Afford Anything - PSA Thursday - How Does the CARES Act Impact Student Loans?

Episode Date: June 11, 2020

Welcome back to PSA Thursday, a mostly-weekly segment in which we talk about how to handle money, work, and life in the middle of a pandemic. In this episode, we cover how to manage student loans in the midst of the pandemic with Travis Hornsby, a Chartered Financial Analyst and the founder and CEO of Student Loan Planner. He's an expert in the complex topic of student loans. Travis shares deep insights into the changes that have occurred, and how those changes might alter the way you think about and manage your student loans going forward. Learn more about your ad choices. Visit podcastchoices.com/adchoices

Welcome to PSA Thursday, a special bonus weekly segment of the Afford Anything podcast in which we talk about how to handle money, life, and work in the middle of a pandemic. These episodes are stripped down, bare bones versions of the Afford Anything podcast. There's no intro music, no outro music, no sound effects, and the interviews do not have key takeaways. And today's episode, as you are about to hear, is the first PSA Thursday episode that features an interview. Today, we're going to talk about the CARES Act and its impact on student loans. What are the changes in government policy around student loans that have taken place as a result of the pandemic? What's new? What's changed? What's different? What do you need to know? And what is the best strategy for optimizing your management of your student loans in the year 2020? Those are the questions that we're going to address in today's episode. And with me on the show today to answer these questions. questions is Travis Hornsby. He is a chartered financial analyst, the founder and CEO of

Student Loan Planner, and the host of the Student Loan Planner podcast. He is an expert in the complex topic of student loans. And if there is anybody who can deep dive down that rabbit hole, it's him. So let's hear from him about how to manage your student loans during the era of coronavirus. Before we get started with today's episode, a quick reminder that your dollar is your voice. We are raising funds for three amazing nonprofit organizations, and there are many to choose from. So far, not including my match, so far we have raised $7,150 for the Committee to Protect Journalists, which is a 501C3 nonprofit that protects journalists who right now are being targeted while they are doing their jobs. We've also raised almost $500 for the Atlanta Food Bank and Children's Development Academy.

For more details on this, plus a list of resources, including other organizations, GoFundMe campaigns, and more, check out afford anything.com slash PSA Thursday. Now, with that said, here is Travis Hornsby talking about student loans. Hi, Travis. Hey, Paul. Travis, I wanted to bring you on the show to talk about student loans. To open with, and this is admittedly an incredibly broad question, how has the CARES Act impacted student loans? in a pretty big way. You know, if we remember back to like how all this started, I think a lot of people think about

the NBA shutting down. I think it was Thursday, March 12th. And then the day after that, President Trump held a press conference March 13th, when he came out and said a bunch of different things, including we're going to suspend student loans for 60 days. And he said something about suspending the payments, the interest and all that. The thing is, is he didn't have the legislative authorization to do that. He just sort of said, we're going to go out and just create this COVID forbearance.

And I think what had happened is he talked with the leaders in Congress who agreed that they needed to do something for student loan borrowers, which is why he said that. And then when Congress passed the CARES Act a couple weeks later, what they did is they backdated that relief to March 13th on the day of that press conference. So from March 13th until September the 30th, there's this massive relief for borrowers with loans owned by the Department of Education, which is everyone that has a direct loan. and a lot of people that have loans called FFEL loans from before 2010. So these loans have no payments and no interest required until September 30th. And the reason, you might ask, why did they choose September 30th? September 30th is actually the end of the federal fiscal year. So it's a really convenient, easy time to just say we're going to have this relief last until this point, and then we're going to cut it off.

Similar to mortgage forbearance programs, is there then a balloon due on October 1st, or does it get added to the end of the list? loan. Actually, it's even better than that kind of forbearance. It's very different, in fact, because with the mortgage forbearance, you still have to pay the principal and the interest. The payment's getting added to the end of the loan. It's because that mortgage is, you know, downstream, it's owned by a private investor, whereas student loans are, in most cases, owned by the government, which doesn't have that profit incentive and doesn't necessarily need to get paid interest. The government can choose whether or not to get paid interest. And so that's what it did, is it just waived all the interest that would have normally accumulated during that time.

So that interest is not going to need to be made up later, if that makes sense. I see. Yeah, so furthermore, the payments, you know, they're not forgiving any principal, although they wanted to. So some of the bills out there included 10 to 30,000 of student loan forgiveness for principal, but that didn't ultimately pass. But what the zero-posed payments do qualify people for is credit towards forgiveness plans. So you actually get to have all of those zero-dollar payments. between March 13th and September 30th,

count towards loan forgiveness programs like income-driven forgiveness, as well as public service loan forgiveness, which is a big deal. Right. So in terms of the number of months in which you have to have on-time payments in order to qualify for those programs, those zero months count. Exactly, which is a big deal because we have people that, in some cases, have to pay two or three thousand dollars a month for their loan forgiveness, maybe as physicians, for example, that were a little preoccupied, dealing with some other issues, right? Other health issues during this time. And so those payments

are suspended, but they still count towards public service loan forgiveness as well as other loan forgiveness programs. So there's been a whole bunch of people obviously impacted besides looking at the human cost of COVID. Obviously, the economic cost of COVID has been enormous. And so we're seeing by and large, anywhere from job losses just across the board in different fields. Like some fields are not that affected and some fields are just extremely so. So, it's just very helpful for student loan borrowers just to have paused payments completely during this time with zero interest accruing. So you can choose to make extra payments on your loans if you want to, and then that would all go towards principal, but that's something that you're not required

to do. Now, this applies to federal loans. What options do people have if they have private loans? So there are a little over a dozen states, I think, that came to agreements with private student loan companies to allow a 90-day pause forbearance, if you will, on student loan payments. That does not mean that the interest is paused. The interest is still going to accumulate for private student loans because Congress is not reimbursing private student loan companies for that interest. So if you live in a certain number of states, California, New York, you do have the right for a 90-day forbearance to pause your payments without any kind of negative credit events or extra fees other than the normal interest that would accrue. So that's

the protection that you have for a private student loan borrower, but even if you live in a state where there is no agreement in place with states and private loan companies, most private loan companies that I know of are just voluntarily offering this forbearance. It's not that difficult to get a forbearance if you need it right now. You simply just need to contact your private loan company and request one, and they'll generally give you one for at least a couple months, if not longer. Going back to the federal loans, are there any differences in terms of the different types of federal loans, Stafford loans versus Pell Grants. Are there any differences in the way that those are handled, or does this apply to all of them across the board? It applies to all direct loans

across the board. The issue is the federal student loan system is kind of like a sandwich. So whenever there's a new set of rules and Congress comes and makes a new kind of update to the student loan rules, they just layer on a new layer of the sandwich instead of replacing the sandwich with a new one. because of that, before 2010, there was this program called the FFEL loan program. And some of those loans were guaranteed by the government and owned by private entities. In other words, it's sort of a federally guaranteed student loan program versus a federally owned student loan program. Right, like Fannie Mae or Freddie Mac.

Exactly. And imagine if Freddie Mayor, Fannie Mac had been completely absorbed by the government and the government was the direct issuer mortgages to every American versus having private banks to it, right? So that's kind of what happened to student. loan in 2010 as the government took over the role of issuing student loans pretty much completely. There is a private student loan market for people that are looking for private student loans for school, but it's a very, very small market now than compared to what it used to be.

And if you look at these old loans that are owned by private entities, the government was looking to do relief very fast. They weren't looking to get into the weeds and make sure that it was a perfect bill. They were just trying to get something passed quickly. And so they found resistance and difficulties basically having these loans that were federally guaranteed versus federally owned, they had problems with getting those payments and interest suspended because they're owned by private trusts, basically, which are owned by banks and different kinds of groups. That's why they didn't include a lot of the loans from before 2010 that were issued to students who attended school before 2010.

So it's a little confusing for people who have student loans from before 2010. Some of those people have loans that qualify and some of them do not. And ultimately, at this point, if you've been billed, you know that you probably have a loan that was one of these loans that was federally guaranteed instead of federally owned. What can a person do if somebody's listening to this and they're thinking, wow, I don't even know if my loan qualifies. A, how do I find out? And B, if it doesn't, what are my options? Yeah, you can go into student a dot gof, which is a federal website and log in with your FSAID. Basically, it's a username and password that everyone can access with just a couple clicks if I forgot my password, which will help you reset it, right, if you can't get in.

But you get in, and then it's going to show you, and then names of the loans, if it says Department of Ed in front of the loan name, then it's owned by Department of Education. If it does not, then it's owned by a private entity. And the nice thing is you can still actually qualify for a payment and interest freeze by consolidating your loans. So in doing that, essentially, you just need to go onto that same website and request that your loans be consolidated into a direct student loan. And then that new loan would qualify for the payment and interest freeze. The downside of doing that is any payment credit that you've built up on income-based repayment would be wiped away. And you would have to start over with zero credit towards income-based repayment forgiveness if that applied to you. So it's just something to kind of weigh if you think that you need to pay off your loan eventually,

then you would want to have your loan be consolidated in a direct loan format. If you think that you're going to go pursue forgiveness eventually, you need to be very careful before taking any rash action that might hurt you more than it helps you. In terms of weighing that decision, how much should the amount of time that a person has been working towards that forgiveness weigh into that decision? I think quite a lot. I mean, you know, if you've been paying your loans since 2010,

you would have 10 years towards the 25 needed for forgiveness. So that would mean, you know, 15 years to go, you need to evaluate what loan programs you're actually eligible for. So, for example, you might be eligible for pay as you earn, which is a 20-year program, and that 20-year program allows you to pay 10% of your income instead of with income-based repayment, it's 15%. So there's often a really strong case to be made for consolidating your loans and resetting the clock, so to speak. But it's something that needs to be evaluated on a case-by-case basis if you have, I would say more than 100,000 of student loan debt. If you have less than that, you're probably not going to be in a situation where you're going

to get a ton of forgiveness where it's going to matter that much. So for the people with more modest five-figure balances and less, I would probably tell them to just go ahead and consolidate your loans and get them set up so that you can benefit from this payment and interest freeze from the CARES Act. If you have more than $100,000, be really careful because with that kind of a size of a balance, you can really easily mess something up that will cost you a lot of money. You've talked about direct student loans. Are Parent Plus loans considered direct loans? Parent Plus are actually direct loans, yes. Parent Plus loans are owned by millions and millions of

parents around the country. They're a little bit different because parent plus loans to be eligible for income-driven repayment options have to be consolidated anyway. Parent-plus loans, they are covered by this payment in interest freeze. So the good news is pretty much most student loans are all covered. There's maybe about 6 million people that have student loans out of the 45 million total borrowers that are not protected in any way by this CARES Act. So 6 million people is a lot of people, but if you're listening to this, there's also like an 85% chance that you're good. So that's the encouraging news that I would tell people is you're probably okay when it comes to this payment and interest freeze. And if you're not, you can definitely do some things to get some benefits or just

know that you're set up as well as you possibly can be. We've talked about how the CARES Act has impacted student loans. In what ways has it not impacted student loans? How have things not changed? So I'm stunned by how many people out there are telling folks, now is the time to pay extra on your student loans. I actually think that that's pretty bad advice. The simple reality is if you have zero percent interest on your student loans, you could make more money by simply putting your payments that you would have paid towards your debt into a checking or savings account and earn more money on your interest than you would save by paying towards your student loans. So, for example, if you wanted to pay an extra $10,000 a month on your student loans right now,

because you're just really flush, that $10,000 a month probably should be, you know, at a minimum going to a savings or a checking account where it might earn 1% interest instead of zero. And then when this interest freezes over, you could take that one big lump sum and just dump it on your loans. And you would be financially better off from that. That's just a simple interest arbitrage argument, but there's actually a lot of really good arguments why you want to be paying as little as possible on your loans right now besides just that interest arbitrage. One situation could simply be, what if the economy gets worse? You know, we're recording this. The Dow is at 25,000. There's 40 million people that are unemployed. The strength of the economy and the strength of the stock market is going to heavily depend on how fast everyone can get back to work.

And if that goes a lot slower than anticipated, and if a lot more jobs are destroyed than we think, That could affect you. That could affect your income and your job. And if you put all this money into your student loans when it could have been reserved for savings in case the worst happens, or if the stock market falls 50%, that capital could be available for investing

instead of easing it towards debt, you'd be far better off. So that's one thing that I'm telling people is it's actually totally okay to pay the minimum right now and to use that money that you wouldn't want to put towards your debt, towards your savings and investing instead. Yeah, absolutely. There's many good reasons to have additional liquidity, additional cash reserves in the middle of a crisis. If you think about the benefit of having cash, when times are flush and no one's afraid, then maybe the benefit of that's a little bit less. But when people are scared and there's a lot of uncertainty, that is a wonderful time to have a little bit more than you need so that you can be nimble and respond to any opportunities that might present themselves.

And there's also the consideration with the CARES Act only affects payments and interest for a defined period of time. They might extend that. They might go longer than September 30th. I think that they probably will if I had to guess now. The simple reason, Paula, for that is the payments for every student loan borrower that's affected by this, which is most student loan borrowers. So, you know, 40 million people are going to have their payments start again on October 30th if the CARES Act doesn't get extended. and October 30th is four days before the election. The Democrats proposed extending it for basically a year. So the Democrats proposed extending the CARES Act suspension of payments and interest in Seoul September 2021. So if you are a Republican, do you want to go into an election four days before the election where you restart hundreds of dollars per month of payments in a economic contraction for 40 million people?

You probably don't want to do that. And so that's telling you that this interest freeze and payment assistance, I mean, this really could extend longer than that. But the thing is, is even if it extended to September 2021, that doesn't affect anything about your long-term strategy, which I think is probably the most interesting part of this for me. Because whether or not you pay off your student loans or treat your student loans like a tax where you pay the minimum possible and take advantage of all of the loopholes that exist for student loan repayment to, pay as little as you can to get the maximum forgiven, that's a wonderful analysis. And it's an analysis that if somebody feels like they're stuck and they can't ever achieve financial independence because of their student loan debt, once they understand the rules, not only is it possible, but you can achieve financial independence years sooner than you

thought you possibly could, which is really the part that makes me the most excited about all this, is that student loans don't need to be this soul-crushing burden that affects people lives and emotions in such a severe way. What should a person do if they understand mathematically why making additional payments on their student loans is not a wise idea at this time, but they do feel that emotional crush, that emotional burden, and they want to have student loans paid off for psychological reasons. To what degree should they weigh those factors and how do they make a decision? There's nothing wrong with that. In fact, you know, the psychological burden of debt

that encourages a higher savings rate is a positive fear, right? There's plenty of different worries that induce behaviors that are good in us as humans. So I would just say this. If you want to pay extra towards your student loans, you have to make your house, make sure that your financial house is really in order right now. And what does that look like? That means you need to have one year's worth of expenses in the bank. If you have less than that, we have a recession. You could lose your job. Enhanced unemployment benefits could be not extended. And then you'd in a world of hurt if you're focused on your loans instead of your overall financial health. So I would say first you have to have a year cash in the bank. The second thing I'd say is you need

to be saving for retirement right now. You need to be putting aside at least 10% of your income into retirement savings, either in a 401k or in an individual retirement account. And then the last thing that I would say is on top of retirement savings, you should have at least a couple hundred dollars a month going away into some kind of investment account outside of retirement savings, simply because if you want to have the potential to live off of, to be able to stop working before the age of 60, you want to have a big pool of money that's not tied up until age 59 and a half. Now, obviously, there's ways that you document maybe getting access to that a little faster. People can also consider real estate in your real estate course. So there's a lot of

ways to skin a cat, but the idea is you want to have plenty of cash to handle short-term emergencies. You want to have plenty of contributions going into retirement savings so that you have the right habits for that so that you can retire one day. And you want to have a significant amount of money going into non-retirement investments, such as mutual funds and real estate, so that you have the option of retiring well before the age of 60. And if you're doing all that and you're doing all three of those things in a healthy way, then by all means, take some of additional funds that you have available and put it towards your student loan debt. But if you're not doing those things, you're kind of like eating it healthily, but you're not set up for holistic

health. You're kind of super worried about, you know, one specific problem in your life, but you're not focused on your holistic health. And you really need to be focused on your holistic financial health versus getting myopically focused on one particular problem. That's an excellent analogy. So it would be like focusing on having excellent nutrition while simultaneously getting two hours of sleep a night and chain smoking cigarettes. Exactly. And binge drinking, right? So if you have a healthy diet but you're doing all those other negative things that you're not in good shape at all, right? You know, the other analogy is make sure you have your own oxygen masks secured on well before you consider doing any other things.

You really need to focus on behavioral habits. I listened to a recent episode where you had a behavioral economist on the show. Danny Raleigh. Yeah, and that's just, that was a great episode. It's just so important to make sure you have the right habits that you are automating in your life so that you're wealthy one day. Because what I see so much of is we have so much anti-debt sort of popular advice or popular wisdom in the culture that what happens is when you focus on your debt so much, you forget to focus on the other side of the net worth equation, which is assets. It's really easy to not go on that trip when Disney World reopens. It's really easy to not go to that trip to Disney World because you have to pay down that $20,000 credit card or $20,000 student loan because it's a thing that makes sense.

We have to pay this off because I feel the weight and burden of not having this in my life anymore. But one thing that we almost never do as humans is we're not making that same sacrifice so that we can invest that same out of money and to index mutual funds. That decision inhibits us from retiring much sooner than we could otherwise be able to do. So that's why it's so important to develop the good habits because behaviorally, we're not going to make that conscious decision to not take the kids to Disney World so that we can retire five years sooner from a higher contribution to our mutual funds in any particular year. That decision needs to happen in an automated way on a monthly basis. So for example, in my own life, we have an automated amount of money every month that sweeps into BTSAX, BTIAX,

Total Stock Market Index, Total International Stock Market Index funds at Vanguard. And that way, I don't have to make any conscious decisions. It happens automatically based off of what our budget is. And then if I do have extra money that I want to invest, I can do that as well. But those one-time investments don't have to be the end-all-be-all because I already have my automated investment plan set up. In this conversation, we've talked about varying levels of student debt that people have. Certainly there are some people who are listening to this who have low five-figure debt,

while others have more than $100,000. How could a person with greater than $100,000 worth of debt ever reach financial independence? The first thing that I want people to know is that student loans can be a tax instead of a debt. So there's many different income-based programs. The two that are most commonly used or pay-as-you-earned and a revised pay. as you earn. So both of those plans allow you to pay what's called 10% of your discretionary income. What that really means is that you get a deduction. It's kind of like the standard deduction on your taxes before you have to pay 10%. So what that really works out to is about 8% of what you

actually earn. And that's based off of U.S. earnings. So just to give you kind of an example, if you're in the United States, the worst case scenario for your federal student loan payment is about an 8% income tax. If you're living abroad, you actually qualify for the foreign earned income exclusion, which gives you $100,000 write-off on income earned abroad on your U.S. taxes. So people who live abroad who have student loans can pay basically 8% of zero if they're earning less than $100,000. So for example, people that live abroad, like GoCray Cracker, or just one people in the FI community that I know that live abroad that make a lot of their income from dividends. So you could live abroad and pay literally zero on your student loans in the

United States, and that would be considered totally in good order. Your balance would grow, but what's interesting is, in addition to that 8% quote-unquote income tax, you can generally put aside about 3% of your income into index mutual funds to cover any negative consequences of loan forgiveness. So, for example, when loans are forgiven, in the private sector, you have to pay income taxes on the forgiven balance. And from our projections, usually about a 3%, you know, three to five percent contribution to index mutual funds will cover that future anticipated tax liability. So if your income is very low, as, you know, an FI person's taxable income might be less

than $50,000 because they're very smart with tax efficiency, right? That person might be able to put aside, say, 10 to 15 percent of the taxable. that total income away for their student loans, even if they have $400,000. What's so fascinating about that is if you look at somebody like a Mr. Money Mustache who retired on $20,000 a year with $500,000 of assets, somebody who's interested, especially in a lean FI lifestyle where they're only going to be spending maybe $20,000 to $40,000 in retirement can focus on reaching that $500,000 to $100,000 net worth milestone while basically viewing their loans as a tax instead of a debt. So if you look at your debt as a debt,

then you have to pay that student loan off to zero. So that means having to make all those sacrifices to get that suit a loan to zero. And then on top of that, try to get your assets up to that $500,000 or a million mark, which will take time to do. Instead, for certain individuals who feel like they have no way out that really are interested in this FI lifestyle, if you focus on assets and have the student loans really be treated as a tax instead of a debt, then what you can do is reach financial independence maybe five, 10 years sooner, which if you're not in a great place, mentally, emotionally, whatever, that's a wonderful thing to realize that you have a lot more options than you ever thought possible. That's certainly one path to financial

independence, certainly paying off your student loans is another path, and it really does depend on the individual, what path they want to take. So there's so many loopholes that are way too far down the rabbit hole for, you know, sort of a shorter, shorter episode to talk about. but there's just so many ways to get someone's payment to be a fraction of what you would think it should be and actually have that be a rational decision to make. So student loans are super, super complicated. What that does is reward people who put in the time to really understand the rules of the game so that you can bend those rules to help you live your ideal life versus having the student loans keep you in a debtor's prison where you feel like you can ever do that.

Well, thank you for spending this time with us. Where can people find you if they would like to learn more about you. Student Loanplanner.com is our site where we publish a lot of free content about student loans. And then also the Studio Loan Planner podcast is our podcast show where we delve into all kinds of crazy loopholes and strategies for people who owe large student loan debt that rivals the size of some mortgages out there. Thank you, Travis. That's our show for today.

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