Morningstar Column - Student Loans: A Road Map for Advisors

By Phuong Luong

This article was originally published on Morningstar.com on February 12, 2021.

One of the most common questions for financial advisors working with millennials is, “What should I do about my student loans?”

As an elder millennial, I do not remember a world without student loans--without promissory notes, student loan entrance and exit counseling, and repayment plan options. I vividly remember the anxiety I felt as a teenager and first-generation college student when I signed a complex contract made up only of fine print for thousands of dollars of educational loans. Borrowers in my age cohort have the highest average outstanding student loan debt of all borrowers--$42,600--and “an end balance 287% higher than the value of their original loan.” Student loan debt is a highly personal topic for me and my peers.

Unfortunately, student loan issues are more relevant now than ever before, and not just for millennial clients and their advisors. There’s now more student loan debt than credit card debt in the United States, with 42 million Americans of all ages owing $36,520 on average and over 65% of today’s college students graduating with student debt.

The problem has grown quickly, and rules surrounding student loans change often, so it’s difficult for advisors to keep track of how to best support clients in this area. My goal of this two-part series isn’t to make you a student loan expert, but to share what I’ve learned advising clients across income and wealth spectrums. In the second installment, I’ll also share referral resources to student loan experts and advocacy groups, so you can better advise and support clients with student debt.

Student Loan Borrowers Aren’t Who You Think They Are
Media attention on student loan borrowers tends to focus on millennial borrowers in white collar roles. In reality, student loan borrowers are a highly diverse group that cuts across demographics such as educational attainment, income, race, and age. If you currently don’t have clients with student loan debt, either personally or in their family, there’s a good chance you will.

Early in my career, I worked with a client whose employer required her to earn an advanced degree to maintain her job while she was in her mid-50s and after having been in her role for four decades. She's in her 60s now and will be carrying $35,000 in federal student loan debt into her retirement years.

The data show that 2.8 million or 5.3% of adults aged 60 years and older have student loans to their name. The chart below shows the average student loan debt by age group by the end of 2020:

Education Data provides excellent research and statistics on the state of student loan debt in the U.S. that help paint who today’s student loan borrowers are and their situations:

• Among adults with student loan debt, 93% report borrowing to pay for their own education, while 81% report borrowing to pay for a child’s or grandchild’s education.

• 30% of borrowers have a student loan debt balance between $20,000 and $40,000, and 6% of borrowers owe more than $100,000.

Student loans are an issue for clients across the income and wealth spectrum. But there are clear inequities in who is borrowing and how much they must borrow for their education that stem from systemic inequality and racial wealth divides. According to Education Data:

• First-generation college students are twice as likely to report they are behind in making student loan payments.

• 54% of all student loan debt is held by white and Caucasian student borrowers--while making up about 61% of the U.S. population.

• 20% of loans go to Black students--while making up about 13% of the U.S. population.

• Black and African American college graduates owe an average of $25,000 more in student loan debt than white college graduates.

• American Indian and Alaska Native student borrowers owe the highest monthly payments.

• Hispanic and Latino borrowers were the most likely to delay getting married and having children because of student loan debt.

Common Student Loan Financial Planning Scenarios 
The two main types of student loans are federal student loans and private student loans. Ninety-two percent of student loan debt is funded by the federal government and about 8% is from private lenders. In the different financial planning scenarios I’ll share here, I’m most often referring to federal student loan rules and strategies because they make up the majority of student loan debt and have more borrower protections and repayment options compared with private debt. 

One of the most common situations I’ve seen as a financial planner are borrowers who have graduated college and earn around $60,000-$70,000 in annual income with $30,000-$60,000 in student loan debt. These clients are likely paying at least the standard minimum payment on their student loans.

Clients with lower incomes and high debt burdens are often unable to pay their minimum monthly payments because of limited room in their budgets. They are frequently in deferment or forbearance or are enrolled in income-driven repayment plans that reduce their required monthly payments but extend the life of their loans. This often leads to negative amortization, where the outstanding balance is growing even while required income-driven payments are made. These borrowers tend to be candidates for debt-forgiveness programs, if possible.

However, it’s important to note that income level is not an eligibility test for federal debt-forgiveness programs. Lauryn Williams, CFP, CSLP, founder of Worth Winning, specializes in student loan planning and is also a consultant at Student Loan Planner. Her clients with student loans tend to have gone to professional--medical, dental, law, business--school and have incomes above six figures but similarly large amounts of debt also in the six figures. Depending on client goals and situations, Williams advises that these clients “have to examine their loans closely because they might need to aim for debt forgiveness or pay the loans back aggressively.”

To help clients plan a course of action, Williams recommends reviewing a clients’ student loan debt/income ratio. According to Williams, “I would say if you owe more than 1.5 times what you make, then you are a candidate for forgiveness. It is more about debt/income ratio than about earnings. For example, a doctor could earn $150,000 per year. They could also have $500,000 of student debt, which is more than 3 times what they make. That is not a person who should be trying to aggressively pay down debt.”

Ben Martinek, EA, CSLP, CFP, with Student Loan Tax Experts agrees that paying attention to a client’s individual debt/income ratio is key to devising a sound strategy for repayment. This becomes more complex when working with client couples, who frequently have student-loan-related tax-planning needs. Martinek offers the following scenario: “Let’s say an individual makes $225,000 and doesn't have any student loans. Their spouse works at a nonprofit, makes $75,000, and carries $150,000 in student loan debt. In this arrangement, the individual income/debt ratio is 2:1. Pursuing Public Service Loan Forgiveness (PSLF) can make sense [in the long term], but it will require that the couple files their tax return separately and incur a modest temporary increase in [annual] tax liability.”

Some of the most complex situations are borrowers with loans in default and lower incomes.

This is not an uncommon situation: 25% of borrowers default within their first five years of repayment. They may not have finished school, have been victims of predatory lending from for-profit institutions, or have had difficulty finding jobs that pay enough to cover living expenses and their student loan debt. They might benefit from deliberately seeking employment that qualifies for loan forgiveness or checking if their loans are eligible for discharge or cancelation.

The First Step for Advisors
There is no one-size-fits-all approach to student loan planning. Sound financial planning for student loan borrowers requires understanding their goals, current income and income trajectory, the types of student loans they have and their balances, and potential tax implications. Here’s how to start:

1) Understand your client’s goals. The client may want to own a home, but perhaps the monthly cost of servicing debt is in the way, so they’d like to lower their monthly payments somehow. Or the client may simply want to be debt-free and is not sure about other goals yet. It’s important to understand the timeline as well. Some clients may be eager to clear all debt as soon as possible, and some may want to stretch out payments over a fixed, graduated, or income-driven repayment plan.

2) Track down all of the loans. The client may have federal student loans, private student loans from conventional lenders, or a combination of both. 

• Federal student loans: To get a clear picture of a client’s federal student loans, have them log into their U.S. Department of Education Student Aid profile. In the dropdown that appears on the top right, select My Aid. From there, the client can click Download My Aid Data to download a .txt file. The client or advisor can then upload the .txt file into a free student loan planning tool from the VIN Foundation to see a summary of their loans and access a repayment simulator to explore different scenarios. VIN's Upload My Aid Data File tool was made for veterinary students, but it is applicable for any borrower with federal student loans.

• Private student loans: Pull their credit report at www.annualcreditreport.com to see all of their private student debt owed. Federal student loans will appear as well, but important details will not be available from the credit report alone.

• Request their most recent student loan statements from all student loan lenders.

3) Check the loan status(es). The client may have loans that are in good standing, late, or in default. Note the type of repayment schedule, minimum monthly payment amount, and the interest rates.

Next Steps
In Part 2 of this two-part series on student loans, I’ll provide recommendations for the most common student loan questions and expert resources to add to your advisor tool kit for clients.