Are you struggling with what to do with your student loan payment after becoming a trailing spouse? If so, you are not alone. Though my family doesn’t have any student loan balances anymore, I’ve come to know many men and women receiving their professional and graduate degrees right around the same time they followed their spouses to their overseas career. They never got the chance to fully receive the return on their educational investment, while at the same time were burdened by large student loan balances.
Student loan issues are especially acute for trailing spouses and their families because of the loss of earning potential. While most of us strive to continue our career and income, it’s not always a straight path. We often have to endure periods of no or low income, and lack of continuity in our income history.
The beginning of income-driven payment plans for federal student loans reduced the burden of making payments somewhat; however, it also introduced another level of complexity in managing student loan debt and household finance in general. In this post, I’d like to outline a system to help you make basic payment decisions, and share strategies to deal with some common scenarios expat families face.
While there are many student loan payment strategies, they can be summarized into three decision points:
Private vs. Federal
The income-driven payment plans (and the ultimate forgiveness of balance) are only available for federal student loans. Whatever loans you took out with private lenders are treated just like any other unsecured personal debt – it’s your responsibility. In fact, student loans are even more burdensome because they are unlikely to be discharged during personal bankruptcy proceedings.
If you have private loans, the first step is to find out what special provision is available to you in case of unemployment, disability, or death. Will you or your co-signers have to keep making the payments no matter what? Or they allow you to temporarily stop the payment, forgive part of your payment or balance, or even discharge the loan in whole? If the rules for payments are stringent, look into refinancing with other private lenders who may offer you some protection with similar (or even lower) interest rates.
The worst-case scenario is you or your co-signers are stuck with the payments until the balance is completely paid off. In this case, you need to have proper disability and life insurance coverage on the income where the payments come from. You also should look into making accelerated payments or keeping a larger than normal emergency fund to cover periods of unemployment.
Income-Driven vs. Standard Payment Plan
For your federal student loans, you now have the options to choose between income-driven plans and standard payment plans. (Check your eligibility for different types of income-driven plans.) Income-driven plans usually cap your payments at 10% or 15% of your disposable income, while the standard payment plans simply amortize your loan over a 10 or 15-year payment period so you have fixed payments every single month.
It is worth noting that your student loan servicers usually look at your adjusted gross income on the latest filed tax return to determine your income level. If you file jointly with your spouse, your joint income level will be used. So for trailing spouses with large loan balances and little to no income in sight, filing your tax return separately from your spouse may significantly lower your monthly payments. However, married filing separately comes with its own tax disadvantages. Therefore, you should do a calculation on the savings on loan payments versus increase in taxes for the household before proceeding.
Paid-off vs. Forgiven Balance
Under the standard payment plan, you are supposed to pay off the loan balance in 10 to 30 years, and that’s the end of your responsibility.
If you choose income-driven plans, your balance is forgiven after 20-25 years worth of payments; however, the remaining balance is taxable as income in the year of forgiveness. So if you have no income for 25 years and make no payments, you still have a large responsibility at the end of 25 years, given that the loan balance may grow from all the unpaid interest.
(Although some cancelled debt may end up being tax free due to insolvency, I’d hope that you actually have a large positive net worth after 25 years, which makes you solvent.)
One exception would be if you make 10 years worth of the monthly payments (120 times non-consecutive) while being a full-time employee for any organization that qualifies under the Public Service Loan Forgiveness (PSLF) program. Your balance is forgiven after 10 years and the forgiveness amount is tax-free.
Another exception is the Teacher Loan Forgiveness Program, in which the borrower’s loan balance is forgiven after five years of consecutive qualifying teacher service. Given the nature of our nomad lifestyle, it would be much harder for you to qualify under this program.
So how do these decision points work in real life scenarios for trailing spouses? Below are some possible situations you are in and the strategies you can employ to manage student loans.
#1: Stable full income from a portable career in the foreseeable future
Congratulations on having good earning prospects! In this scenario, your decision is similar to anyone with a stable career.
First, determine whether you would pay off federal loans in full. If you will likely qualify for some loan forgiveness program like PSLF, choose the payment schedule that gives you the lowest monthly payment possible. Otherwise, choose the payment schedule that has the lowest lifetime cost that also fits into your budget without compromising retirement savings.
The lifetime cost doesn’t just include your total payments, but also the tax on the forgiven loan amount if applicable. For the more sophisticated, you may even apply an inflation adjustment on payments over the life of the loan.
If you have additional private loans payments on top of federal loans, and the total payment is above 10% of your income or at an unaffordable level, look into refinancing the private loans with adjustable interest to lower monthly payments, and pay down principal more aggressively to lower lifetime cost.
On the other hand, you may have surplus in your budget and wonder whether you should pay down student loans faster or invest the money instead. The rule of thumb is that if your investment’s after-tax rate of return is likely to be lower than the student loan interest rate, then paying down principal is more beneficial.
Usually you’d start paying extra toward the loan with the highest interest rate. However, depending on your risk capacity, you may choose to pay off private loans first even if they have lower interest rate than federal loans. The reason is that federal loans have greater protection and more flexible payment plans. Just because you are able to afford all the payments now, it doesn’t necessary mean your situation won’t change. You need to do the calculation on whether the saving in interest is worth giving up the flexibility and protection.
#2: Unknown job prospects from one country to the next, but usually full income when you find a job
If you are not employed on a telework arrangement or self-employed, it’s likely you need to quit your jobs and find new ones in different countries every few years. And there are bound to be some gaps between your full-time jobs.
For your federal loans, you have the options to switch between standard payment plan and income-driven ones as your circumstances change. However, if you are unlikely to qualify for loan forgiveness, either at 10 years or 25 years, switching to lower payments during periods of unemployment will only capitalize more unpaid interest to the original principal.
To give you more flexibility, instead of making additional payments toward the principal when you have full-time income, make monthly payments in advance so you don’t have to make any payments during periods of unemployment as you move from one country to the next. You may not be able to reduce interest cost that way, but it gives you more flexibility to stay current with your payments.
The same principal applies to your private student loan payments. If your budget is tight enough that you are unable to make extra payments, you should find out in advance whether you are able to apply for deferment or forbearance during your unemployment and their cost.
#3: Portable career from one country to the next, but low or unstable income relative to spouse
If you have large student loan debt and low income, while your spouse has no debt and high income, filing separately may actually be more beneficial for the household. In this case, the saving in federal student loan payments from an income-driven plan can be larger than the increase in tax liability if you file separately.
In addition, if you also happen to work full-time for an organization that qualifies you for loan forgiveness, such as for a 501(c)(3) non-profit, your loan balance is forgiven tax-free in 10 years. You may end up paying very little over the life of the loan.
Of course, filing separately is not always better. You need to do the calculations to know which filing method saves you money over time. The easiest way to do this is to use the studentloans.gov calculator to estimate your payments under different filing methods, and use tax software like Turbo Tax to estimate your tax liability under filing jointly or separately. If loan forgiveness won’t be an issue, you will want to see that:
Tax(Separate) – Tax(Joint) < Loan Payment(Separate) – Loan Payment(Joint)
It’s also possible that your income may gradually grow and stabilize, which turns you into someone in the #1 scenario. Your can also approach your private loan payments similarly as laid out in #1.
#4: No or little income in sight, either due to circumstances or your own choice
When you don’t have income at all for an extended period of time, it sometimes can be more beneficial to simply work the lowest payment possible into your spouse’s income. You will have to do the math.
While it’s tempting to file separately so you don’t have to make any student loan payments to your federal loans at all when you are not working, you are actually growing your principal balance by not paying anything toward interest. On the other hand, the tax liability for the working spouse will most likely be higher if filing on his/her own. So the total cost will be the tax on the ballooned principal in 25 years, plus the extra tax payments every year.
You will need to compare that to simply making minimum payments based on the Adjusted Gross Income for filing jointly, and possibly paying off the loan before 25 years. For many, simply paying monthly out of the working spouse’s income might come out ahead.
If you also have payments for private student loans, that might change the calculation. Just remember that eventually you want to choose the method with the lowest cost over the lifetime of all the loans, while at the same time making sure you can afford the monthly payments in your household budget.
(If you are in the #4 scenario, you might be interested in checking out the “Income Strategies for Trailing Spouses” series.)
In summary, there is no one best rule for how to manage your student loan, especially when your household income fluctuates significantly. Just remember that lifetime cost, monthly budget, and flexibility are all important, and you need to adjust the weight of each according to your own situation.