This is the first in an occasional series looking at the student loan crisis and the role advisers play in navigating it.
When Ian Aquilino, 23, graduated from Penn State University last year, he kicked off what's become a rite of passage for many of today's youth: chipping away at his student loan debts.
The New York-based actuarial assistant wrapped up his college education with some $42,000 in student loan debt — the sum total of a variety of loans, including a private loan with a variable rate that's now at 8.5%. About 20% of his net pay — $500 a month — goes toward servicing these debts, which he's managed to reduce to about $34,000.
Mr. Aquilino said the debts were necessary to launch his career.
“I come from a lower-middle-class family that didn't have any savings,” he said, noting that he's a first-generation college student. “My parents didn't understand the cost, and we did not have a lot of money when I was growing up.”
The private loan, his most costly obligation, began with a rate of 6%, which Mr. Aquilino admits “wasn't great, but I had no choice.”
The lion's share of his net pay goes toward paying his rent and servicing his debt. He even makes extra payments to cut the principal amount. Though Mr. Aquilino participates in his company's 401(k) plan and receives a matching contribution, the outlay related to paying the debt is deterring him from socking away more.
“If I didn't have these loans, I'd have extra money to save for the purchase of my first home,” Mr. Aquilino said. “I wouldn't be buying right now, but when I do, it's going to be very expensive, and the down payment is a large sum.”
He is not alone. As the cost of higher education escalates beyond the realm of the reasonable, millions of young Americans find themselves with too much debt. Under such a crushing load, many are forced to put off buying homes and achieving other milestones of adult life. Oppressive debt also jeopardizes their ability to prepare for their own retirement.
A growing number of financial advisers are finding themselves on the front lines in the battle to reduce — or at least manage — college debt.
“I see a lot of pre-financial planning clients who are looking for help with cash flow, emergency savings and getting the debt under control,” said financial planner Leah Manderson.
NEED FOR RELIEF
Last Monday, President Barack Obama issued a presidential memorandum directing Education Secretary Arne Duncan to issue regulations that would expand the existing Pay As You Earn plan to allow nearly 5 million federal direct student loan borrowers a chance to cap their repayments at 10% of their income. The president hopes to make the repayment option available to borrowers by the end of 2015.
But there also was disappointment in Washington for indebted graduates. The Bank on Students Emergency Loan Refinancing Act, proposed by Sen. Elizabeth Warren (D-Mass.), which would have let student borrowers refinance their loans at a lower rate, went down in a 56-38 Senate vote. It needed 60 to end debate and allow for a final vote on the floor.
The need for relief is clear, however. According to the president's memo, 71% of students with a bachelor's degree graduate with average debt of $29,400.
Managing such debt has become the centerpiece of financial planning with these clients. It's the new reality of working with the 20- and 30-something crowd.
“Student loan planning is becoming more of a priority for these clients,” said Sophia Bera, a fee-only adviser and founder of Gen Y Planning.
It's fairly common for such clients to have eight to 10 student loans by the time their education is wrapped up.
Even if a graduate is on track to haul in big earnings, it's going to take time for him or her to reach full potential.
Until then, borrowers are preoccupied with servicing their debts and meeting their living expenses. Stretching those dollars to build an emergency fund or save for retirement becomes all the more difficult.
It's not just graduates with humanities degrees who struggle with repayment.
Ms. Manderson, who works on guiding Gen Y clients on debt management, said a few student loan debts won't sink anyone. “But it's when it's six figures of loan debt for people in professional services — even with those salaries it can be a bit of trouble from a cash-flow perspective.
That's where help from an adviser comes in.
First, cash is king with these clients.
“With younger people, the cash flow is important to them — it's not the size of the loan but the amount they pay each month toward that loan,” said Eric Roberge, an adviser with Beyond Your Hammock. “If we can decrease that burden each month [via a program that caps repayment as a portion of income], then they'll have room to save for retirement.”
HELP IS AVAILABLE
When it comes to working with debt-laden students and their parents in the process of repayment, advisers would do well to get familiar with programs that can help ease the process.
For example, the Public Service Loan Forgiveness Program is for graduates who work full time in public service jobs. Under the program, borrowers may qualify to have the remaining balance of their federal direct loans forgiven after making 120 qualifying payments.
Thomas Brooks, founder of Alliance Financial Services and College Funding Advisors, is familiar with this program, as his two daughters are public service employees and he's helping them with their loan repayments.
“Don't forget that [public service workers] aren't earning a lot in the beginning, and the fact that there's forgiveness after 10 years — 10 years is enough,” said Mr. Brooks. “They did this to become good citizens.”
Under Pay As You Earn, which went into effect in December 2012, the applicant must have a partial financial hardship, a status that's triggered when the monthly amount they would have to pay on their federal direct student loans under a 10-year standard repayment plan is higher than 10% of their discretionary income. Loan balances may be forgiven after 20 years.
There's also the Income-Based Repayment (IBR) program, which has been available since 2009 and allows borrowers with a partial financial hardship to cap their federal student loan payments at 15% of their discretionary income if they make timely payments. Borrowers may be eligible for forgiveness after 25 years of faithful repayment.
As far as figuring out how best to juggle repayment with other competing priorities, advisers need to ensure clients prioritize the costliest and most difficult-to-retire debt first, and then retire credit card debts as quickly as possible.
Meanwhile, Ms. Bera said the key is to pay off any private loans, as they aren't eligible for federal forgiveness programs.
“Take care of the private loans first and pay them down as quickly as possible,” she said.
Clients should also examine their eligibility for Pay As You Earn and other programs that will help them handle repayment of their federal direct student loans while on a low salary.
In its current form, Pay As You Earn applies only to those who began borrowing after October 2007. The president's revision would expand that eligibility to include students who borrowed before that period.
From there, work on building an emergency fund. Ms. Bera recommends building that fund with three to six months' worth of net pay. Couples can skew a little closer toward the three-month figure, but sole breadwinners and singles should sock away more, she noted.
Finally, make sure your young client is putting as much toward his or her retirement plan as possible — and that he or she is eligible for the employee match, Ms. Bera said.
On the horizon, advisers need to warn clients that if they participate in the Income-Based Repayment program, their forgiven debt may be taxable as income.
“As you move closer to the loan forgiveness point — within five years — it would be better to have the cash set aside for the tax bill,” Ms. Bera said.
Because many of these programs are relatively new, their full impact on loan forgiveness is far down the line.
“We're going to see the issues of people having $100,000 in loans forgiven after 20 years and the huge tax bill that comes with that,” Ms. Bera added.