If you’re still waiting for your tax refund but are far behind on your student loan repayments, you might want to rethink any big plans you had for spending your refund. That’s because there’s a good chance the government is going to apply that refund to your outstanding payments instead of sending it to you.
If you are in default on your federal student loans (late on your payments by 270 days or more), the Department of Education can take your tax refund using the Treasury Offset Program. This program authorizes the interception of federal payments — such as tax refunds or Social Security income — in whole or in part to pay debts owed to other federal agencies. There are some limited consumer protections, but debtors aren’t always aware of them.
Here are several things to keep in mind.
1. Heed the Notice
First, people who have student loans in default get a notice warning them in advance that they are at risk of having any potential tax refund seized for student loan repayment, Jay Fleischman, a student loan and bankruptcy attorney, told Credit.com in 2015. That notice contains instructions for a review of your loan information and how to avoid the offset.
2. Request a Hearing
If your refund is taken, you can still request a hearing. If it was taken in error, the money will be refunded. However, be aware what constitutes as an error does not generally include your not having received a notice. A successful hearing on your behalf would typically require you be able to prove your student loan was not in default.
The one case in which you are likely to be able to recover the money is if you filed jointly with a spouse, and it was his or her student loan that was in default. “You may be able to make an injured spouse claim,” said Fleischman.
3. Review Your Withholdings
It’s also a good idea to adjust your withholdings whether you’re subject to a tax refund offset or not, because a large tax refund means you overpaid your taxes during the year. If you are in default on your federal student loans, you probably need that money. But at this point, there is nothing you can do to change the overwithholding from last year. Still, revisiting how much you’re having withheld for taxes is a smart move for anyone who got a large refund.
4. Get Back on Track
The bigger problem is how you are going to deal with the default on your student loans from now on. You’ll want to get out of default and keep it that way. Fortunately, there are many payment options; you should be able to make one work for you. In some cases, income-based repayment payments can be set as low as $0. It might also be worth looking at whether you qualify to have some or all of your student loans forgiven.
There are some options for people who are behind on payments to get back on track, though, even if forgiveness isn’t an option. To get out of default, you can combine eligible loans with a federal Direct Consolidation Loan or visit the government’s default rehabilitation program. If you make nine consecutive on-time payments (the payments can be extremely low), your account goes back into good standing, and the default is removed from your credit report.
Defaulting on a loan seriously damages your credit score, and because student loans are rarely discharged in bankruptcy, the debt can beat down on you for decades. (You can see how your student loans are currently impacting your credit scores for free on Credit.com.)
Much has been made of the student loan problem. While you’d be hard pressed to find disagreement that it’s an issue, there is plenty of disagreement about how bad things really are. On the one hand, it’s easy to find stories chronicling massive default rates (12%), oppressive $800-a-month loan payments and the big one: total outstanding student loan debt now dwarfs total credit card debt.
On the other hand, many folks argue persuasively that the problem is not as bad as one might think. A 2014 study by Goldman Sachs, for example, found that former students with $30,000 in debt (about average at the time) were no less likely to buy a home than their debt-free peers. Students with an average college debt load who select 20-year repayment terms end up with monthly payments that are just shy of $300 — a significant amount, surely, but roughly the same as a car payment. Isn’t college worth that?
Student loan expert Mark Kantrowitz added both science and sanity to this debate recently with publication of a paper titled “Who Graduates with Excessive Student Loan Debt?” In it, he makes the case for a reasonable formula to asses just how much student loan debt is too much. He then goes on to untangle the available research showing the real-life consequences faced by those with too much debt — and in fact, all Americans, because consequences like “delayed household formation” impact everyone.
First, the math.
There’s no arguing that student loan debt has ballooned — overtaking total credit card debt in 2010, total auto loans in 2011, and topping $1 trillion in 2012. Only total mortgage debt is bigger now. To put a finer point on it, some more dramatic numbers: Only 46% of college graduates left school with debt in 1993, and it averaged $9,320. Last year, 71% left school with an average of $35,051 in debt.
Connecting Increased Income Potential With Debt
But how much debt is too much? After all, $35,000 could be a huge mountain for a kindergarten teacher earning $25,000 annually; but to a Wall Street trader earning a six-figure salary, that $300 monthly payment sounds like beer money. So it’s important to connect increased income potential with debt to really calculate what is “too much debt.” Here’s how Kantrowitz, publisher and VP of Strategy at Cappex.com, figures it:
Half the income increase attributed to a college degree should be enough to repay the student loan within 10 years. If half the extra income coming in doesn’t pay off the loan in 10 years, the student probably overpaid.
Using data from 2013, Kantrowitz shows that college graduates ages 25-34 earn a median of $18,530 more annually than their peers who didn’t graduate from college. After taxes, that yields $10,655 per year, and half of that is a touch over $5,000, or a little more than 10% of income available to repay student loans.
Here’s How the Formula Works
As one example, Kantrowitz cites the average starting salary of a former student with a humanities degree at $45,000, compared to $30,000 for a high school graduate. After taxes, that works out to a $9,000 annual “college degree” bonus. Half of that is $4,500, which is 10% of income, and enough to service an average $35,000 debt over 10 years.
An even simpler rule of thumb Kantrowitz uses argues that students should not take out student loans that exceed their expected first-year salary — so if you think you’ll earn $40,000 as an entry-level accountant, that should be the upper limit of borrowing. That corresponds roughly to paying off the loan with 10% of income over 10 years, arriving at the same places as the calculation above.
Not a bad deal. But how many students end up on wrong side of that math? About one in four borrowers.
By this measure, Kantrowitz calculates that 27.2% of students graduating with debt have too much debt, and can’t repay their loans using the 10%-for-10-years model. In addition, women are more likely to graduate with excessive debt than men (29.1% to 24.3%), “mostly due to women earning lower income than men after graduate,” Kantrowitz says.
Meanwhile, the “too much debt” line is also partly dependent on major. Students majoring in theology (64.7%), law and legal studies (43.1%), communications (36.2%), agriculture (34.1%), education (33.9%), humanities (33.5%) and design (33.1%) are more likely to graduate with excessive debt. On the other side, engineering (16.3%) and computer science (23.8%) students are on the right side of the debt line.
The Consequences of Too Much Student Loan Debt
What does all that mean to the graduates? And to society? There are dramatic, and specific consequences to leaving school with too much debt. Here are the highlights from Kantrowitz’s paper, which references a Department of Education longitudinal study of college graduates.
Those with too much college debt were more likely to:
Delay buying a home (49.8% vs. 38.1% of those without excessive debt)
Delay getting married (27.1% vs. 20.9%)
Delay having children (36.4% vs. 27.9%)
Take a job instead of enrolling in further postsecondary education (43.3% vs. 33.0%)
Take a job outside of field (50.8% vs. 36.4%)
Work more than desired (47.8% vs. 36.4%)
Work more than one job (33.0% vs. 23.4%)
In short, debt prevents college graduates from following their dreams, from working in their field of study (making college a bit of a waste), makes them more likely to delay starting a family, and makes them more likely to work a second job.
Other research shows indebted young people are less likely to create startup companies or engage in entrepreneurship. Of course. It’s hard to fund a start-up when you are still paying for college.
Perhaps you went to college back when tuition could be earned with a few months’ summer work, and don’t feel the need to worry about student debt right now. That’s misguided. Wrap all those negative consequences together and you get what sociologists call “delayed household formation.” This has serious consequences for overall economic activity. From the obvious: if young people in their 20s aren’t buying starter homes, families in their 30s and 40s have trouble selling starter homes and trading up; To the less obvious: Young people who live in their parents’ homes aren’t buying couches and rugs, let alone toilet bowl brushes and coffee makers.
These impacts can be seen across the economy. For example, furniture analyst firm firm ABTV warned about in a report last year.
“It’s a sticky wicket: Baby Boomers are downsizing to smaller spaces, new home sales are increasing gradually, but mortgage reforms have made it difficult for younger homeowners to qualify, given the debt loads many are carrying from student loans,” the report said.
Discussions of student loan debt often descend into loud arguments over whether young people are spoiled and why they don’t deserve “free college,” a debate that’s become even more raucous thanks in part to presidential candidate Bernie Sanders campaign platform. Plenty of other proposals, by candidates in both parties, have sought to ease the student loan debt burden on young people, an obviously popular topic with millennials.
Whatever your views of free college or debt relief, it’s undeniable that reforms are needed. They begin with making sure college is a good value for former students. A degree that requires more than 10 years to repay is not only a bad deal for them, it’s a bad deal for everyone.
If you want to see how your student loans may be impacting your credit, you can get a free copy of your credit reports from each of the major credit bureaus annually. Also, you can look at your free credit scores, updated monthly on Credit.com, which will also show you major credit scoring factors like payment history.
If you’re already behind on payments, there are some options available to help you get back on track, even if forgiveness isn’t an option. To get out of default, you can combine eligible loans with a federal Direct Consolidation Loan, or you can go through the government’s default rehabilitation program. If you make nine consecutive on-time payments (the payments can be extremely low), your account goes back into good standing, and the default is removed from your credit report.
Nearly 70% of student loan borrowers whose loans have gone into default could have qualified for reduced, income-based repayment plans, thus avoiding the late fees, bad credit and stress that go hand-in-hand with falling behind. That’s why the government wants to raise awareness about the various ways student loans can be repaid.
To that end, the Department of Education and the Consumer Financial Protection Bureau have come up with a free, personalized guide to student loan repayment options called the Payback Playbook.
About 43 million Americans owe student loan debt, with outstanding debt estimated at $1.3 trillion.
“Millions of consumers needlessly fall behind on their student loan debt, despite their right under federal law to a payment they can afford,” said CFPB Director Richard Cordray in a prepared statement.
A screengrab of the Payback Playbook prototype, showing repayment options.
Here’s how the proposed playbooks would work:
Borrowers entering into repayment after graduation would receive the playbook from their servicer, which will hopefully help cut through some of the information clutter by clearly presenting three personalized repayment options.
Struggling borrowers who have missed a payment or are at risk of default will receive a playbook that provides a single option with personalized instructions written in plain language describing how to lower their monthly payment.
The Department of Education offers numerous plans to borrowers with federal student loans that help make payments more affordable. These include options that let borrowers set their monthly payment based on their income.