CHAPTER FOUR

PAYBACK TIME

My wife Heather is the perfect illustration of the student loan crisis.

You may want to sit down for this.

As of January 2017, Heather had $211,694.20 in student debt. That’s right; Heather is the Millennial Problem and she wants you to know it. Before passing judgment (and wondering how she married a financial advisor), let’s examine how she got there.

Heather and I met during freshman year at the University of Florida. Aesthetically speaking, we were opposites: I, a clean-shave-and-polo-type guy from sunny South Florida, and she, a Birkenstocks-and-tie-dye-type girl from the Philadelphia area. Heather inherited approximately $120,000 from her late grandfather to fund her college education. She knew that this generous gift could cover her entire education at a public university, or part of her education at a private college. She chose the more conservative route, hoping to have money left over at graduation to build her adult life.

Heather became a state resident of Florida and saved tons of money on tuition. She lived comfortably, but not extravagantly (her 1998 Nissan Altima, named Thomas The Engine That Can’t, had a duct-taped front headlight and couldn’t exceed 60 mph without shaking like a scared little boy). To complete her bachelor’s degree in journalism, she didn’t borrow any money and graduated debt free, with a few dollars to spare.

As the only child of divorced parents, Heather’s main goal after college was to make enough money to become financially independent. She didn’t want to rely on anyone and looked forward to being an “adult,” for whatever that meant. This caused her great angst because she wanted to become a journalist, but was worried it wouldn’t get her there fast enough. Doing what she thought was a safer bet for her future, she took the LSAT and applied to law schools around the country. Heather has always been uber-competitive, so the list included many expensive private institutions. When the thick envelopes came in, the one she fell in love with happened to be in New York City.

She was ecstatic, but terrified. She knew that the cost of tuition at this law school, as well as the living expenses, would be higher than anywhere else; it was unlike anything she had ever dealt with before. So, when they went to visit the school, Heather and my father-in-law sought additional guidance. They sat down with the school’s financial aid officer to review costs and determine whether attending seemed like the right move. The aid officer was quick to reassure Heather and her dad that financing would be available for the total cost of attendance, including anticipated living expenses. She showed them how much that would be. The financial aid officer then provided them with data on the starting salaries for graduates pursuing private legal practice. The numbers were well into six figures—more money than Heather ever imagined making at her first job. A summer associate gig at a big law firm would almost certainly cover at least one year’s tuition, and she would have the rest of the loans paid off in no time.

The proposition seemed very risky. But through her whole life, Heather had risen to challenges, competed, and won. Borrowing money to jumpstart a high-paying legal career seemed like nothing more than an aggressive investment. Sure, she wasn’t used to playing such a wild hand, but if not then, when?

That was in 2007. Heather’s law school class was scheduled to take part in on-campus recruiting with dozens of employers in August and September of 2008, right when the markets crashed. Suddenly, summer associate classes diminished in size or were cancelled altogether. Public service offices froze their budgets. The Career Services department was paralyzed. No one was getting a job.

Thankfully, Heather was very good at writing law school exams and at being interviewed. She graduated with honors, and with the little chance she had, managed to be one of a fraction of the class to graduate with full-time employment. The job paid $81,000, far less than those on the financial aid office’s idealistic data sheet. Her bi-weekly salary couldn’t even cover the interest that was accruing on her loans. Forget about living expenses. This was New York City, after all.

So began her saga of many years: chasing salaries to stay afloat, diminishing her true passions in life, and failing to acknowledge why she went to law school in the first place—a question she only now can answer in earnest, the way she did earlier—all while making payments of $1,775.43 per month for the next 30 years.

The whole recession thing didn’t help, either.

Heather’s tale is a cautionary one, but let it be known that I am not someone who thinks all loans are bad. That would be ridiculous. Utilizing credit and incurring debt greases the economic wheel. Banking systems worldwide take on debt to keep their engines running. Businesses use credit to facilitate and expand their operations while individuals, like you and me, rely on loans for financing major purchases like homes, vehicles, and of course, higher education.

Did Heather make a huge mistake? It’s not as simple as saying “Hell yeah, she did.” Had she understood the consequences of her actions at the outset and coupled them with the emotional honesty to answer whether the degree was truly worth that risk, she could have made a more calculated financial decision. And we both would have avoided many sad nights and hard conversations.

When it comes to debt, I often see two types of people.

I like to compare these people to two types of birds. There are the eagles, who are too proud to bear the burden of their debt, and willing to throw every available dollar at their liability, even if it means extreme sacrifice. How noble! Then there are the ostriches, those who stick their heads deep into the dirt, burying their reality in hopes that it will all just go away. For them, it never will.

This chapter will show you what I showed Heather: that you don’t need to be an eagle or an ostrich. Both birds represent extremes, and extremes don’t fit comfortably into anyone’s life. I will provide you with a way to think about student loan repayment in a manner that coincides with your specific financial needs, so that you can increase your chances of reaching your goals without going to extremes.

Let’s fly. Caacawww!

GETTING ORGANIZED

Before you dive into understanding your student loans, you must get organized. This way, you can view your debt situation in its entirety. I understand that some of you might be coming off a four-year bender and have misplaced those loan confirmation documents. Not to worry; they won’t forget about you.

Either just after you’ve graduated or when you are finishing your final credit hours, you will start receiving notifications about your initial loan payments coming due. These notifications are often replete with confusing gibberish and lots of numbers.

You will want to review the outstanding balance of each loan and separate which loans are federal and which are private. Then, learn the interest rate associated with each loan, the repayment term of each loan, and the monthly payment for each loan. Creating a table like this helps:

Federal loan borrowers might receive notification that their loans are being sent off to a different service provider. This confuses matters more. Since Heather graduated from law school, her federal student loans changed providers twice, the second time more effortlessly than the first. If you cannot locate your federal student loans or who is currently servicing them, you can view all the information relating to them in a central database, the National Student Loan Data System.¹ Create an online account and everything should be there. After creating an online account, you will be able to view all your federal student loans and the details of each of them. If you are a private borrower, you will still need to know which financial institution issued your loan. But again, chances are they won’t forget about you. Ever.

You will have, at most, a six-month grace period on certain loans from the time you graduate to make your first payment, unless you seek an extension. From the moment you formally enter repayment, you are on the hook for servicing the accruing interest and eventually chipping away at the original principal.

We are going to focus primarily on repaying federal student loans. For one, this is because you have more opportunities to make strategic decisions regarding these loans. The federal student loans provide the most flexible repayment options to choose from, which include opportunities for loan forgiveness and forbearance, should you qualify or endure financial hardship. Private loans, on the other hand, are generally less flexible and are often only taken out after your options in federal loans have been exhausted.

I highly recommend that after reading this chapter, you visit the U.S. Department of Education’s Website for Federal Student Aid as an additional resource. I have to admit, the federal government provides a hell of a lot more clear and useful information on this Website now than they did years ago when my and Heather’s loans went into repayment. For that, the “swamp” in Washington gets a very small golf clap.

But keep that applause light. Even if the online information has gotten better, servicing your loans may prove troublesome, even frustrating at times, given the inexperienced folks hired to help you navigate this twisted world of numbers and interest rates. As just one fun example, Heather had great difficulty setting up the “auto debit” feature with one of her loan service providers, which resulted in the provider debiting her bank account several days after the due date. When she called (and waited, and waited), no one could advise her whether this late payment resulted in additional interest being passed along to her, even though the late payment was not her fault. She asked for an amortization schedule, and they not only couldn’t provide one, but they didn’t even know what it was. Heather and I may take perverse joy in yelling at the cable company, but this kind of incompetence is too personal and expensive to laugh about.

The point here is not to bash anyone. If anything, Heather and I have had increasingly better service during the past several years since that happened. Our takeaway is that the folks on the other end of the phone line or computer aren’t financial professionals. Some of them don’t fully understand the options they are reciting back to you, let alone, understand them well enough to suggest which one is best for your life. You need to take that on yourself.

Speaking of “amortization,” this refers to the repayment of a loan’s principal through time. An amortization schedule illustrates, during a set period, how much of each loan payment you make goes to principal (what you originally borrowed) and how much goes to interest (what you are periodically being charged to borrow that money).

There are two main repayment lessons that you learn from the concept of amortization. First, at the beginning of repaying a loan, most of each payment consists of interest, and toward the end of repaying a loan, most of each payment consists of principal. Second, recall that even though you may have received the principal years earlier, the money is still “borrowed” until you pay it back. Therefore, the longer the term of a loan, the more interest you pay during the life on that loan. This concept is crucial to determining which repayment plan is right for you because there is a tradeoff between using longer repayment plans—therefore having lower monthly payments—and how much more money in interest you will pay during the life of the loan.

THE REPAYMENT PLANS

Before evaluating which payment plan is right for your situation, you must understand what they specifically offer, as well as their benefits and liabilities. For a complete overview of all Direct Loans and Federal Family Education Loan (“FFEL”) repayment plans, visit that same Department of Education Website I mentioned earlier. But in short, here are the four main types of federal loan repayment plans you will encounter:

Standard Repayment: This is the default repayment plan for almost all federal student loans. Your monthly payments are fixed at a certain amount for up to 10 years (or up to 30 years if you consolidated your loans, as will be discussed later). Because of amortization, you will pay the least amount through time if you choose this option.

Graduated Repayment: This plan, also available for almost all federal student loans, starts payments lower than the standard repayment plan and increases usually every two years. It is designed to create less of a financial burden in your early working years and escalate as your income grows. Payments are fixed during each two-year graded period up to 10 years (and up to 30 years for consolidated loans). Again, because of that whole amortization thing, you will pay more through time than the standard repayment plan.

Extended Repayment: This plan is available for almost all federal student loans with balances of $30,000 or more. You can repay under either a fixed or graded schedule, lasting for a term of up to 25 years. Outside of income-driven repayment plans and 30-year repayment plans for consolidated loans, it provides the borrower with the most flexibility due to its smaller monthly payments. But in turn, you will pay even more with time than the standard or graduated repayment plans.

Income-Driven Repayment: If you qualify for them, these plans allow for even lower monthly payments, which are based on a percentage of your discretionary income—anywhere from 10 to 20 percent. Income-driven repayment plans can generally be used on Direct Loans, except for Parent PLUS Loans and Unsubsidized Consolidated Loans that had consolidated a Parent PLUS Loan.

Monthly payments may be lower than the other repayment plans above, so if you absolutely need to make small payments, this is your best option. But sometimes, your monthly payments under these plans are so small that they won’t even cover the interest accruing on your loans each month. This is known as “negative amortization” and will cause your loans to grow, having you pay even more interest with time. Therefore, it’s important to only use these plans after careful planning; otherwise, they will do more harm than good for you.

CONSOLIDATION

Consolidating your debt has its benefits. For one, it can make the debt easier to manage. The federal government makes consolidating fairly easy for its student loan borrowers through its Federal Consolidation Loans.²

If you borrowed money each semester, you will see that a new loan was created each and every time. So, if you borrowed money to pay for four years of undergraduate coursework in traditional semesters, you could have eight separate loans to manage, and that’s assuming you borrowed only Subsidized Direct Loans. If you also borrowed Unsubsidized Direct Loans on top of those Subsidized Loans, you could have as many as 16 separate loans.

A Federal Consolidation Loan would aggregate your loans by each type of loan (Subsidized versus Unsubsidized, including PLUS Loans) into larger ones with an interest rate equal to the weighted average of all the loans in that category. They do not lower your interest rates; they simply blend the rates of all your federal loans together into their weighted average.

For example, if you had an outstanding Subsidized Loan of $10,000 at a rate of 5 percent and another for $10,000 at a rate of 7 percent, you would end up with one $20,000 Subsidized Consolidated Loan at 6 percent.

Lastly, Federal Consolidation Loans allow borrowers of FFEL loans (that’s you, older Millennials) to utilize those income-driven repayment plans that would otherwise not be available. Basically, if you want to take advantage of the federal government’s assistance, you need to do it on their terms.

One reason to refrain from federal consolidation would be that if you have loans with varying interest rates, you would lose the ability to pay off the loans with the highest rates first. For example, if you keep your loans separate, you could pay the $10,000 Subsidized Loan with the 7 percent interest rate first, thereby saving money, because that loan charges more than the other. Note that this strategy assumes you are at least making payments that cover the interest on all of them.

In addition to Federal Consolidation Loans, there are also private consolidation loans available through financial institutions such as banks and the increasingly popular financial technology companies. All consolidation is technically a form of refinancing. But private consolidation loans can offer the chance to actually lower the interest rate of your loan(s) based on your creditworthiness and financial fitness.

Depending on the rate assigned and term chosen, consolidating your loans privately could result in substantial savings in interest, lower monthly payments, or both. However, you will probably lose the flexibility that federal loans afford; namely, the income-driven plans and the ability to change from one repayment plan to another at any time. Before consolidating with a private lender, you must assess how comfortable you are with losing this flexibility and locking yourself into the set terms of a private loan.

But with confidence in your ability to meet your monthly obligation, private consolidation loans can dramatically improve your student debt situation. I took the plunge and refinanced my student debt with a bank’s private consolidation loan, bringing my interest rate from 6.67 percent on a standard 30-year repayment plan, to 3.5 percent on a new 15-year consolidated loan. For a few dollars more each month, I sliced the term in half, saving more than $120,000 in interest during the life of my loan. For reasons including my good credit and earning potential, a bank was willing to bet on me. All in all, it was a match made in repayment heaven.

LOAN FORGIVENESS: WHAT ARE THE CHANCES?

I want to address the mysterious concept of student loan forgiveness. You can achieve this Holy Grail of Loan Disappearance by committing to an income-driven repayment plan for many years, or to a career in public service for less (but still many) years.

With income-driven repayment plans, you must re-qualify each and every year. To do this, you must furnish your federal loan service provider with proof of income, typically in the form of your most recent tax return.

You ostriches out there: these programs are not an opportunity for you to pay as little as possible, continuing to bury your head in the sand, hoping your loans will go away in 20 to 25 years. You are only doing yourself a lifetime of disservice by limiting yourself this way. What if, a decade from now, you are offered your dream job, and it pays so much that you no longer qualify for the plan? Your interest has ballooned on top of the principal from you coasting on your low payments for so long. See, these plans are specifically designed to provide you with maximum flexibility so that you can focus and work harder on increasing your income, afford a different repayment plan, and eventually pay your loans in full. They’re not an opportunity to game the system.

You will also have a giant tax bill waiting for you at the end of the road. The amount of debt discharged is taxable as income during the year that it’s forgiven. This could literally leave you with a six-figure tax bill. I’m guessing that from all the years you’ve suppressed your earning potential to game an income-based repayment plan, you don’t have that kind of cash lying around. Now you’re in it with the IRS for six-figures plus. This is the last place you want to be. Trust me. I’d rather owe money to a loan shark than those guys.

For those who’ve chosen to pursue public service, there’s student-loan forgiveness for you, too. After 10 years of service in a public role (it doesn’t have to be consecutive), your student loan debt is forgiven without a tax bill waiting for you on the forgiven balance. This type of forgiveness incentivizes you and honors the fact that you are a public servant, committed to doing good for your government or community. Now, I admire anyone who chooses to dedicate a decade of his or her career to the greater good. But be emotionally honest about your goals, and keep in mind that if you are neck-deep into this commitment, you might need to turn down a potentially attractive private gig.

I also want you to recognize that all these forgiveness programs are here today, but no one can promise they are here to stay. In fact, under the current administration, it’s looking more each day like they won’t be. A little bit of skepticism would do every Millennial some good, given what we’ve seen.

WHAT DO I DO?

Well, it depends on your individual situation. Just because you can pay a standard 10-year repayment plan doesn’t mean you should. And just because you can extend your payments out longer or qualify for an income-driven plan, doesn’t mean you should do that, either.

What you should do is revisit your goal priorities. Longer-term repayment plans can provide you with the flexibility you may need at this moment to support yourself or put more money toward other goals. But these plans must be used with caution because you will be paying more interest through the life of the loan. Nothing is free and you will pay to tap into this type of flexibility. Only you can determine if that’s okay.

Upon graduating law school, Heather had no choice but to participate in an income-based repayment plan while working her first job. She could not have afforded the standard monthly repayment otherwise. When she stepped up to a higher-paying job, she continued with the income-based plan for a bit, but voluntarily made payments above her monthly amount when she could, covering the interest and a tiny bit of principal. At a time of great uncertainty with her career, she felt more comfortable keeping that flexibility as an option. It was a crutch in case things didn’t pan out as planned.

Now, Heather and I pay more than our interest and into the principal of all our student loans each month. Could we be eagles and pay much more? Sure. But to do that, we would have needed to sacrifice our home savings and our current lifestyle. We are being honest with ourselves. We’d rather own a home for our baby Hazel to grow up in and attack the remainder of our student debt later. That’s our choice to make, just like you get to choose what’s best for you. We fully understand the cost of this choice, and so must you if you plan on becoming financially independent.

Let me keep it real for a moment, though. Heather and I aren’t happy about carrying our fat load of debt around. We fantasize about having a windfall just large enough to pay it off; about how much farther our income would take us if it just all went away. But we’re not ostriches. Our decision on how to address this debt was a tough one to make, and our continued effort to pay it back is a constant fire under our asses. We will always feel a sense of urgency until the day it’s gone, even if we have found a way to live comfortably while it’s here.

Some call it guilt; some call it motivation. Just keep in mind that you are not necessarily seeking to owe nothing as much as you are seeking control over your cash flow in a manner that makes sense for you.