30 Dec When student loans break the bank

Q. Our youngest son just graduated from film school, and while he looks for full-time work, he’s doing some project work in the industry. He has federal student loans but also $94,000 in private loans with a $850 monthly tab. It has a 14-year payback term with no option to extend. He could put it in forbearance for a year with the interest still accumulating. I’m pulling from retirement funds to help now, but we don’t know what to do. Help!
— Debt-worried dad

A. That’s a lot of debt to carry straight out of college.

It’s very generous of you to help, but you’re risking your retirement to do so. Of course we all want to take care of our kids, but as you get older, you may really miss the money you’re taking out of your retirement accounts today. The funds you’re taking out of the account are not only gone forever, but you now have a smaller balance accumulating gains over time.

If you are prematurely withdrawing funds from retirement accounts to help pay your son’s student debt, forbearance for a year sounds like a reasonable road to take, said Brian Power, a certified financial planner with Gateway Advisory in Westfield.

A year can make a big difference, he said.

Power said depending on your age, if you’re under age 59 ½, you may have to pay a penalty in addition to taxes on any withdrawals from a retirement account.

He said you might be better off borrowing from the 401(k) — assuming that’s allowed by your plan — rather than take outright withdrawals because the tax and possible penalties are very severe.

Another benefit with the 401(k) loan is that you’d be paying yourself back the interest.

But a lot can change in a year, so the forbearance may be a reasonable option.

“The forbearance can buy you some time to look into other borrowing alternatives,” Power said. “You may want to consider taking out a home equity loan to pay off the student loans. Home equity loans could reduce your payments significantly and provide a tax deduction on the interest payments.”

Another possibility is to consider whether a family member would give your son a loan — a personal note.

“A family member could lend the graduate the loan amount or partial loan amount to pay off the student debt,” Power said. “This will give the graduate a lot more flexibility on the terms of the loans such as interest rate and time frame to pay off the personal note.”

Your son also needs to look at the Federal Direct Loan Program for his federal loans to make sure he’s taking the payment plan that best suits his situation.

Power said the program offers five different repayment plans:

• Standard Repayment: The borrower will pay a fix amount each month for the life of the loan. The payment would be determined by your borrowed amount, interest rate, and term of the loan.

• Graduated Repayment: The borrower would make payments lower than the standard repayment plan, but would gradually increase every two years.

• Income Contingent (ICR): In this plan, the borrower would make payments based on their income, family size, loan balance, and interest rate. Borrowers in the ICR can have a payment as low as $0.00/mo.

• Income Based (IBR): This plan bases the borrowers payment strictly on their income and family size. The balance of the loan and interest rate are not used in calculating the monthly payment. The borrower would be responsible to pay 15% of their discretionary income to their federal student loans. Borrowers in the IBR can have a payment as low as $0.00/mo.

• Pay As You Earn (PAYE): This plan usually has the lowest monthly payment, and is also based on your income but uses 10% of your discretionary income as a payment instead of the 15% used in IBR. Qualifying for the PAYE repayment plan is more difficult than the others. Borrowers in the PAYE can have a payment as low as $0.00/mo.

If you enroll into either the Income Contingent, Income Based, or Pay As You Earn repayment plans, you loan balance would be forgiven at the end of the term if you still have a remaining balance. The term of the loan would be between 20-25 years depending on which repayment plan you choose, and when your loans were originally borrowed. How much you will forgiven will depend on your original loan amount, how much you are earning, and how much your earnings fluctuate during your repayment term.

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This story was first posted in December 2015.