam because it is both confusing and sounds too good to be true.

If you find verification on studentaid.gov or through your federal loan servicer, you can be certain it isn’t a scam.

The Red Flags – Signs the Letter Might be a Scam

No Company Name Listed – One letter didn’t mention the company’s name at all. Instead, it just referred to itself as “The Company” in the small print, never revealing its actual name. Legitimate companies always state their names clearly. The fact that you can’t find the company’s name probably means they’re hiding it on purpose.

Generic Greetings – One of the more obvious signs of a scam is that it says “Dear Borrower” instead of your name. Knowing your name doesn’t necessarily mean it is valid, but not knowning your name almost certainly means it is a scam.

Instructions to create your Federal Student Aid ID – Another letter gave me steps on how to set up my Federal Student Aid (FSA) ID. They ask you to create an FSA ID so they can use it later. However, you should never share this ID with anyone.

The Department of Education warns that your username and password are as legally binding as your written signature. Giving someone your FSA ID is like letting them sign documents for you, which could let them make unwanted changes to your account without your permission.

New Laws – Talking about new laws is a common trick scammers use. They might tell you about a “new law” that supposedly only they know about. It is unlikely, however, that there is a new student loan law that you haven’t heard about from watching the news, reading a newspaper, or visiting sites like this. If you cannot verify any new student loan law from a trustworthy source, the odds are very high that you are looking at a scam.

Document Preparation and Application Assistance – The fine print on both letters I received made it clear that the only thing they were actually offering was to help submit applications or process paperwork. If I contacted them, they’d likely compare their service to hiring an accountant for tax returns. But, this is misleading.

These document preparation companies charge hundreds of dollars, hoping you won’t realize they’re just filling out a 20-minute form. They almost certainly will not offer helpful insight for your specific financial circumstance.

Important Deadline – If a letter mentions an important deadline on your student loans, be wary. Your student loan servicer would inform you directly of any important deadlines for your student loans. If the first you hear about this “deadline” is from an advertisement or letter from an unknown company, there probably isn’t a real deadline at all.

The Consumer Financial Protection Bureau also has a great page on identifying Student Loan Scams.

They highlight the following red flags:

Protecting Yourself from Fradulent Student Loan Letters

If you get a letter and question its legitimacy – If you doubt a letter’s authenticity, first look up the company’s name online. Be aware, however, searching online might not catch all the scams. Some companies are skilled at creating fake positive reviews and hiding the very real complaints. The Consumer Financial Protection Bureau has some additional advice for evaluating these companies.

If you think they took or are about to take your money – If you’re worried that a scam company has taken your money or is about to, getting your money back can be tough.

If you already paid them, demand they return your money immediately. Inform them that you will be submitting a complaint to the Consumer Financial Protection Bureau and your state’s attorney general if it isn’t promptly returned. These scammers go to great effort to stay off law enforcement’s radar. The threat of reporting their scam is the threat they are most likely to take seriously. Please be aware that, while law enforcement is often good about pursuing these companies, they are usually slow to respond because they need time to build a case.

If you wrote them a check that hasn’t been cashed yet, you can ask your bank to stop the payment. If you paid by credit card, you can tell your credit card company it was a fraudulent charge and ask them to reverse it.

No matter what happens, keep an eye on your credit report. Scammers might have your personal info and could try to steal your identity.

Getting Back at the Scammers

You might feel a strong urge to get back at these dishonest individuals and companies.

Calling scammers to waste their time may seem tempting. Doing so, however, would end up wasting your own time and might even make you more of a target for them.

The most effective step you can take is to file a complaint with the government. The attorney general in most states is responsible for protecting consumers from scams. By reporting to your state’s attorney general, you help law enforcement become aware of the scam.

One person’s complaint might not change things overnight, but if enough people report these scams, it could help prevent others from becoming victims.

Bottom Line – Don’t Take Anything at Face Value

Student loans can be overwhelming and impact a lot of people. Student loan scams have plagued the U.S. for years. Fortunately, a little bit of caution can help avoid most student loan scams.

Generally, a good rule of thumb regarding student loans is to double-check everything you are told, regardless of the source. It’s possible that you misunderstood something, a student loan servicer might have told you something in error, or someone could be trying to take advantage of you.

In essence, if something feels off to you – even if you can’t pinpoint exactly why – it’s important to trust your instincts.

For additional information about student loan scams, read here.

The post Scam Alert: Student Loan Payment Reduction, Consolidation and Forgiveness by Mail appeared first on The Student Loan Sherpa.

Borrowers often believe they must choose between paying off loans and saving for retirement. After all, every dollar you put towards retirement is a dollar you can’t use to pay down student loans.

What if it was possible to build a retirement and make student loan debt disappear at the same time?

It might sound surprising, but there are at least four different strategies that can be used to work towards both milestones.

Use Student Loan Forgiveness to Build a Bigger Retirement

The federal student loan forgiveness programs can be excellent opportunities to eliminate student loan debt. For borrowers with large student loans and a smaller income, these programs can be life-changing.

Borrowers on income-driven repayment plans can have their remaining balances forgiven after 20 to 25 years worth of payments. Those employed by the government or an eligible non-profit can have their loans forgiven after just ten years of payments.

Unfortunately, there is some risk in chasing after student loan forgiveness. While borrowers should understand the rules of loan forgiveness, there are no guarantees. Even though the concern over the high rejection rates in the media may be exaggerated, there is no denying that forgiveness comes with a bit of uncertainty.

Borrowers worried about qualifying don’t have to skip the program entirely. Instead, they can chase after student loan forgiveness but protect themselves if it doesn’t happen.

One option is to open a savings account as a Plan B fund. Borrowers make the minimum student loan payments as they pursue forgiveness and any additional funds that they have available go into the Plan B account. Going this route allows borrowers to attack their debt aggressively, but also try to maximize forgiveness opportunities.

If it becomes clear that forgiveness won’t happen, the Plan B fund can be used to put a huge dent in the debt balance. If forgiveness does work out, the Plan B fund can be used as a huge head start toward retirement.

Refinance and Build a 401(k) or IRA

Those who aren’t eligible for forgiveness can still lower payments and save for retirement.

Companies like SoFi, Splash, and CollegeAve all refinance student loans for borrowers with a decent credit score and income. These companies pay off the older high-interest loans in full, and a new loan with a lower interest rate is created.

Further Reading: Learn how student loan refinance companies make money.

By refinancing, borrowers can free up some additional cash each month. This additional money can be put towards retirement in a 401(k) or an IRA.

For example, suppose a borrower pays $500 per month on their student loans. They may be able to refinance and get the monthly payment lowered to $350. This means an extra $150 monthly. Instead of keeping this money, they can invest it in an IRA.

Depending upon the terms of the student loans, a borrower can refinance student loans to get them paid off more quickly AND use the additional funds available each month to save for retirement. The key to the process is finding the lowest refinance rates available.

Get Your Employer Involved

One of the best ways to build a retirement is to take advantage of employer matching programs. If your employer offers a dollar-for-dollar match, it means each retirement contribution essentially doubles from day one.

Unfortunately, some student loan borrowers do not take advantage of this program because they feel they need every dollar from their paycheck to pay down student loans and pay for the essentials. (Editor’s Note: Passing on an employer matching program is usually a bad idea as it is essentially passing on free money.)

New legislation now allows employers to tie 401(k) matching contributions to employee student loan payments. In other words, payments toward student debt can become retirement contributions depending on your employer.

Because this is relatively new territory, many employers don’t know about this option, and many others will be hesitant to do so. However, some employers may embrace the opportunity. The matching cost to the employer is the same whether the match is based upon a student loan payment or a retirement contribution.

Discuss with your boss or HR how employers can now match contributions based on student loan payments. Many companies are looking for ways to attract young, talented people, and this could be very appealing.

Turn Retirement Tax Breaks into Lower Student Loan Payments

This is my favorite student loan hack.

Borrowers on IDR plans like IBR, PAYE, and SAVE can lower their AGI —and their payments — by contributing to a retirement account.

As most borrowers know, when IDR payments are calculated, the government usually uses your most recent tax return. The important number pulled from the tax return is the AGI or Adjusted Gross Income. A higher AGI means higher student loan payments, and a lower AGI likewise means lower monthly payments.

Contributions to a 401(k) or a traditional IRA lower the AGI. Accountants call tax breaks that lower the AGI above-the-line deductions. For each dollar that is put in a 401(k) or IRA, the AGI is reduced by one dollar.

If a student loan borrower puts $300 per month in an IRA, their AGI will be $3,600 lower the following tax year. The lower AGI means a lower tax bill AND lower student loan payments. Borrowers can use the federal government’s student loan repayment estimator to see how changes to their AGI would change their monthly student loan bill.

Putting money in a 401(k) or IRA provides student loan borrowers with three primary advantages:

1. A lower tax bill in April,
2. A lower monthly payment on an IDR plan, and
3. A larger balance in their retirement accounts.

It is worth noting that a lower monthly IDR payment can mean spending more in interest over the life of the loan, so borrowers should factor total loan cost into their planning. However, for borrowers who will eventually qualify for federal student loan forgiveness, this option can result in a larger portion of the loan balance being forgiven.

Final Thought: Plan Ahead and Know the Rules

These advanced strategies can be confusing, but they are worth understanding for better financial planning.

All student loan borrowers should familiarize themselves with the terms of their student loans and understand how the debt impacts their finances.

By understanding and planning, borrowers can use these strategies to quickly and efficiently eliminate their debt. They will also be empowered to meet other important financial goals, such as retirement.

The post 4 Ways to Save for Retirement AND Eliminate Student Loan Debt appeared first on The Student Loan Sherpa.

Sherpa Thought: This article is not meant to spark a political debate or take sides in the upcoming election.

Instead, it is crafted to be an analysis of the potential consequences of the 2024 election for student loan borrowers.

Forgiven Student Debt: Taxed Starting in 2026

One of the first major concerns for borrowers is the taxation of forgiven student debt. Starting in 2026, student debt that is forgiven could be considered taxable income. This means that borrowers might face significant tax liabilities, potentially limiting the financial relief they experienced from forgiveness.

I’m still hopeful that the tax on forgiven student debt will be permanently eliminated, but a second Trump term likely increases the odds of the tax on forgiveness returning.

A Halt on New Help for Borrowers

During a second Trump presidency, it’s likely that initiatives to fix past issues, and the introduction of new repayment plans would cease. Borrowers should not expect new improvements or relief measures.

Cessation of Forgiveness Initiatives

President Biden has been aggressive about remedying past student loan issues with programs like the one-time account adjustment and temporary expanded public service loan forgiveness. These initiatives have provided significant relief to borrowers. However, Trump hasn’t shown any inclination to expand or fix existing federal student loan repayment programs. Under his administration, such programs would likely be halted, leaving many borrowers without anticipated relief measures aimed at easing their debt burdens.

Stagnation of Repayment Plans

The introduction of new repayment plans would also likely stop, meaning borrowers would not see new options designed to ease their repayment burdens. The focus would shift away from creating new, borrower-friendly policies, leaving many to rely on existing plans that may not fully address their financial needs.

SAVE Plan: A 50/50 Chance of Survival

The SAVE (Student Aid and Value Education) plan, which aims to provide financial relief to borrowers, faces uncertain prospects. Its survival is estimated at 50/50 under a Trump administration. The GOP has been largely opposed to the SAVE plan, and multiple lawsuits threaten its existence.

Challenges to Eliminate SAVE

Eliminating the SAVE plan would not be straightforward. It would require substantial time and effort to roll back the rules.

While Trump’s core supporters might favor the elimination of the plan, it doesn’t present a significant political victory he could boast about. Additionally, it would directly harm many of his supporters who benefit from the SAVE plan.

Rolling back an existing rule is difficult, increasing the likelihood that it survives.

Potential for Grandfathering Existing Borrowers

There’s also a possibility that the administration might grandfather in existing borrowers under the SAVE plan, allowing them to continue benefiting while preventing new borrowers from enrolling. This compromise could be a strategic move to avoid widespread backlash while still fulfilling a political agenda.

PSLF in a Second Trump Administration

The Public Service Loan Forgiveness (PSLF) program, which forgives the remaining student loan balance for borrowers working in public service for ten years, is another area of concern of many borrowers.

The good news is that PSLF is almost certain to survive. PSLF is established by statutory law, making it nearly impossible to eliminate without 60 senators’ approval.

However, the program could be made significantly more difficult to access.

In the past, many borrowers found it challenging to qualify for PSLF, and a second Trump administration might reinstate similar hurdles, reversing the recent ease of qualification.

Other Programs and Protections Remain

Income-Driven Repayment (IDR) forgiveness will likely still exist, as it is also protected by statutory law. The Income-Based Repayment (IBR) plan, another critical option for borrowers, is similarly safeguarded.

Looking beyond existing statutes, there are some additional protections for borrowers.

Master Promissory Note: A Key Guardrail

The master promissory note, which outlines the terms and conditions of federal student loans, serves as a key guardrail for borrowers.

Specifically, the REPAYE plan is mentioned in the master promissory note.

This means that even if the SAVE plan were eliminated, it would likely revert back to REPAYE, which carries many benefits similar to SAVE. It ensures that certain rights and protections cannot be easily stripped away, even by new administrative policies.

Complexity of the System

The complexity of the student loan system itself acts as a barrier to drastic changes.

Student loan programs have a meaningful impact on many lives, and while there is opposition to these programs, it is not a primary voting issue for many detractors. This complexity and the broad, deep-rooted benefits of these programs make significant overhauls less likely.

Final Thoughts

A second Trump presidency could bring several challenges for student loan borrowers.

The taxation of forgiven debt, the potential cessation of new relief measures, and the uncertain future of the SAVE plan and PSLF are key concerns.

However, statutory protections and the inherent complexity of the system provide some safeguards. Borrowers should stay informed and prepared for possible changes while advocating for policies that support their financial well-being.

The post The Worst-Case Scenario for Student Loan Borrowers in a Second Trump Presidency appeared first on The Student Loan Sherpa.

However, while paying off student loans early is a commendable goal, aggressive repayment can have drawbacks. Focusing solely on student debt may cause borrowers to overlook financial opportunities and make mistakes.

Today, we will explore how to avoid repayment mistakes and prepayment penalties. We’ll also discuss strategies for integrating early student loan repayment into your broader financial goals.

Should I Be Concerned About Prepayment Penalties with Student Debt?

Student loan borrowers who are ready for aggressive debt elimination needn’t worry about prepayment penalties.

The federal government does not impose any fees for early repayment of student loans. Furthermore, Congress has prohibited private student loan lenders from charging prepayment fees since 2008. According to 15 U.S.C. § 1650(e), private educational lenders may not impose “a fee or penalty on a borrower for early repayment or prepayment of any private education loan.”

In short, lenders cannot penalize borrowers who wish to tackle their student loans ahead of schedule.

Will Early Student Loan Repayment Affect My Credit Score?

Some borrowers worry that early student loan repayment may negatively impact their credit score.

There is some truth to this concern, as some borrowers have reported a drop in their credit score after paying off a student loan. The most likely explanation is that the borrower’s oldest line of credit, the student loan, no longer appears on their credit report. When the oldest line of credit disappears that average length of credit is shortened, and this can reduce a credit score.

However, even if there is a risk of a credit score drop, the impact is typically minor and temporary. If the score does decrease, it will likely be a small change, and the score should recover fairly quickly. Consider this: if a credit score is a measure of creditworthiness, shouldn’t paying off a loan improve the score?

Ultimately, spending extra money to artificially boost a credit score rarely makes sense. In most cases, a few points in either direction has no impact on the consumer, so spending extra money each month for a few extra points would be a huge waste of money.

In very rare instances, delaying a final payment can make sense. For example, borrowers who are looking to buy a house and worried that a small drop in credit score might be costly should contact their mortgage company or a mortgage broker. Depending on your financial situation, they may advise you that paying off the student loan first might be helpful. Other times, they might suggest waiting to pay off the loan until the mortgage is final.

Will I Miss Out on a Student Loan Tax Deduction?

Some borrowers choose to delay paying off their student loans because of the tax break they receive.

This strategy is generally not advisable, however. The deduction applies only to a portion of the student loan interest paid and provides a meager tax benefit.

Some borrowers may not even qualify for this tax break. Furthermore, those who do qualify will hardly benefit from delaying repayment. For every dollar spent on student loan interest, the maximum tax savings will be 22 cents. This small saving usually doesn’t justify the additional interest costs accrued by prolonging the loan repayment.

Opportunity Costs – The True Expense of Early Repayment

When planning their financial futures, student loan borrowers often face choices between paying off the student debt or working towards other goals.

When you make a student loan payment, that money is gone for good. For example, if you spend $500 on your student loans, you cannot use that $500 for anything else. Economists call this concept as opportunity cost.

To put it simply, if we focus solely on paying off student loans, we will postpone or neglect other financial goals. These deferred goals represent some of the most significant hidden costs of early student loan repayment. The following are some examples of the decisions student loan borrowers must face:

Saving for Retirement – For those with high-interest student loans, it usually makes sense to prioritize paying off the debt before focusing on retirement. However, borrowers with lower interest rates on their loans might benefit more from starting to save for retirement early.

A generous employer matching program should usually be a higher priority than student debt elimination. Similarly, many borrowers should choose to refinance their student loans at a lower interest rate to free up cash for retirement savings. This site has previously detailed the options and provided a suggested priority order for borrowers seeking to balance retirement goals and repayment goals.

Buying a House – The process of purchasing a home while managing student loan repayment can be quite complex. Qualifying for a mortgage often requires setting aside funds for a down payment. However, it can be frustrating to see money sitting in a savings account earning minimal interest while being charged a much higher interest rate on the student loans. Despite such frustrations, homeownership offers numerous personal and financial benefits that can make the irritations worth it.

With careful planning, many borrowers can qualify for a mortgage. Often, this strategy involves prioritizing the repayment of specific student loans before buying a house, while addressing others through aggressive repayment after the home purchase.

Loan Forgiveness – Another hidden cost of early student loan repayment that borrowers often overlook is the loss of potential student loan forgiveness. Many government programs require ten years or more to qualify. However, there are numerous forgiveness programs that borrowers should investigate before deciding to pay off their loans early.

The Significant Cost of a Small Emergency Fund

Having an emergency fund is crucial.

An emergency fund serves as a safety net, providing funds for unexpected expenses such as medical bills, car accidents, or urgent home repairs. Additionally, an emergency fund is essential in the event of job loss. Without any income, making sure that a roof stays over your head and food still arrives on the table can become challenging.

Given the high risks associated with not having an emergency fund, student loan borrowers should prioritize building up their cash reserves before focusing on early loan repayment. This site has previously taken a deeper look at how much should be in an emergency fund and how to balance the fund with student loan repayment.

Keeping Your Eyes on the Prize

The purpose of this article is not to discourage borrowers from repaying their student loans early. In fact, it is quite the opposite. Many borrowers benefit from eliminating their student debt early. The goal here is to dispel a few myths and help borrowers make well-informed financial decisions.

Paying off student loans guarantees a return on your investment. The savings on interest accumulate, and monthly payments can be eliminated. The financial and non-financial advantages of debt elimination can be significant.

Getting rid of student loans can be very satisfying, and the right strategy can make the debt disappear surprisingly quickly.

The post The Hidden Costs of Paying Off Student Loans Early appeared first on The Student Loan Sherpa.

How to Look Up Your AGI

Finding your AGI is straightforward and there are a few options to locate the exact number:

1. 1040 Form: On the standard 1040 tax form, your AGI is listed on Line 11.
2. 1040-SR Form: If you use the 1040-SR form, designed for seniors, your AGI is on Line 11.
3. IRS Website: If you don’t have access to your physical tax documents, you can look up your AGI on the IRS website. Log into your account on IRS.gov, navigate to the “Tax Records” section, and you’ll find your AGI on your most recent tax return.

Understanding Adjusted Gross Income (AGI)

AGI is your gross income after specific adjustments, also known as “above-the-line” deductions. It includes your total income from wages, dividends, capital gains, business income, and other sources, minus allowable deductions like student loan interest, retirement plan contributions, and tuition fees.

Difference Between AGI and Annual Salary:

• Annual Salary: This is your total income before any deductions.
• AGI: This is your income after accounting for allowable adjustments. It’s typically lower than your annual salary due to these deductions.

To be clear, Adjusted Gross Income isn’t something that is used just for student loans. Instead, it is a critical figure during tax season. AGI is essential for determining eligibility for various tax credits and deductions, in addition to calculating your tax bill.

AGI for Married Couples

For married couples, understanding how AGI works is vital, especially when estimating student loan payments:

• Joint Filers: Couples who file jointly will have a shared AGI, which includes the combined income and deductions of both spouses.
• Separate Filers: Couples who file separately will have independent AGIs, meaning each spouse’s AGI is calculated based on their individual income and deductions.

When estimating student loan payments, using AGI is the best way to get an accurate picture of payments on various repayment plans. If your AGI includes your spouse’s income, it means you filed jointly and your spouse’s income will be factored into your student loan payment. If you file seperately, your spouse’s income is not included in your AGI and it does not impact your student loan payments.

For this reason, many married student loan borrowers elect to file their taxes separately.

Keeping AGI Down to Lower Student Loan Payments

Keeping your AGI as low as possible can result in lower monthly payments for those on income-driven repayment plans like SAVE. Here are some strategies:

• Above-the-Line Deductions: These deductions lower your AGI and include contributions to certain retirement plans, student loan interest, tuition fees, and health savings account (HSA) contributions.
• Below-the-Line Deductions: These deductions, such as standard or itemized deductions, do not affect your AGI.

Examples of Deductions That Lower AGI

1. 401(k) Contributions: Money contributed to a 401(k) retirement plan reduces your taxable income and thus your AGI.
2. Traditional IRA Contributions: Putting money in an IRA will also lower yoru AGI. (Note: Roth IRA contributions do not reduce AGI.)
3. Health Savings Account (HSA): Contributions to an HSA are deductible, lowering your AGI.
4. Student Loan Interest: Up to $2,500 of student loan interest can be deducted, reducing your AGI.

To dig deeper, check out this article for more detailed strategies on how to lower your AGI to reduce student loan payments.

By understanding and managing your AGI, you can better control your student loan payments and take advantage of income-driven repayment plans to reduce your financial burden and get more student debt forgiven.

The post Adjusted Gross Income (AGI) and Your Student Loans appeared first on The Student Loan Sherpa.

The idea of using 401(k) or IRA savings to reduce immediate student debt burdens can be appealing, considering retirement seems distant while student loans demand immediate attention.

However, this strategy often leads to more financial woes than relief. While there are rare instances where such a move could be beneficial, most borrowers find an alternative approach to be preferable.

Can retirement funds from a 401(k) or IRA be used to pay off student loans?

If you have money in retirement accounts, no law prevents you from using your money to pay off your student loans.

However, just because you can make this move doesn’t mean you should.

There are three major issues with taking money out of a retirement account to knock out student debt:

• Income Taxes on Withdrawals: Withdrawing from a 401(k) or traditional IRA incurs income taxes, as these funds are tax-deferred.
• Early Withdrawal Penalties: If you’re under 59.5 years old, early withdrawals typically trigger a 10% penalty.
• Reduced Retirement Savings: Using these funds for student loans decreases your retirement savings, potentially leading to financial challenges later in life.

Early withdrawal penalty exceptions

There are several circumstances where an IRA or 401(k) early withdrawal penalty can be avoided. These exceptions include buying a first home, medical expenses, and Covid-19.

Educational expenses are also included, but this exemption doesn’t extend to student loan payments. Therefore, using retirement funds for a child or grandchild’s education is penalty-free, but the same rule doesn’t apply to paying off your own student loans.

It’s important to note that even in cases where penalty-free withdrawal is possible, it might not always be the wisest financial move if there are better alternatives.

Alternative Options

Rather than tapping into retirement funds, consider these alternatives:

Refinance Student Debt: If you have enough money in your retirement account to eliminate your student loans, the odds are pretty good that you could find a lower interest rate through student loan refinancing. One lender, Earnest, even considers retirement accounts when making lending decisions. Several lenders currently offer refinance rates around 5%. If the interest rates on your student debt are lower than what your retirement account is earning, you will come out way ahead.

401(k) Loans: A 401(k) loan, where you borrow from your fund and repay it, could be an option, avoiding taxes and penalties. However, failure to repay means taxes and a 10% penalty.

Reduce Retirement Contributions: Lower your contributions to your retirement fund to free up funds for paying off high-interest student loans, especially if you’re not benefiting from employer matching.

These strategies provide different approaches to managing student debt without compromising retirement savings.

When it makes sense to use retirement accounts for a student loan payoff

There are a few circumstances where dipping into retirement accounts is a reasonable choice.

• If you have already reached age 59.5 – If you are old enough to make a penalty-free withdrawal and you feel confident about your finances heading into retirement, pulling the money out to pay down student debt makes sense.
• If you have money in a Roth IRA – Roth IRAs are treated differently than traditional IRAs. Savers can withdraw Roth contributions at any time without penalty. Roth accounts only charge a penalty if earnings are withdrawn before age 59.5. Moving money out of a Roth account makes sense for borrowers who have high-interest student loans. If your student debt is charging 13%, but you only expect to earn 7-10% on your Roth account, moving the money is a logical choice.

The Big Concern with 401(k) and IRA Withdrawals

Raiding your retirement accounts may provide temporary relief from present difficulties but can lead to severe future challenges.

Consider this scenario: you decide to forgo student loan payments for the next three months. In the short term, it provides some relief. However, in the long run, your loan balance grows, accompanied by late fees, ultimately worsening your overall financial situation. Similarly, prematurely tapping into your retirement account is a short-sighted move.

Managing student loans can be demanding, but facing an underfunded retirement later in life presents even greater challenges. When you can no longer work and struggle to meet your financial obligations, the difficulties multiply.

The post Should I Empty My Retirement Accounts to Pay Off My Student Loans? appeared first on The Student Loan Sherpa.

For borrowers on income-driven repayment plans, monthly payments are calculated based on what a borrower can afford to pay. Putting money in certain retirement accounts essentially shields that income from being included in monthly payment calculations.

It might sound like a bit of accounting voodoo, but getting lower payments via retirement contributions is pretty simple.

Why Putting Money in a 401(k) or 457 Retirement Plan Means Lower Student Loan Payments

The whole “process” is basically three steps:

1. Put money in an eligible retirement account.
2. Claim a tax deduction for the retirement contribution.
3. Get a lower student loan payment on an IDR plan.

Step three is the one with the potential for confusion. To make sense of it, borrowers need to understand how monthly payments on Income-Driven Repayment (IDR) plans work.

The appeal of an IDR plan is that borrowers can make payments based on what they can afford to pay. The Department of Education calculates a borrower’s “discretionary income” in order to determine what they can afford to pay.

The starting point for the dictionary income calculation is usually the borrower’s Adjusted Gross Income (AGI) from their most recent tax return. The larger your AGI, the more you will be expected to pay on an IDR plan.

Shifting back to the retirement side of the equation, some retirement contributions qualify for a tax deduction. This tax deduction lowers the taxpayer’s AGI. The reduced AGI essentially shelters income from student loan payment calculations.

In other words, putting money in a retirement account lowers your income for tax purposes. This “lowered income” means lower payments on income-driven repayment plans.

If things are still a bit fuzzy, the next section will cover the eligible retirement accounts, and later on we will do a quick example with actual numbers.

The Exception: Roth 401(k)s and “Post-Tax” Accounts

Sadly, not all retirement account contributions mean lower student loan payments.

Some retirement accounts are considered “pre-tax” because the money placed in the retirement account isn’t taxed yet. These accounts are also commonly called tax-deferred, meaning you don’t pay taxes until the money comes out of the account.

These contributions that lower your tax bill are the ones that lower student loan payments. Common examples include most 401(k)s, 457 plans, and IRAs.

Borrowers don’t get a student loan benefit if the retirement account is a “post-tax” account. Post-tax contributions don’t lower your tax bill, which means they don’t help with student loan payments. Common examples of post-tax retirement accounts are Roth IRAs and Roth 401(k)s.

Sherpa Tip: If you get a tax deduction for putting money in your retirement account, it also means lower payments on income-driven repayment plans.

Other Ways to Save for Retirement and Lower Student Loan Payments

Clever borrowers might also wonder if other tax breaks mean lower student loan payments.

The answer is yes. Several other tax deductions also mean lower student loan payments.

However, not all tax deductions mean lower student loan payments. The critical detail on tax deductions is whether or not the deduction lowers your AGI. Tax pros call deductions that lower AGI “above-the-line” deductions. The tax breaks that don’t lower AGI are “below-the-line” deductions.

The following deductions are “above-the-line” and will lower income-driven student loan payments:

• Health Savings Account Contributions
• Alimony Payments
• One-half of Self-Employment Taxes
• Student Loan Interest

Deductions that do not lower student loan payments include the following:

• Charitable Contributions
• Mortgage Interest
• State and Local Taxes

Taking Advantage of Lower Payments for Tax Breaks

Before getting too excited about the opportunities for lower student loan payments, it is worth remembering that debt elimination is the goal of all borrowers. Lower monthly payments are nice, but they also mean spending more on interest in the long run.

The people chasing after student loan forgiveness will benefit the most from using retirement contributions to lower payments. If you are on your way to Public Service Loan Forgiveness, putting money in the correct retirement account means lower monthly payments, a reduced tax bill, more money saved for retirement, and more student debt forgiven.

Even if forgiveness isn’t on the horizon, the lower payment is still helpful. If you have a reduced federal student loan bill, it means you can focus your efforts on attacking your high-interest private loans or saving for a home down payment.

An Example with Actual Numbers

Suppose I make $60,000 per year working for the government.

I have a lot of federal student debt, so I enroll in an income-driven repayment plan. If I choose the SAVE plan, my monthly payments will be $226 per month, according to the SAVE Payment Calculator.

I realize that I need to be saving more for retirement, so I have my employer start withholding $200 per paycheck for my retirement. Taxes vary from state to state, but for this discussion, let’s assume my $200 contribution per paycheck lowers my take-home pay by $150. After a full year, I will have set aside $5,200 for my retirement.

That retirement contribution lowers my AGI by $5,200. According to the loan simulator, the lower AGI reduces my monthly payment to $183 per month. If I’m working for an employer eligible for PSLF, the lower payments would mean more debt forgiven after ten years.

In the months I receive two paychecks, I will have set aside $400 for retirement, spent $43 less on my student loans, and only lost out on approximately $300 worth of take-home pay.

To recap, by setting aside money for retirement, I’ve accomplished the following:

• Lowered my monthly student loan payment,
• Increased the money set aside for my future,
• Lowered my tax bill, and
• Increased the amount of debt that can be forgiven.

Long-Term Benefits: This approach has significant long-term benefits. The $200 set aside each paycheck can reasonably be expected to grow as time passes. Your original contributions may have grown considerably by the time you reach retirement age, depending upon your investment strategy. A hidden advantage to this approach is that borrowers get an early start on interest working for them instead of against them.

Clearly, some sacrifice is required to utilize the connection between retirement, payments, and forgiveness. However, for the borrowers who can forgo a bit of income today, the future benefits are pretty significant.

Why this is my Favorite Student Loan Hack?

For many student loan borrowers, retirement is a problem for the future. Student loans are the crisis of the present.

Taking advantage of this hack requires setting money aside for retirement. I love the idea of saving for the future and making the present a little bit easier.

The post How 401(k) and 457 Retirement Plan Contributions Lower Student Loan Payments appeared first on The Student Loan Sherpa.