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Smart Ways to Pay Back Your Student Loan

What comes after graduation day? The job of repaying the cost of college. That often involves hard choices, but with a solid strategy, you can tackle your debts without jeopardizing your future.

 

TWENTY MILLION COLLEGE STUDENTS attended college last fall—and two out of three who graduate are likely to graduate with debt. They’ll have lots of company. Americans collectively owe $1.57 trillion in student loan debt,¹ making it the second-largest source of consumer debt after mortgage loans.

 

How much individual graduates owe is partially dependent upon where they go to school. According to Educationdata.org, North Dakota was the state with the lowest rate of loan debt per student, with an average amount of $29,200. The great per-student debt was in Maryland, at $42,700. (Even higher was the District of Columbia, at $55,400.)²

 

Finding the Right Repayment Plan for You

There are a number of repayment options available to graduates with federal student loan debt. They include a 10-year repayment plan, a graduated repayment plan with payments that start low and steadily increase, and various income-based plans that may be available to you. Those who work for the government or in the nonprofit sector may also be eligible for the Public Service Loan Forgiveness program. If you owe private loans, the issuing bank sets the repayment terms.

“Lower monthly payments and more time to pay off your loan may sound tempting, but you’ll likely end up paying more in interest over the life of the loan.”

—Jean Y. Kim, managing director and wealth strategist at Merrill’s Strategic Wealth Advisory Group

 

“Deciding which repayment plan is right for you requires thoughtful consideration and a solid strategy,” says Jean Y. Kim, managing director and wealth strategist at Merrill’s Strategic Wealth Advisory Group. “For instance, having lower monthly payments and more time to pay off your loan may sound tempting, but you’ll likely end up paying more in interest over the life of the loan.” For that reason, she says, “even if you’re eligible for an income-driven plan with a lower monthly payment, unless it reduces your interest rate or suspends it altogether it may not be your best choice. If you can afford to make higher payments, you should.”

 

Three More Tips from Kim

  • First, “try to pay the interest on your loans while you’re in school. Otherwise, it will be added to your principal and accrue even more interest, which means a larger loan balance when you graduate.”
  • Also, “pay back the loan that has the highest interest rate first.”
  • Consistency is key. “Regular payments show future lenders that you have discipline.”

How Recent Legislation May Benefit You

The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019 allows you to withdraw up to a lifetime limit of $10,000 from a 529 education savings plan free of federal (and possibly state and/or local income taxes), to pay principal or interest on qualified student loans for the beneficiary of the plan or a sibling of the beneficiary, notes Kim. The lifetime maximum applies to the beneficiary and any sibling of the beneficiary individually. In the past, putting such assets toward paying off student loans would have been treated as a non-qualified distribution, resulting in federal and possibly state and/or local income taxes and potentially a 10% additional federal tax on the earnings portion of any withdrawal. Such loan repayments may have an impact on student loan interest deductibility, and state tax treatment may vary. Please consult your tax professional for more information regarding your specific circumstances.

 

One other note: The CARES Act, enacted in 2020, offers relief for many people with student loans by permitting companies to reimburse employees for student loan payments, along with other tuition assistance, up to a combined total of $5,250 tax-free. The CAA (Consolidated Appropriations Act) of 2021 extended these benefits through the end of 2025.

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¹ Federal Reserve Bank of New York. "Quarterly Report on Household Debt and Credit," November 2020.

²  Educationdata.org, “Student Loan Debt by State,” Sept. 29, 2020

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