Q&A: Watch out for shady companies promising to help you repay student loans

Dear Liz: I’m 32 and have a little over $100,000 in student debt from undergraduate and graduate school. I’m trying to get my professional life on track, and I can’t figure out how to pay the loans off. Everything I see online seems shady. What are the questions I need to be asking myself? What are the things I should be searching for on the Internet to help me get control of my financial situation?

Answer: “Shady” is exactly the right word to describe many of the companies promising student loan debt relief. They’re making false promises and charging troubled borrowers fat fees for government help that’s available for free. Many of these outfits get disciplined in one state, only to pop up in another.

If you’re struggling to pay federal student loans, you have several options for making the payments more manageable. You can research income-based repayment programs at StudentLoans.gov. Private student loans don’t have the same consumer protections or numerous repayment options, but you can contact your lenders directly to see what they offer.

The amount of debt you have is large but not insurmountable, especially if it qualified you for a well-paying job.

You don’t have to rush to pay off the federal student loans because those offer low, fixed rates, but you may want to prioritize paying off variable-rate private loans.

Also, don’t let your concern about your debt prevent you from saving for retirement. That, too, will be expensive, and the longer you wait to contribute to a retirement fund, the harder it will be to catch up.

Q&A: When student debt payoff becomes complicated by identity theft

Dear Liz: I went back to school in 2002 to get my teaching credential. I took out several student loans and set up a repayment plan upon graduating with automatic deduction out of my checking account. Several years ago, the IRS started garnishing my bank account stating that there was a lien but I never received any other type of indication what was going on.

After contacting the IRS, we found that someone took out a fraudulent student loan using my former married name. I also got my credit reports, which showed the loan. I was able to get the signed loan documents from the U.S. Department of Education but now the department does not respond to my certified letters or phone calls.

I’m at a loss at what to do at this point. I filed a police report and notified the credit reporting agencies. I’m out almost $10,000. Is there any other advice you could give me?

Answer: First, follow up with the credit bureaus to make sure the fraudulent loan has been removed from your credit reports. Consider setting up credit freezes at all three bureaus to reduce the chances of being victimized again. The Identity Theft Resource Center at www.idtheftcenter.org has more information to help you protect yourself.

Getting the actual loan dismissed and your money back is a more difficult task. You may be able to have the loan erased under what’s known as a false certification discharge, but qualifying for that isn’t easy, said Jay Fleischman, a Los Angeles attorney who specializes in student loan problems.

It’s not enough to have a police report. You’d need to identify and file a lawsuit against the thief. If you can get a court judgment against that person, you would provide the Education Department with that as well as proof of your identity and possibly signature samples from the approximate date of the loan.

Even if you did everything necessary to prove eligibility for discharge, the department could still deny it if you received any benefits from the loan — if it paid any costs of your education instead of someone else’s, Fleishman said.

At this point, you may need to hire an attorney familiar with identity theft issues. You can get referrals from the National Assn. of Consumer Advocates at www.naca.net.

Q&A: When a student loan co-signer dies

Dear Liz: I have a friend who recently died after co-signing a student loan for her son. She was making the payments. Does that loan go to her son now to repay?

Answer: Possibly. Another possibility is that her estate is on the hook.

It all depends on the loan agreement, which varies from private lender to private lender. (We know this is a private loan because federal student loans, which have many more consumer protections, do not require co-signers.)

In many cases, nothing happens if the other borrower takes over the payments and continues to make them on time. Some lenders, however, have a contract clause that makes the balance of the loan due immediately. In the past, lenders also could consider a death to be an “automatic default” that could seriously damage the living borrower’s credit. Fortunately, the Consumer Financial Protection Bureau pushed lenders to change their policies on new and existing loans so that co-signer deaths no longer trigger such defaults.

If you’re close to this young man, you should urge him to check the contract and to contact the lender.

Q&A: Deploying a windfall wisely

Dear Liz: I recently received a $38,000 windfall. I have a student loan balance of $37,000. I want to buy a home, but I can’t decide if I should have a large down payment and continue paying down student loans slowly, or make a balloon payment on my student loans and put down a smaller amount on the home. The mortgage rate would be around 4% while the student loans are at 6.55%. The price of homes in my area is at least $250,000 for a two-bedroom house (which my income supports). I want to make a smart decision.

Answer: At first glance, the answer may seem obvious: Pay down the higher-rate debt. But a deeper look reveals that the second option may be the better course.

Student loan interest is deductible, so your effective interest rate on those loans may be less than 5%. If they’re federal student loans, they have all kinds of consumer protections as well. If you lose your job, for example, you have access to deferral and forbearance as well as income-sensitive repayment plans. In most cases, you don’t need to be in a rush to pay off this tax-advantaged, relatively low-rate debt.

A home purchase may be more time sensitive. Interest rates are already up from their recent lows and may go higher. If you can afford to buy a home and plan to stay put for several years, then you probably shouldn’t delay.

A 10% down payment should be sufficient to get a good loan. You’ll have to pay private mortgage insurance, since you can’t put 20% down, but PMI typically drops off after you’ve built enough equity. You usually can request that PMI be dropped once you’ve paid the mortgage down to 80% of the home’s original value. At 78%, the lender may be required to remove PMI. (Note that these rules apply to conventional mortgages and don’t apply to the mortgage insurance that comes with FHA loans.)

You can use the remaining cash to pay down your student loans, but do so only if you already have a healthy emergency fund. It’s smart to set aside at least 1% of the value of your home each year to cover repairs and maintenance, plus you’ll want at least three months’ worth of mortgage payments in the bank. Even better would be enough cash to cover all your expenses for three months.

Q&A:Prenup may help with student loan issue

Dear Liz: You recently heard from someone who discovered after marriage that his wife had more than $100,000 in student loans. Would having a prenuptial agreement help in this situation?

Answer: Possibly. Debts incurred before marriage are considered separate rather than joint debts, but creditors still sometimes try to go after joint assets to get paid. A prenuptial agreement, which is a written contract created before marriage, could help a couple limit liability for each other’s debts.

In this case, the husband was willing to help his wife resolve the debts, but knowing about them before marriage would have been helpful — to put it mildly. The loans probably would have turned up during the financial disclosures required when drafting a prenuptial agreement. Even couples who won’t consider a prenup should pull their credit reports together so each knows what he or she is getting into.

Q&A: When a new spouse brings surprise debt to the marriage

Dear Liz: I’m 58 and got married for the first time almost two years ago. I discovered my wife has several incredibly large outstanding student loans, including a parent Plus loan for her son’s education that she thought was in deferment and that has nearly doubled to well over $100,000. In addition, my wife has her own student loans, which total over $40,000 and have rates from 3% to nearly 7%. Needless to say, I was shocked and dismayed to discover this debt and wish she had shared it with me earlier.

We have looked into consolidating the loans into the U.S. Department of Education’s student debt relief program, which creates a monthly payment program based on income and forgives the remaining balance after 25 years. I’m uncomfortable with this plan. The long duration of monthly payments would be a big struggle and, after 25 years, we would have paid nearly $40,000 over the current principal even with the outstanding balance being forgiven.

I’m contemplating liquidating all my non-retirement accounts and half of our savings to pay off the larger parent PLUS loan.This would leave us with very little liquid reserve but still some substantial retirement accounts. Our combined income is around $75,000. We would then consolidate my wife’s lower-rate debt and try to take a personal loan out to pay off the higher rate loans if we can secure a lower rate. Do you have any other suggestions as to my options?

Answer: Your situation is a perfect example of why couples should review each other’s credit reports before marriage. At the very least, you could have figured out a plan to deal with the debt at least two years earlier and saved the interest that’s accrued since then.

As you probably know, your wife is stuck with this debt. The government can pursue her to her grave because there’s no statute of limitations on federal student loan debt collections. The government also can take part of her Social Security retirement or disability checks, something collectors of other kinds of debt can’t do. Even bankruptcy isn’t a viable option for most borrowers because student loan debt is extremely hard to get erased.

It’s understandable that you don’t want to be making student loan payments into your 80s, but paying the loans off much faster probably isn’t a reasonable option, given your income. So liquidating other assets to pay off the parent loan may be the best option. The wisdom of this approach, however, depends on how well you’ve saved for retirement, your job security and how much of an emergency fund would remain. If you lost your job after paying off the parent loan, you couldn’t get that money back to pay your expenses. By contrast, you could have your payment lowered under the Department of Education’s plan if you lost a source of income.

Consolidating your wife’s debt inside the federal student loan program would allow her to retain some important consumer protections that aren’t available with other debt, such as the ability to defer payments for up to three years if she faces an economic setback. If you do refinance your wife’s debt with private lenders to lower the rate, consider doing so with a private student loan rather than a personal loan if you want to retain the ability to write off the interest.

This is a complex decision with a lot of moving parts, so you’d be smart to discuss your plan with a fee-only financial planner before deciding what to do.

Q&A: The downside of federal student loans

Dear Liz: Are federal student loans turned over to a collection agency still collectible after 20 years?

Answer: Yes. Very much so. There is no statute of limitations on federal student loans, which means collectors can come after you until you pay or die, whichever comes first. Statutes of limitations on most other types of debt limit how long you can be sued. Federal student loans also typically can’t be erased in bankruptcy.

Those aren’t the only ways federal student loans differ from other debt. The government can seize your tax refunds or take part of your wages without going to court. Even Social Security benefits aren’t protected, as they are from other creditors.

So it makes sense to dig yourself out of this debt if you possibly can. You can find out how to do so at the U.S. Department of Education’s Federal Student Aid site (studentaid.ed.gov).

Q&A: Parents paying a child’s private student loans

Dear Liz: My husband and I are paying my youngest son’s private student loans. My husband is paying two loans and I’m paying three. I have plans to retire next year. Should I tell the lenders after I retire and give my loans to my son to take over?

Answer: If these are private student loans, then you and your husband probably co-signed them with your son. That means you’re equally responsible for the debt and can’t just walk away without consequence.

Some lenders do release co-signers if the student borrower is creditworthy. The lenders typically don’t volunteer information about this option, so your son would need to request it. The Consumer Financial Protection Bureau has a form letter your son can use to ask for information about the process.

If that doesn’t work, your son may be able to refinance or consolidate the loans with a new lender to get your names off the loans.

All this assumes your son is willing and able to take over this responsibility. If he’s not and you stop paying, your credit scores will suffer and you could face collection actions.

Q&A: Co-signing a grandchild’s student loan

Dear Liz: My granddaughter, who will graduate college in a year, has asked me to co-sign her third private loan, which will bring her total debt to $30,000. She needs three people to co-sign. Her parents and the other grandparents have agreed and she wants me to be the third party. I love my granddaughter and trust her intentions, but I really don’t like co-signing a loan for anyone. If I refuse, I’ll really be in the doghouse. Is there any way I could guarantee that I would only be responsible for this loan if the others don’t pay?

Answer: Co-signers are equally responsible for paying a debt. There isn’t a hierarchy. If your granddaughter fails to pay a loan, it will affect the credit reports and credit scores of anyone who co-signed that loan.

It would be unusual for any student loan to require three co-signers. What she may have meant is that her parents co-signed her first loan, her other grandparents co-signed the second and now she wants you to co-sign the third.

In any case, there’s no way to get the guarantee you want. If you’re not comfortable co-signing, don’t. Your family members should be the ones in the doghouse if they pressure you in any way to go along with this scheme.

Q&A: Refinancing an education loan

Dear Liz: You were asked a question about whether it would be wise to refinance a parent PLUS loan through a private lender and you said yes because the interest rates are so much lower. Doesn’t this ignore the benefit of the IRS tax credit? I figured out that my interest rate is effectively a couple of percentage points lower because I get a $2,500 tax credit every year.

Answer: As long as you’re refinancing with another education loan, the interest is still tax deductible. The deduction is “above the line” — meaning you don’t have to itemize to get it. The student loan interest deduction can reduce your taxable income by up to $2,500 if your modified adjusted gross income is less than $80,000 for singles and $160,000 for married couples filing jointly. The amount you can deduct is phased out at higher incomes and disappears after $90,000 for singles and $180,000 for marrieds.

If you’re not clear whether you’re refinancing into an education loan (rather than, say, a personal loan), you should ask your lender.

To clarify, it’s not always a good idea to refinance, even if you get a better rate. That’s because federal education loans have consumer protections that private lenders don’t offer. For example, you can pause your payments for up to three years if you lose your job or have another financial setback. Private lenders may offer hardship deferments, but typically those max out at 12 months.