By Justin Green
According to the CARES Act, federal student loan payments and interest were suspended until Sept. 30, 2020. Recently, President Trump announced an executive memo extending the deadline for the suspension to be extended throughout the end of year. Initially, there was some confusion around the announcement.
The main issue: Can the president make that decision without Congressional approval? A second issue concerned whether skipped payments would count towards loan forgiveness from October until December. Betsy Devos, Secretary of Education, has since confirmed that they will indeed count towards forgiveness. And I don't think the executive memo will be challenged by either political party as both sides support some type of relief for borrowers, but one never knows. So stay tuned for communication from your student loan servicers as they will be required to update you.
If the borrower is currently enrolled in a student loan forgiveness plan, then there is little to no benefit to make any payments during the current freeze. There are many different avenues to student loan forgiveness, but essentially it is a program designed to relieve borrowers of a portion of their debt obligation due to years of low income, public service employment or other qualifying reasons. Student loan forgiveness options are a topic for another post, but beware if that is the track the you're on as a borrower, then strategies 2 and 3 do NOT apply to you.
Assuming the memo holds up then you might be wondering how you should proceed. Here are three ideas:
1. Don't make payments and build your emergency fund.
If you're a young borrower and haven't built up an emergency fund of 3- 6 months of living expenses, then now would be a good time to accumulate one. Take advantage of being allowed to skip student loan payments by redirecting those payment amounts straight into a savings account. This has multiple benefits, including the ability to increase your emergency fund. It also prevents you from getting used to having that extra income to spend and then falling victim to what is called "lifestyle creep". By redirecting the skipped payments into savings, it will be like you never had the extra money to begin with and you won't feel such a shock when payments resume.
A similar strategy could be used if you are carrying high-interest credit card debt. Shift the monthly loan amount to the high-interest credit card or another higher cost loan rather than pay on the student loan until required to do so.
If you are pursuing student loan forgiveness, then most likely you shouldn't be making payments. The payments will reduce the amount of principal eventually forgiven.
2. Make normal payments and reduce the principal owed.
Maybe you're a borrower with a sufficient emergency fund, no high-interest debt and are fortunate enough to have your income unaffected by the pandemic. If that's you, then consider continuing to make the normal monthly payments. You will be able to make a bigger dent in your loans as your full payment will be applied to principal rather seeing a portion directed toward paying interest. Also, you will never miss a beat. When the student loan payments kick back in, you won't have to readjust your budget to account for the payments.
Keep in mind, this strategy does not make sense for borrowers pursuing student loan forgiveness.
3. Accelerate payments
If you fit into Scenario 2, but you've been really fortunate and are in a situation where you have a significant amount of discretionary income each month, then maybe now is a good time to accelerate your student loan payments. The entirety of your payments will reduce the principal, and this ultimately could take months off of your repayment schedule.
All in all, the point of the suspension of payments and interest is to provide relief to borrowers so don't feel guilty if you're not able to pay on your loans right now. Borrowers have options and there is no one right option for every borrower.
Justin Green, MSPFP, CFP®
Justin is a financial planner at Four Ponds Financial Planning. His areas of focus include financial planning for young professionals, student loan guidance and retirement advice. He earned his Bachelor of Science degree at State University of New York at Cortland and his Master of Science in Personal Financial Planning from Kansas State University. He is a member of the Financial Planning Association (FPA) and Garrett Planning Network. He volunteers as a member of the FPA of Massachusetts NexGen Committee.