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Student Loan Payments, Interest Are Back in January for Unforgiven Debt. Here's How to Deal With It

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For many federal student loan borrowers, strategizing repayment is critical, given that payments, interest and collections — paused since March 2020 — are expected to resume after Dec. 31.

This is true even as nearly 45% of borrowers, or close to 20 million people, would have their debt fully canceled under President Biden's federal student loan forgiveness plan, according to initial estimates, though recent political developments have reduced eligibility for some loan holders.

If you have student debt that won't be forgiven as part of the Biden plan, the next steps to take depend on a borrower's specific circumstances, according to professionals who advise on student loan matters.

Here are six considerations:

Understanding your forgiveness eligibility comes first

The application for the Biden administration's forgiveness plan is expected to open around early October, and borrowers are advised to apply before Nov. 15 to receive relief before loan payments resume, according to Federal Student Aid

Borrowers with loans held by the U.S. Department of Education are eligible for relief if their individual income is less than $125,000 ($250,000 for households). Eligible borrowers who were Pell Grant recipients can receive up to $20,000 in debt relief; otherwise the maximum relief is up to $10,000. Borrowers whose outstanding loan balance is less than their maximum debt relief amount will receive relief equal to their full loan balance, according to Federal Student Aid.

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Don't try to make repayment decisions based on the expectation of additional broad-based forgiveness, since it is unlikely, said Michele Streeter, senior director of college affordability at The Institute for College Access & Success. There are, however, other relief programs such as Public Service Loan Forgiveness or income-driven repayment forgiveness to factor into the financial analysis. 

Get a handle on your post-forgiveness balance

Loan balances remaining after relief is applied will be re-amortized, according to Federal Student Aid. This means borrowers' monthly payments will be based on their new balance. Loan servicers should communicate the new, potentially lower, amount. 

Some borrowers may want to pay down, or pay off their balance close to when payments resume, to take advantage of the zero-interest environment. "In some cases, knocking out the remaining balance before the restart is a great strategy," said Michael Lux, an attorney and founder of a website dedicated to student loan education, strategy and borrower advocacy. "It's an excellent way to take advantage of the 0% interest and reduce future interest spending on the debt."

This however, may not be an appropriate strategy for everyone.

Investigate other student loan forgiveness options

Some borrowers with larger balances could be better off sticking with minimum payments once they resume in January while they work toward other forgiveness. 

If they haven't already, borrowers should investigate whether they may qualify for additional forgiveness under limited-time changes to the Public Service Loan Forgiveness program, which are available until Oct. 31. They can visit Federal Student Aid's website to learn more.

Borrowers might also be able to benefit from a new income-driven repayment plan proposed by President Biden. Among other things, borrowers would have to pay no more than 5% of their discretionary income monthly on undergraduate loans, said Lindsay Clark, chief borrower advocate at Savi, which provides borrowers with student loan-related advice. "This is down from the 10% available under the most recent income-driven repayment plan," she said.

This could be especially beneficial to lower- and middle-income borrowers with high balances remaining after the government's broad-based forgiveness. However, the proposal still has to work its way through procedural channels, and some experts aren't expecting the new plan to be available until at least the summer. 

Crunch the debt numbers

How to approach repayment is a personal decision based on an individual's overall financial picture.

Lauryn Williams, a certified financial planner who is a member of the CNBC Advisor Council and a senior student loan advisor at Student Loan Planner, offered the hypothetical example of a borrower who makes $75,000 a year, has $170,000 of student loan debt and receives $20,000 of forgiveness. That borrower, whose debt after forgiveness is still twice as much as she earns, is a good candidate for income-driven repayment. 

So instead of rushing to pay down student loan debt, the borrower should consider putting that money into her 401(k) or 403(b). Because student loan payments are based on adjusted gross income, you can get a lower student loan payment by saving for retirement in a pre-tax retirement account, Williams said.

If, however, a borrower who makes $75,000 and will owe $30,000 after the Biden forgiveness relief might consider paying back the loans more aggressively. The borrower could set money aside in a savings account for the next few months, then make a big lump sum payment before year end to lower the loan balance before interest resumes, Williams said.

Borrowers with relatively low balances who are on solid financial footing and don't expect to need the various protections that federal loans offer, including income-driven repayment and forbearance, might also consider refinancing at a lower interest rate with a private lender, Williams said.

The tax factor

Borrowers who have debt forgiven under the Biden plan won't owe federal taxes. But many could be responsible for state taxes. Indiana, for example, recently said that forgiveness will trigger state income taxes, and some borrowers may owe county levies on top of state income tax. Mississippi and North Carolina have made similar announcements, and state-level taxation could be possible in Arkansas, California, Minnesota and Wisconsin. 

Borrowers whose state will or is likely to levy taxes, should ensure they have enough set aside to cover that obligation as they weigh repayment decisions.

The big picture

Borrowers considering making a voluntary payment should also ask their servicer how much outstanding interest they'll owe before they can start to pay off principal, Clark said. When the payment pause lifts, outstanding interest will be capitalized and tacked on to their existing balance. "You might want to pay off the outstanding interest to avoid having an overall larger balance when the pause ends," Clark said.

Borrowers should be sure to think about the bigger financial picture when making decisions about student loan repayments, Lux said. "Borrowers may find it is more beneficial to save for retirement or a home, depending on their student loan interest rate," he said.

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