Student Loan Forgiveness
In our last post, we began the discussion on the federal student loan forgiveness programs in the US by explaining briefly how they work and posed a few questions for consideration.  All that information is essential to make sense of what we are going to cover in this article.  So hop back over there to get caught up before going any further.

Is Forgiveness Free?

The burning question that actually got me curious enough to embark on this research on student loan forgiveness was, “Just how much money does it save?”  After all, with my Christian background, the notion of debt “forgiveness” gives the impression that grace and mercy is applied to wipe all of my financial “sins” away!  Why wouldn’t anyone want the ball and chain of their student loans cast into the depths of the sea?

Alas, the unfortunate reality is that the government’s definition of “forgiveness” isn’t quite as free as what God promises in the Bible.  (And I suspect that even the most hardened unbeliever would prefer the Bible’s definition in such circumstances!)  If you think Uncle Sam is handing out freebies to poor forlorn college students, think again.  We need to crunch some numbers to see what’s the catch.

What Saith The Numbers?

To get a quick survey of the lay of the land, we’re going to look at a couple of scenarios that I ran through the government’s student loan repayment calculator. Besides the assumptions that they used (which you can read about on their site), here are the constants that I am using in each of the following examples:

  • Tax filing status: Single
  • Adjusted Gross Income: $40,000
  • Family Size: 1
  • Interest Rate: 7%
  • State of Residence: Tennessee (just because that’s where I am)

So in other words, the ONLY variable that we will be playing with is the total loan amount. I realize that I’m making a bunch of arbitrary assumptions just to come up with a little fuzzy math, but the point is to go through the motions of what you could do for your own situation.  Don’t take this as gospel, but simply an example for comparative purposes.  Naturally, your variables will be unique so hop over to the calculator to give your specific numbers a spin.

And bear in mind, this only applies to qualified FEDERAL student loans.  Private loans and certain types of government loans do not qualify for forgiveness at all.

A couple of other tidbits before we dive in:

  • We will only focus on four types of repayment plans in the tables below as they will adequately illustrate the main points. You can investigate the many other repayment plans using the Federal Student Loan Calculator on their site if you are interested.
  • The “Crumb Saver” repayment plan is our own creation where 50% of earnings are applied to the loan. This is essentially what we would do if we had student loans. I used this Bankrate Student Loan calculator for my numbers. For simplicity’s sake and to keep assumptions conservative, I am NOT factoring in regular increases to income like in the government’s calculations. So I’m assuming that this person is only paying $20,000 toward the loan each year with no increases throughout the course of the repayment period.
  • The “Standard” repayment plan is a 10-year plan with fixed monthly payments. No loan forgiveness is available. This is what you would call a “regular old student loan”.
  • “Income-based Repayment (IBR)” applies to borrowers with loans originating before July 1, 2014. Payments are 15% of discretionary income with loan forgiveness after 25 years.
  • “IBR for New Borrowers” applies to borrowers with loans originating after July 1, 2014. Payments are 10% of discretionary income with loan forgiveness after 20 years.

Scenario 1: $40,000 Loan

The average debt load of an undergraduate student graduating in 2016 is $37,172 so I’m rounding up to $40,000 just to make it easier to calculate. Here’s our first set of numbers:

Repayment Plan First Monthly Payment Last Monthly Payment Total Amount Paid Projected Loan Forgiveness Repayment Period
Crumb Saver (50%) $1,667 $1,667 $43,217 $0 26 months
Standard (10-yr) $464 $464 $55,732 $0 120 months
Income-Based Repayment (IBR) $277 $464 $64,733 $0 162 months
IBR for New Borrowers $185 $464 $82,806 $628 240 months
  • Immediately you should see that in nearly every circumstance, despite any slower payment schedules, the loan amount of $40,000 will be fully paid off before any forgiveness kicks in. This will be the case whenever income is high relative to the loan amount.
  • Even in the plan that has any debt left to forgive, the amount ($628) is so miniscule that it’s pointless.
  • Significantly, you will see that in both IBR plans, the borrower ends up paying massively more in interest than either Standard or Crumb Saver plans.
  • In the Crumb Saver plan, by tightening the belt to pay 50% into the loan, this student can be debt-free in two years and pay only $3200 in interest.
  • To put it into perspective, the Crumb Saver plan saves $40,000 compared to the IBR for New Borrowers plan (the one with lowest monthly payments) AND results in cutting short the loan by nearly 18 years.
  • As icing on the cake, should this extra $40,000 be invested at a conservative 5% (much lower than the 7% interest the loan is charging), it would grow to be nearly $100,000 in 18 years!
  • I hope this is adequate to prove that if your annual income is the same or close to your debt total, loan forgiveness isn’t a viable option.

Scenario 2: $80,000 Loan

Let’s up the ante a little bit. Suppose this same individual has double the amount of debt but still only earns $40,000 per year. How does this change the picture? Let’s take a look.

Repayment Plan First Monthly Payment Last Monthly Payment Total Amount Paid Projected Loan Forgiveness Repayment Period
Crumb Saver (50%) $1,667 $1,667 $94,131 $0 57 months
Standard (10-yr) $929 $929 $111,464 $0 120 months
Income-Based Repayment (IBR) $277 $929 $187,288 $14,951 300 months
IBR for New Borrowers $185 $612 $87,704 $104,296 240 months
  • At first glance it may look like the IBR for New Borrowers is saving loads of money because not only is the total amount paid lower than even the Crumb Saver Plan, but over $104,000 is also forgiven on top of that!
  • But you must remember that the amount forgiven is TAXABLE INCOME! So you must factor in the tax bill you’ll be facing from having an extraordinary bonus of $104,000. Using an estimated tax rate of 20% (who knows what they will be in 20 years?), this is an additional $20,800 paid in taxes, which bumps your ACTUAL total amount paid to around $108,500—well over the total amount paid in the Crumb Saver plan.
  • Not to mention, in the Crumb Saver plan, you would be completely debt-free in under 5 years allowing you over 15 years to save and invest the surplus.
  • In case you were wondering what that might look like, an estimated $14,300 surplus invested for 15 years at 5% could potentially grow to be as much as $30,000.

Scenario 3: $120,000 Loan

Let’s get crazy and say that this poor chap has student loans three times as much as his annual income. Surely, this guy is in need of some serious loan forgiveness, right?

Repayment Plan First Monthly Payment Last Monthly Payment Total Amount Paid Projected Loan Forgiveness Repayment Period
Crumb Saver (50%) $1,667 $1,667 $156,071 $0 94 months
Standard (10-yr) $1,393 $1,393 $167,196 $0 120 months
Income-Based Repayment (IBR) $277 $1,224 $197,254 $132,746 300 months
IBR for New Borrowers $185 $612 $87,704 $200,296 240 months
  • You immediately notice that, amazingly, the total amount paid for the IBR for New Borrowers is the same as the previous example only now there’s a huge sum of over $200,000 that’s forgiven.
  • An increase of $200,000 in taxable income will launch this guy up several tax brackets but we’ll keep him at a 25% tax rate for just over $50,000 in taxes owed.
  • So the actual total amount paid in this plan is about $138,000, and it is $18,000 less than what’s paid in the Crumb Saver plan. So while there does seem to be real savings in the IBR for New Borrower plan, it’s still important to ask whether the other costs are worth $18,000.
  • The Crumb Saver plan would have you debt free after 8 years instead of 20—how much is 12 extra years of freedom worth to you? Besides, if you got raises (which we didn’t factor into our assumptions) in those 8 years and increased your payments, you would be both saving on interest and speeding up the payoff, diminishing the benefit of the debt forgiveness.
  • Whereas if you got significant raises during the 20 years that you were on the IBR for New Borrowers plan, your payments would proportionately increase also. However, that would increase your total amount paid plus reduce the total forgiveness amount. Ironically, if you earn more in this scenario, you save less overall.
  • Besides, unless you have a very recent student loan (since July 1, 2014) you wouldn’t even qualify for this program. So by that fact alone, most of the people who this would even apply to are likely still in school where they’re not even thinking about paying things off yet. If you’ve already graduated and are in the thick of making loan payments at the time I’m writing this, unfortunately, that pretty much proves that you don’t qualify. Sorry.
  • Oh yeah, and don’t forget you’re going to have to scrounge up $50,000 somehow to pay that tax bill at the end of this journey. Hope you’ve been saving up somewhere because otherwise, you’ll just have to borrow again to make that payment!

Some Additional Thoughts

  • In none of the scenarios did the old IBR plan (for those with loans older than July 1, 2014) do better than the Standard or Crumb Saver plans. Monthly payments were definitely lower, but the total amount paid was consistently higher in the end. Certainly not acceptable to any self-respecting Crumb Saver.
  • The only plan that might even be of consideration is the IBR for New Borrower plan, and it only applies to those who have loans since July 1, 2014.
  • Even then, it only truly saves money when the amount owed is vastly more in relation to annual income. (The amount owed will need to be at least three times greater than annual income before it even starts to make sense.)
  • If that’s the case, it begs the question of why your expensive education is earning you hardly any money. It would seem likely that there’s some other issues at play, if this is the case.
  • The more you earn relative to what you owe, the worse the debt forgiveness plan is for you. Which may not sound like a big deal, but…
  • What about incentive? If an individual in an IBR plan realizes that by earning more money, their loan payments will also increase—perhaps even to the point where they lose any benefit from debt forgiveness down the line—what do you think that would do for motivation to work harder and to get ahead? Honestly, why would I want to work for more when it actually results in me receiving less? And if I’m led to think this way, isn’t it contrary to why I went to get an education in the first place?

What About Public Service Loan Forgiveness?

As referenced briefly in our previous post, there is a special program that has a 10-year forgiveness schedule where the forgiven amount isn’t taxed as income. It requires employment over the full 120-month period in a public service capacity or with a qualified nonprofit organization. I think this may be the only scenario where the numbers could work vastly in favor of the borrower. There are cases of highly educated people working for very little in these settings for the greater good. Nevertheless, there are still a few questions to consider:

  • Would you be content being locked into those qualified fields for the duration of the 10 years? For many, they’re truly fulfilling their calling to work in these areas but it would be a shame to get into it for the debt forgiveness only to feel trapped when you want a change.
  • How comfortable are you being locked into 10 years of debt? This is something only you can answer, but remember that the borrower is still a slave to the lender even when they are working in public service.

Update 5/21/2017: Some new information about this Public Service Loan Forgiveness program makes me retract what I said here about it being a valid option.  Hop over to this post where we give this program a second look.

There’s a Better Way

I recognize that there can be unique situations out there for which one of the debt forgiveness programs would be beneficial. I’m sure they can help someone. I just hope to dispel the notion that student loan forgiveness is a get-out-of-jail-free card that magically erases student loan debt for everyone.

In case you haven’t picked up by now, I believe that for most people, there’s a better way than counting on student loan forgiveness. Do it the old fashioned way: change your attitude toward debt, learn to work hard, manage your lifestyle to be well within your means, save your crumbs, make big chunky payments, and pay that hairy beast off as fast as possible. You’ll save a huge amount of interest that way, you’ll develop this thing called self-discipline, you’ll massively reduce your stress, you’ll avoid being hitched up with Uncle Sam for decades, and most important of all, you’ll be free.

Oh, and you won’t be a moocher.

I know the numbers I ran are very general and won’t apply to every situation.  What did I miss? Are there other considerations that need to be factored in to this discussion?  Tell us what you think!

Here are other articles in this series on student loan forgiveness: