Rebecca Bailey
CLEARING UP CONFUSION ON STUDENT LOANS AND THEIR REPAYMENT
MARIA GEFFERS
Tell us about yourself and when you decided to become a CPA.
REBECCA BAILEY
I started in this when I was applying for college. I decided to pick accounting as my major. They really pushed typical public accounting, which is where the CPA license comes in. When I was in college, there were tax and audit tracks but not much beyond that. I knew I didn't want a busy season to be part of my life until retirement. For those who don’t know, that’s usually four months of committing to 80-plus hours of work per week. I was lucky to find a public accounting firm that was in risk management.
I got some exposure to internal control auditing and operational risk management. I still had my own student loans to pay, however, so, I was trying to pay the bills. Through proactive self-education, I had found some strategies that worked for me. In college I would try to get scholarships and work 20 to 30-plus hours a week part- time. I would buy used textbooks and sell them back. I finished my undergrad in three years so I could cut out an entire year of expenses. I tried to proactively manage how much money I borrowed every year, and I was able to decrease the amount each year. Initially I was going to come out of college with $60,000 in loans, but with interest that grew over the years.
In trying to manage that, I talked to some of my friends, and they had asked me questions about being a CPA. They would tell me I should be charging people money for certain tasks. As part of that proactive education process, I was seeking out classes locally with financial advisors. I would show up and I would know more about student loans than they would, but I would try not to be the overachiever in class. My experience was that those classes are a marketing ploy to sell a life insurance policy and call it a day.
TOM GEFFERS
Many of the people we work with say their CPA or accountant can’t help them with college finances. When is the best time for people to start repaying loans?
REBECCA BAILEY
It depends on a multitude of factors, but the interest is the kicker. It keeps people drowning for an extended period. The sooner you can pay off the loans, the better.
TOM GEFFERS
People tend to put off the subsidized loans. Do you recommend people pay the interest on the loan when they are in college if they can? It can be difficult to do but if you have the mindset to do it and you get on a schedule, that’s the best thing to do. We recommend to college students that they build good credit while they’re in college. They should have a credit card in their name and pay all their small expenses and their parents make a payment every 30 days. Then the kid has great credit when he graduates, so he can refinance the loans. What do you think of that philosophy?
REBECCA BAILEY
There are some nuances in those subsidized loans. It depends on your budget. The enrollment status is the most influential factor in that. If they're below halftime, that interest is not being paid by the federal government. You must maintain halftime enrollment status for that to happen. When they’re in college is when it would be beneficial to pay the interest on those subsidized loans. It also depends on who is on the loan and who is making the payments for those subsidized loans. That comes into play from the tax perspective of who gets to claim the student loan deduction if they’re eligible. If you only have subsidized loans, then you’re in that situation. While you’re in college, I wouldn’t recommending paying more than $2,500 a year because that’s the maximum deduction.
This is based on income limitations. In relation to the good credit, there are a few other things I would recommend. I would recommend having the kids be an authorized user on the parents' credit account prior to turning 18. That will lengthen the amount of time of their credit history, which will ultimately help them long-term. It also allows them to learn good behaviors about how to use credit without the additional peer pressure of being in a new environment all by themselves.
If the student is not able to get a credit card on their own, due to some of those missing factors that are needed or looked for from a credit risk perspective from credit companies, they can apply for a secured card. That can be tied directly to a bank account or a different asset they have. It may not be a ton, but it's a starting point. Usually, they offer low balances and it’s a steppingstone for them. Finally, if the student has a car, whether it’s used or new, put them on the loan for the car. It will give variety to their credit profile.
MARIA GEFFERS
Could you explain the difference between a subsidized loan and an unsubsidized loan?
REBECCA BAILEY
The federal government will pay the credit on the interest that accrues on subsidized loans offered by them. That's the subsidy for that. They will pay the interest on those loans if you're maintaining that halftime enrollment status, or if you are in deferment. For example, if the student goes on to graduate school, they can't make payments on their undergraduate loans. That would be another time. Also with the federal loans, they'll do that if you can't pay because you're unemployed. That's one of the benefits of the subsidized loans compared to unsubsidized. Given all those conditions, that interest is accruing and added to the balance when you start repayment. That’s how my $60,000 in loans got to be over six figures.
TOM GEFFERS
What is the biggest mistake people make with their repayment plans?
REBECCA BAILEY
People are not proactively managing their repayment plans. They don’t recognize what the implications of their choice could be long-term, which can lead to a big mistake or a costly mistake. The two aren’t always synonymous.
TOM GEFFERS
The average loan in Pennsylvania for college is around $40,000. I don’t have a problem with that amount because that college degree could earn them an extra million dollars in their career. But when I see $100,000 or $150,000 in Parent PLUS loans and personal loans, it can get very costly. Talk about consolidating loans.
REBECCA BAILEY
From a federal perspective, it's consolidation. Then you can further consolidate federal and private loans as well. That's where the strategy comes in. If you're a student or family that has both federal loans and private loans, the strategy becomes more important. You need to figure out what to prioritize and where to allocate the monetary resources at that point.
TOM GEFFERS
I’ve seen people who consolidated their loans and the payment reduced dramatically if it’s done correctly.
MARIA GEFFERS
Can you explain what the PLUS loan is and how it works?
REBECCA BAILEY
The PLUS loan is the federal government's way of marrying federal access to funds and parental credit worthiness that's assessed on the private side. Rather than taking those federal loans, there's a limit every year that can be offered directly to the student. The PLUS loans are really for an additional need that needs to be met, which can be more than the expected family contribution that comes out of the FAFSA. If there are additional funds needed beyond those initial subsidized and unsubsidized portions of the federal loans, the PLUS loan could be another option. Those are funds offered by the federal government. It's a loan given to the parent, based on their credit history.
The danger with the Parent PLUS loan is that the interest rates are very high. Many times, you can go to private lenders and get a lower rate based off how the system was built for parent PLUS loans. The reason why consolidation is much more cost effective, and the payments can be lowered for federal loans, is because they have income- driven repayment. There are four different types of income-driven repayment plans. Income-based repayment is one of them. Consolidation is the gatekeeper to those income-driven repayment plans, and parent PLUS loans do not have access to any of those.
MARIA GEFFERS
You don’t recommend that at all?
REBECCA BAILEY
No, I would not.
TOM GEFFERS
How do the income-driven repayment plans work?
REBECCA BAILEY
The goal with income-driven repayment plans is to align the income of the borrower to a payment they can afford. The federal government will take the most recent tax return for that borrower, and they will, depending on which of the four plans you choose, take 10% to 15% of your discretionary income to be the payment. One of the four options is income-contingent repayment, which is for people who have income below the poverty line. You may not even be making a payment. There are qualifications for each of the four income-driven repayment plans.
TOM GEFFERS
When you come across someone making a high income who is not going to get much aid because of his income and assets, how should he file his tax return? If he owns a business, are there things he can do on his tax return to take advantage of the taxes if the child works in the business?
REBECCA BAILEY
Having a family member as an employee has great benefit. The bigger picture is managing the tax plan to align that. It's important to start thinking about that as early as the 10th grade. Your FAFSA will be based on your late 10th grade and early 11th grade year for your freshman year of college. When you make the tax plan, there are a few things that can be done. As with most things, there's more flexibility for business owners, in general.
TOM GEFFERS
Are there things the government gives you on your tax return that you can take advantage of as a family that will save you money? Can they take advantage of tuition if they are going back to school as an adult?
REBECCA BAILEY
The biggest tax credits for that are the American Opportunity Credit and the Lifetime Learning Credit. The American Opportunity Credit can only be taken for the first four years of undergraduate enrollment. Then the Lifetime Learning Credit can be used no matter where you are in the process of going to college. You can always utilize that. There is also a tuition deduction. A CPA would argue that's more beneficial because you can take the whole amount of the tuition. It really depends on the client, and what they want. Most people want the money in their pocket from a tax return. The American Opportunity Credit, especially in that first four years, is the way to go. That can get interesting because it’s a $2,500 deduction you can take, but $1,000 is refundable. That can be money in your pocket if your tax liability isn’t higher than that.
Everyone needs to know that we’re giving general information, not specific information, because everyone's position is different. This is just a generic overview of what's going on. To really know, you need to speak to a qualified person personally, with your CPA or a certified college-funding specialist.
MARIA GEFFERS
Your website says you can help people save $225,000 on their student loans in their lifetime. Are you only helping people with extremely high loans or people going to medical or dental school?
REBECCA BAILEY
It's not that elite. It goes back to the tax strategy involved and how that's accomplished. There are a lot of things people don't understand about tax strategy. A lot of times the student loan debt is seen as this big roadblock and it's a gatekeeper to all these other life milestones. Buying a house, getting married, and having kids all come with monetary concerns. People wonder how they can afford these things and actively make the choice, knowing they’re not financially prepared to do so. This is where lesser- known things about tax code could come in handy, especially for people coming out of college who are early in their career.
If they have solid and consistent income, and they’re willing to manage their budget, they can benefit from that, build net worth, and protect themselves financially long- term. It gives them options when those milestones are presented to them that aren’t well publicized or talked about. I recommend to my clients to leverage their 401(k) benefits and max that out. If you’re a W-2 employee with a 401(k) plan, you can take up to $19,500. The biggest asset anybody has in planning for retirement is the time value of money and saving more early on.
If you can stack that away early on, it's not even a challenge to hit a quarter of a million dollars in your lifetime. I recommend W-2 employees with high deductible insurance to leverage their HAS deduction as well. Both of those things directly reduce the income that the government bases your payment calculation on, which is called adjusted gross income. If you can manage the AGI proactively, have it reduced, and still pay yourself first, it opens doors in the future. I know it seems easier to choose the straightforward way now, but people don’t realize how they’re limiting themselves in their options for the future.
MARIA GEFFERS
Don't be terrified that you can get a good education and still live a life that is plentiful and normal. With a little discipline you can live well and manage your loans. Is there anything else you would like to cover that we didn’t think to ask?
REBECCA BAILEY
Don’t pay someone to file your FAFSA for you, when you can have someone file it for free. Many times, you can file it yourself with your tax return. There is a great IRS link that makes it straightforward. This won’t necessarily be the same for schools that require a CSS profile. They charge a small fee for financial aid appeals, which some people don’t even know are available to them. TuitionFit is another great resource I recommend. People can upload their financial aid package letter to that site. It will give them access to a database to show them how their package compares to other people going to that school. The more letters TuitionFit has, the more beneficial their data is.
Lastly, there is an alternative to the parent PLUS loans, called Juno. They negotiate deals using collective bargaining for student loans. Right now, they're guaranteeing the lowest interest rate on the market for newly originated, undergrad loans. I just refinanced with them for my private loans, and I was able to get under 2%. I can't guarantee that for everybody, but that's way better than the six or seven-plus percent that PLUS loans carry.
TOM GEFFERS
Thank you for helping to simplify a complicated topic.
