In this post, I am talk about student debt as it one of the pressing issues for millennials and Gen Z. Student debt is the second worst as the interest rate is anywhere typically between 3-8%. However, as I mentioned in my post about the water not being fine, this monster is growing exponentially. It is only a matter of time before it become public enemy No. 1. In fact, Bernie Sanders made cancellation of student debt a key theme in his 2020 presidential campaign, although it did not really take off.
For Americans, student debt cannot be discharged in Chapter 7 or Chapter 13 bankruptcy unless you can prove undue hardship in courts (almost impossible to do). For Canadians, student debt can be discharged in bankruptcy after seven or more years from the date you ceased studies. So, as of the time of this post, there is no get-out-of-jail free card.
Americans
If there was one way to describe the American student loan system, it would be “wrecked”. As a Canadian, I am glad I did not have to go through that pain! I truly empathize with what students in the US have to go through. The system is a mixed bag between government loans and private loans. Both of these have to paid back with interest although the rates charged on the private loans are much higher. Private lenders, despite charging higher interest, are still afforded the same privileges as the government. Talk about predatory lending, anyone??
The Student Aid website by the Department of Education provides details on the different types of repayment plans for student loans. It is important to understand them fully because each type of repayment plan has eligibility requirements based on what type of loan you have. You can also use the loan simulator to see what you will owe with each plan.
The single biggest issue I see with these programs is that it simply provides you with an opportunity to kick the can down the road. However, the more you delay, the more interest expense keeps building up. If you adopted the rich mindset, then your brain must flashing red signals by now! Furthermore, the hideousness of the system is exposed when you reach the end of the road (20-25 years depending on which type of program you are under). At that point, the loan is written off and added as taxable income. Nothing changes for you but the Department of Education gets to transfer its liabilities to the IRS. And as you know, the tax-man has a lot of leeway in recouping what you owe them.
What about forgiveness?
When it comes to loan forgiveness, some options that you have are:
1. Public Service Loan Forgiveness (PSLF). This program was introduced in 2007 to encourage graduates to make themselves available for public service and non-profit, which generally pay less than private employers. After 10 years of full-time work with a qualifying employer and having made qualifying payments under a qualifying plan, your remaining loan is completely gone. If that is something that applies to you, then do take the time to read this article on how the PSLF works.
Full disclosure. Don’t bet the farm on this one. As reported by Money Under 30, since the applications started rolling in after 2017, only a mere 1.1% of them have been processed so far and an even smaller number have been approved.
2. Teacher Loan Forgiveness. Admittedly, only a small number of people will fall in this bucket. You can see what your options are by reviewing the information on the Student Aid website.
3. Consider re-financing. This option makes sense only when you have the opportunity to significantly lower interest rates. Federal loans can be bundled into a private loan but then you lose the flexibility of the government payment plans. Every case has its own merits so talk to your lender and choose wisely. Here is a link to an excellent resource you can use for building a custom program and refinancing at lower rates.
As I mentioned in my earlier post on credit cards, read and re-read the fine print to make sure that there are no hidden clauses whatsoever.
Can you use your 401(k) to pay off student debt?
I added this piece to the post because the recurring question keeps coming of whether it is a good idea to use 401(k) to pay off the student loan. The short answer is NO. Not only will you be hit with extra taxes and penalties, it is seriously impact your journey to financial independence. Here is a link to an article that does a deep dive into the issue.
Canadians
In Canada, the system is far simpler and more accommodative, especially if you are in the lower income bracket. I guess you could flip that around and say that the system discourages the individual to work harder and increase their income. However, we will leave that debate to the economists!
Federal loans in Canada are covered the Repayment Assistance Plan (RAP). The plan limits maximum student loan payments based on a portion of family income. In the first five years, the payments are reduced and the government will cover the interest. After five years, the government will cover both the outstanding amount and interest, assuming your income cannot cover it. So, over time your loan will eventually go to zero. Also, the forgiven amount wont be transferred to the CRA as taxable income. Compared to the US, these are massive advantages.
Each province in Canada offers it own provincial loan program based on its unique requirements. For example, in Newfoundland, student loans have been replaced by non-repayable grants. Most of these programs are designed to encourage people to establish careers in areas outside the major urban centres.
As you have probably realized by now, the wiggle room is not much. In your journey to financial independence, the best approach is to find ways to increase your income, lower your expenses and get the monkey off your back as soon as you can.
That’s about it.
Thank you!