6 ways advisors can prep clients before student loan payments restart this fall

June 22, 2023 2:53 PM

A calendar with a reminder written that says "Payment due."

Three years, eight extensions, and a pandemic later, the federal government's interest-free student loan payment pause is set to end this fall.

A provision in the debt ceiling deal between President Joe Biden and House Speaker Kevin McCarthy guaranteed the end of the long-running payment pause when it was signed into law earlier this month. According to the U.S. Department of Education, interest will begin accruing starting Sept. 1, with payments starting back a month later.

Experts estimate that the three-year pause saved the average borrower $15,000. For borrowers who have relied on the payment pause to help cover other debts and expenses, the resumption of payments could pose significant financial complications.

According to recent research from the Consumer Financial Protection Bureau, 1 in 13 student loan borrowers are behind on their other debt obligations.

"Median scheduled payments on other debt obligations have increased by 24 percent for student loan borrowers likely returning to repayment," the researchers said. "In percentage terms, these increases are especially large for younger borrowers (252 percent, or $65 to $229)."

The Bureau found that 20% of borrowers, nearly 9 million people in total, have "risk factors that suggest they could struggle when scheduled payments resume."

Financial advisors say that anyone with outstanding student loans needs to act now to make sure they are prepared for the end of the payment pause. Here are the six most important steps borrowers should take and how advisors can guide them:

Check up on the basics

The majority of borrowers with federal loans did not make loan payments during the payment pause, meaning that this fall might mark the first time in three years that borrowers have checked on their loan accounts.

To get ahead of the curve, borrowers can start refreshing themselves on the basic details now. That includes making sure their contact and payment information is up to date, checking to see what their outstanding balances and interest are, and confirming who is servicing their loan.

"Over the last few years there has been a huge shuffle in loan servicers," said Melissa Cox, a financial advisor at Fetterman Investments in Dallas. "Payments are going to restart even if you haven't received notice."

Borrowers can log into the federal student aid website to find out who is servicing their loans.

Finally, avoid any surprises by checking to see if you have an automatic payment setup. If not, consider signing up so you do not miss any payments once they start back.

Start living with the payment

Those heading back into loan payments have long lived in a budget that didn't include them. Getting used to the financial hit early is important.

"Whether you had student loans pre-COVID or accumulated student debt during COVID your budget may not take into account the debt payments," said Assunta McLane, a financial advisor at Summit Place Financial Advisors in Summit, New Jersey. "Take time this summer to review your budget and factor in your debt payment. Going through the exercise now will give you time to better prepare."

Advisors suggests a couple of different approaches to factoring in an additional debt payment now. For borrowers who want to take advantage of the remaining interest-free summer, making payments now can reduce the principle on any loans. Paying down the principle now will also save borrowers money in the long term, as less interest will accrue over time.

Alternatively, some advisors suggest that borrowers adjust to the monthly payment now by contributing the same amount to an emergency savings account until repayment officially starts in October. Doing so will provide a cash buffer for borrowers who may struggle financially once payments restart.

This approach also allows borrowers to prepare for repayment while they await a decision on any potential loan forgiveness action.

"I wouldn't advise paying down any loans right now before any decisions come out as we don't know for sure if there will be any relief at all or how much there may be," said Erik Baskin, the founder of Baskin Financial Planning in Dayton, Ohio.

President Biden's debt forgiveness plan is awaiting a ruling from the Supreme Court, which could announce a decision by the end of June.

Assess your repayment options and strategy

Borrows have a number of options depending on their specific situations.

"Whether you're planning to pay the loans off or you're working toward forgiveness, it's important to be mindful about which payment plan you're on and how you're utilizing your cash reserves," said Brittany Brinckerhoff, a financial advisor at Hilltop Wealth Advisors in Chapel Hill, North Carolina.

If high monthly payments are going to be an issue come October, advisors suggest checking to see what income-driven repayment plans are available. Such plans can be helpful if income is low, but they also lead to more interest accrual down the road.

James Osborn, the founder of Envest Asset Management in Ridgefield, Connecticut, said it is important that any borrowers already on income-driven plans "pay attention to any income recertifications that are required under those programs."

Some borrowers may qualify for loan forgiveness.

"If you work for an eligible nonprofit under the student loan forgiveness program, that time during the payment pause can be used toward that program," Osborn said. "Make sure to submit your form to get credit for the time spent at that employer."

Borrowers who have been in repayment for 20 or 25 years, depending on the type of loan, may also qualify for loan forgiveness. Any time a loan is in forbearance is usually not counted toward the total required repayment time.

However, the Department of Education announced that it will be making a one-time payment count adjustment that includes time spent in forbearance. The details of who does and does not qualify for adjustments or forgiveness are specific for each borrower, so it is important to see how current rules apply to an individual's situation.

Consider refinancing or consolidating your loans

With interest rates higher than in previous years, refinancing now likely does not make a lot of sense for most borrowers. Nevertheless, advisors say it is worth talking to your loan servicer to see if you can secure a lower interest rate.

Osborn of Envest Asset Management said that borrowers can also look into refinancing to a private loan, which may offer lower interest rates.

"It may be the case that you can save money by refinancing to a private loan," Osborn said. "But make sure you do the math on that and understand the pros and cons associated with having a private loan over a federal loan."

Private loans can provide lower interest rates, but they also offer fewer benefits such as forgiveness and forbearance.

Borrowers with multiple different federal loans can also look into loan consolidation. This process creates a single fixed-interest rate based on the weighted average of the interest rates on the loans being consolidated. It can also help a borrower simplify their account by consolidating their student loan debts into one monthly payment.

This option may not be right for some borrowers seeking forgiveness, as consolidation can lead to their payment count toward income-driven repayment being reset.

Analyze other debts

Student loans may not be the only form of debt that a borrower is paying down. Before repayment starts in October, advisors say that a borrower's student loan repayment strategy should be informed by other debts they have, including the interest rates and tax benefits different loans may offer.

"If there are other debts with higher interest rates, perhaps it makes sense to focus on paying the minimum and extra payments on those debts first and pay just the minimum on the lower-interest student loan debt," said Tim Melia, a financial advisor at Embolden Financial Planning in Seattle.

Because student loan interest payments are tax deductible up to $2,500, borrowers might be better off contributing more money toward other forms of debt while making minimum payments to their student loans.

Capitalize on employee benefits

Younger workers are often forced to decide between paying down their outstanding student loans and contributing to their retirement accounts. At workplaces that offer retirement account contribution matching, a borrower's decision to pay down student loans leaves money on the table from their employer.

Come 2024, some employees will not have to choose between funding retirement or paying down student loan debts. Thanks to a provision in SECURE 2.0, employers may make matching contributions to an employee's 401(k) or IRA based on their qualified student loan payments.

Before a borrower determines the strategy they want to take toward loan repayment, they should check with their employer to see if they will be offering this new type of retirement fund contribution.

"It is important to take advantage of this 'free money' opportunity," Melia said. "There are contribution limits to IRAs on an annual basis, and if you don't fund the limit in a given year, that opportunity expires. So, if saving for the future is a goal, taking advantage of annual IRA contribution limits should likely be considered."