Every year, millions of Americans sign up to take higher education courses from post-secondary education institutions. However, most do not have the funds to pay for their education in cash and must therefore take out one or more loans to cover the cost of tuition and other fees. As a result, student loans have grown to a multi-billion dollar industry that provides tools for students of all economic backgrounds to pay for higher education and vocational training.
For many years, student loans have been offered through two main channels: direct loans through the Department of Education, or through Federal Family Education Loans (FFELP) offered by private lenders, such as banks. However, in the spring of 2010, President Obama signed the 2010 law on health and education for reconciliation (HR 4872). This law has imposed several important changes that have consolidated and simplified the student loan industry. As of 1 July 2010, the Department of Education has become the only institution able to offer loans to federal students and FFELP loans are no longer available.
Types of student loans
There are different types of student loans offered by various lenders. Their availability for students varies according to economic needs, credit scores and other factors.
The William T. Ford direct loan program is the largest loan program offered directly by the US government. The three main types of loans listed here fall within the jurisdiction of this program if they were released after 1 July 2010. In order to qualify for a loan under this program, borrowers must meet the following criteria:
- Be a US citizen or non-eligible citizen with a valid social security number
- Have a high school diploma or GED or have completed a qualified homeschool program
- Students must be enrolled (and making satisfactory academic progress) at least half time in a program that awards a diploma or certificate.
- Borrowers aged between 18 and 25 must be registered with the Selective Service
- It cannot be in default on a direct loan that is currently pending
- Potential borrowers with criminal convictions for drug or sexual offenses may face additional restrictions, even if otherwise suitable
Potential borrowers who meet these criteria may be eligible to receive one or more of the following types of loans:
- Federal Direct PLUS Loans . There are two types of Direct PLUS loans: one is designed for parents of dependent university students and the other is for graduate students. The loan for parents requires a credit check and may require an additional loan co-signer if the parents do not have good credit. Direct Plus loans offer a fixed interest rate (currently 7, 9%) and can only be used to cover the exceptional cost of school attendance which is not covered by other types of student loans or financial aid. The PLUS loans, therefore, differ from other types of student loans as they are based on the borrower’s credit rather than the financial requirement. However, debtors still need to complete and submit a FAFSA to qualify.
- Subsidized and unsubsidized loans . Previously known as Stafford loans when offered under the FFEL program, these loans come in two forms: subsidized and non-subsidized. Both types of loans are available for university students, but only those with financial needs can benefit from subsidized loans, while graduate students can only benefit from unsubsidised loans. Both loans impose a fixed rate and repayment must begin within six months of the termination of the courses unless a postponement or a tolerance is granted. The Department of Education pays the borrower’s interest on soft loans while the borrower is at school at least half time, for the first six months after graduation (a period known as the grace period) and during deferral. Non-employed borrowers, however, must pay all interest on their own loans – during school, grace periods and deferrals, interest accrues and is added to the loan balance. Because unsubsidized loans are not based on financial needs, they are often required by dependent students and parents who do not qualify to receive a PLUS loan. As with PLUS loans, debtors must present a FAFSA to qualify.
- Federal Direct Consolidation Loans . This type of loan is available to borrowers who have at least one direct loan or FFEL. Consolidating borrowers can substantially reduce their monthly payments by extending the repayment plan on all their loans. Consolidation can also renew the deferral privileges granted to previous loans. However, you could also lose the benefits associated with consolidating original loans. The interest rate applied is based on the weighted average of all the consolidated loans, which may be less than the rate that the borrower was paying before, if he or she consolidates one or more variable rate loans in a context of low interest rates . Borrowers can no longer consolidate loans to students who have school status, but are allowed to consolidate loans in a grace period, or in a state of repayment or deferral. Loans in the event of insolvency can also be consolidated once they have been rehabilitated.
Other types of loans
The qualification criteria for eligibility applicable to direct loans do not apply to the following types of loans:
- Perkins Loans . Unlike direct loans, the educational institution acts as a creditor for this type of loan. It is designed to assist low-income students with substantial financial needs and is available for both graduate and university students. The loans apply a fixed rate, and the repayment must begin within nine months of the termination of the course, regardless of whether a diploma has been obtained. Perkins specific differences and tolerances are available.
- Private loans . Sometimes referred to as alternative loans, private loans are neither issued, subsidized or processed by the US federal government. Rather, they are issued exclusively by private lenders in the corporate sector. They are available for both students and parents, and the reimbursement conditions can vary substantially. Their issuance is based on the borrower’s credit score and financial conditions, and they are an important source of funding for those who do not qualify for government loans or other assistance.
- Institutional loans . This type of loan resembles private loans as they are not issued or processed by the US government. They are instead issued directly by the school itself.
- State loans . These loans are offered through various state-sponsored programs, and while they are separated from subsidized federal loans, they may be able to offer better terms and conditions than private loans.
Tax rules for student loans
Deduction of interest paid
Taxpayers who make student loan payments are allowed to deduct the amount of interest they pay on their loans each year, provided that the proceeds of the loan have been used to pay for qualified higher education expenses. The amount of interest that can be deducted is the lesser of $ 2,500 or the full amount of interest paid, provided that the payer’s income does not exceed a certain amount.
Lenders who have received more than $ 600 in interest paid by the borrower must issue a 1098E form to the borrower showing the amount of interest paid. One of the key advantages of this deduction is that it is a deduction above the line, which means that tax payers do not have to detail the deductions to receive it.
Taxpayers requiring this deduction must meet the following criteria:
- They cannot be married and stored separately
- The loan must be a qualified loan
- The borrower must assume the legal obligation to repay the loan
- The borrower must have been enrolled as a student at least half time in a qualified diploma or certification program
- The borrower and his spouse cannot be admitted as dependent employees of another tax payer
- The amount of eligible interest that can be deducted begins to disappear when the adjusted adjusted gross income of the borrower exceeds a specific amount set annually by the IRS
Furthermore, the loan itself must be considered a qualified loan with the following characteristics:
- The loan must be used exclusively for the purpose of obtaining higher education
- The loan must be disbursed within a reasonable period of time by the borrower receiving the funds
- The loan cannot come from a relative of the borrower or a qualified plan
- The loan must be made directly to the borrower, the debtor’s spouse or a qualified or dependent child as defined by the IRS (there are some exceptions to the dependent rule as described in Pub. 970)
Higher education costs qualified
Publication IRS 970 also outlines what counts the IRS as qualified higher education expenses for the purpose of taking this deduction. They include:
- Tuition fees and fees, such as laboratory fees
- Textooks, supplies and other equipment
- Room and board (limited to the amount included by the educational institution for the cost of participation or the actual amount of living expenses charged to the student by the educational institution, such as the cost of a dormitory or a residence)
- Other expenses necessary to obtain the instruction, for example the cost of transport
Ineligible sources of income
Furthermore, qualified education expenses are reduced by the following sources of income. Only interest paid on loans used to cover qualified expenses that exceed payments from the following sources can be deducted:
- Withdrawals from educational savings accounts and vehicles, such as 529 plans, Coverdell ESAs, qualified teaching programs (QTP), and US Savings Bonds
- Scholarships and scholarships
- Educational assistance for veterans
- Any other payments received from tax-free sources other than a gift or inheritance
Federal direct loans offer various repayment programs that vary based on length and other criteria. Students can choose the program that best fits their budget and financial goals, although many of these programs require that they meet certain financial criteria.
The first three types of plans listed are available for all subsidized direct and non-subsidized loans and Stafford, as well as all PLUS loans, but not direct consolidation loans. None of these is available to Perkins, private, institutional or state-funded loans.
- Standard refund This plan has a 10-year limit and is provided with a higher monthly payment than other repayment options ($ 50 minimum). This plan is suitable for borrowers who can afford a higher payment and want to get their loans paid as soon as possible. Borrowers who opt for this payment plan pay less interest than other plans. Those with higher incomes often choose this plan to save money in the long run.
- Extended refund . Borrowers with more than $ 30,000 in direct loan debt who did not have an outstanding loan balance of any kind by October 7, 1998 are entitled to a prolonged repayment. The plan can last for a maximum of 25 years and payments can be fixed, which remain at a level throughout the duration of the loan or graduated, which are lower at the beginning and therefore increase every two years. This can be useful for borrowers who expect their incomes to increase over time. But they will pay more interest for the duration of the loan than the standard repayment option.
- Gradual refund . This plan resembles the standard plan as it has a 10-year limit, but has graduated payments like the extended plan, although there are further limits to how much the payments can increase. No payment under this plan can ever be more than three times the amount of any previous payment.
- Income based on income (IBR) . This program is available for direct and subsidized and non-subsidized Stafford loans, PLUS loans for students and consolidation loans. However, it is not available for parents who have a PLUS loan. Payments under this plan are usually (although not always) the lowest of any type of plan. The IBR plan is designed to assist borrowers with a partial financial difficulty. Calculate a monthly payment based on the debtor’s income and the number of dependents (but not the total amount due as per the income quota plan) and compare this payment with the one that would be paid according to the standard repayment plan. If the payment based on income and dependents is lower, then the borrower is deemed to have a partial financial difficulty and is admitted to the program. Once a borrower qualifies, payments amount to 15% of the borrower’s discretionary income, and he or she can stay on the plan regardless of whether or not partial financial distress continues. The plan also offers forgiveness of the loan after 25 years.
- Capital income . This program is available for subsidized and non-subsidized direct loans, PLUS loans for students and consolidation loans. However, it is not available for FFEL Loans, Stafford Loans, or for parents who have taken out a PLUS loan or for consolidation loans that have one of these types of loans in them. Borrowers who have financial difficulties (such as unemployment) can benefit from this plan, which calculates a monthly payment based on the debtor’s adjusted gross income (even the spouse’s income is included for married borrowers), the number of dependents and the total amount due. Monthly payments are recalculated each year and are the lesser of 20% of the borrower’s discretionary income or the amount the borrower would pay each month for a 12-year period multiplied by a percentage of the borrower’s annual income (which is zeroed annually ). If the calculated payment is not sufficient to cover the amount of interest accrued on the loan, then the interest is capitalized (added to the principal balance). However, the amount of capitalized unpaid interest cannot exceed 10% of the total loan balance. The plan can last up to 25 years and the remaining balance at that point is forgiven.
- Pay when you earn . This program is available for subsidized and non-subsidized direct loans, PLUS loans for students and consolidation loans. However, it is not available for FFEL or Stafford loans, nor for parents who have taken out a PLUS loan or for consolidation loans that have one of these types of loans in them. This is a new type of plan available from 2013 that allows the borrower to pay the lowest monthly payment of any type of plan. Borrowers must demonstrate a partial financial difficulty to qualify, and monthly payments are calculated each year based on the debtor’s discretionary income and family size, and forgiveness is available after 20 years.
- Sensitive Plan Income . This plan is only available for FFEL loans and cannot be used for any type of direct student loan. All types of FFEL loans are permitted, including subsidized and non-subsidized Stafford loans, PLUS loans and consolidation loans. It has a term of 10 years and monthly payments vary based on changes in the borrower’s annual income. Payments can also vary based on the particular formula used by the creditor.
Deferral, tolerance, forgiveness and cancellation
When it becomes difficult for borrowers to pay, there are alternatives that allow borrowers to stop making payments on their student loans either temporarily (or, in some cases, permanently) without default:
This is a temporary postponement of student loan payments. Suspensions prevent the accumulation of interest on direct federal subsidized loans (including Stafford loans) and Perkins loans, but interest is added to the principal balance for unsubsidised loans. Deferrals are available for full-time and full-time graduate students, or for those who are unemployed or meet the criteria for financial difficulties. Disabled students can also be qualified, as well as those who are called to perform an active service in the army.
This is a program where student loan payments are reduced or eliminated up to one year. It differs from a reference in such interest continues to accrue on the loan during this period. Availability is available for many students who do not qualify for a deferral.
Two types of tolerances are available: discretionary discretions are granted at the discretion of the lender in the event of qualified financial difficulties or illness, and obligatory subsidies must be guaranteed by the credit institutions in the following circumstances:
- The borrower is serving a medical or dental internship or residency and meets a specific list of related criteria
- The total amount of loan payments to the borrower’s students is at least 20% of the borrower’s monthly gross income (additional criteria also apply)
- The borrower is serving in a national service program, such as AmeriCorps or Senior Corps, for which the borrower received a national award
- The borrower works as a teacher in a capacity that qualifies him for the program to lose the loan for teachers
- The borrower qualifies for partial repayment of the loan as part of the Department of Defense sponsored student loan repayment program
- The borrower is a member of the National Guard who is activated to serve by the governor and has no right to defer the military loan
Forgiveness is a condition under which the borrower is released from the obligation to make further payments on a student loan. Borrowers who obtain approval for the pardon of their remaining student loans will receive a 1099-C form from the lender declaring the exact amount of the debt that has been forgiven, and must declare this amount as taxable income. Check the IRS website for details.
There are a couple of cases where some or all of a borrower’s student loans can be forgiven:
1. To forgive public employees
In 2007, Congress made careers in public service more attractive to graduates by establishing a program that can forgive a portion of their loan balances when certain conditions are met. Anyone with student loans who accepts one of the following types of work is eligible for this program:
- Those who hold a position in a federal, state or local government
- Employees of an organization 501 (c) 3
- Private non-profit employers who provide some form of public assistance, such as health, safety, education or law enforcement
Partisan organizations, as political entities and trade unions, do not qualify and religious organizations are also excluded. The type of job or position one has with a qualified organization is irrelevant, provided that the employer considers a full-time position and that the employee of the borrower works at least 30 hours a week. Educational workers must be contracted to work at least eight months a year.
Borrowers making 120 full-time payments while working in a qualifying job are entitled to receive the rest of the lost student loan balances, regardless of their income level. Payments must also be made on the basis of a qualifying repayment plan, such as a standard repayment or income repayment plan, but only direct loans are eligible for this program: private loans, Perkins and FFEL are not eligible. However, borrowers can consolidate their Perkins and FFEL loans into direct loans, but their 120 payment plans will not start until after consolidation. Once these conditions are met, debtors can apply for a loan with FedLoan Servicing.
2. To forgive the teachers
Educators who teach low-income elementary or secondary schools for five consecutive years and meet certain other criteria can request to get up to $ 17,500 of their forgiven loans. This program forgives both subsidized and unsubsidized loans, as well as Perkins loans (provided they meet certain criteria), but not PLUS loans.
Cancellation is also called “discharge”. When a loan is canceled, it has the same effect as forgiveness, with the difference that the amount of the forgiven debt is not reported in Form 1099-C as ordinary income to the borrower.
The cases in which student loans can be canceled include:
1. Cancellation for qualified educators
Teachers can cancel their Perkins loans if they teach in low-income qualified primary or secondary schools or teach certain subjects, such as special education, math, science, foreign languages or any other topic that the status of the teacher classifies as a lack of teachers.
2. Institutional cancellation
Borrowers who attend a school that closes for any reason before the borrower can graduate can benefit from the forgiven loan, as well as those whose loans have been falsely certified by the school itself or for identity theft. Borrowers who have left the school and who have not been paid the reimbursement to which they are rightly entitled can also be admitted.
However, the loans cannot be forgiven because a student does not graduate, is simply dissatisfied with the institution, or is unable to find work in his chosen field. Institutional cancellations are also not available for Perkins loans.
3. Death, disability and bankruptcy
Borrowers can cancel their student loans if they meet the conditions of being permanently and totally disabled. For this a medical certification is required and several other conditions must be met. The loans are forgiven for borrowers who died upon receipt of a certified copy of a death certificate. Borrowers who file for bankruptcy can only lose their loans if they can provide concrete evidence that convinces the judge that paying the loan will cause them excessive financial difficulties. However, this is generally very difficult to do, and most borrowers do not get student loan debt downloaded in any kind of bankruptcy.
When you set the student loan by default
Despite the numerous programs and forms of help for payments available, a growing number of borrowers are still completely unable to make payments. The average student loan debt ranges from $ 12,000 to $ 23,000, and the New York Fed estimates that about 11% of all borrowers are now over 90 days back in making their payments, which is a higher percentage of delinquency with respect to credit card debt.
The Department of Education has therefore created a predefined resolution group dedicated to helping delinquent borrowers to get involved in their loans. Borrowers in default who wish to rehabilitate their loans can now reach an agreement with the Default Resolution Group to pay a specific amount that will bring the loan back into “current” status. The borrower must pay this amount in the form of nine separate payments for a period of 10 months, and the payments must be made voluntarily by the borrower within 20 days of the due date. Mandatory payments made by seizure or other types of seizure do not qualify.
If all else fails, the Department of Education has powers that rival those of the IRS when it comes to collections. They can eventually garnish the payroll of unpaid borrowers, as well as seize income tax repayments. And while it is possible in extreme cases to obtain delinquent student loan loans, this is not an option for most defaulting borrowers. The Department also works with a large network of collection agencies in an attempt to contact delinquent borrowers and collect back payments from them. Borrowers who face default risk should think carefully about the consequences before they stop making loan payments.