When it comes to college and money, everyone is focused on getting money for college this year or wondering whether the new administration will forgive some student loans of the past. But with the tax return deadline now pushed to May 17, you might want to also focus on the tax implications of scholarships, loan payments and that pile of interest building up inside your student loan balance.
The Impact of Interest
From the start of the student loan process, remember that it’s not just the amount you borrow for a college education that matters. It’s the interest rate you pay. And, sadly, you have very little control over the rates you pay. All federal student loans carry fixed high rates for the life of the loan. That includes Direct PLUS loans that parents of undergraduates take out, which carry the highest rates and fees. Private student loan lenders demand co-signers — and they still charge exorbitant rates.
What’s the impact of those rates over time? The Squared Away Blog at the Center for Retirement Research at Boston College reports that former students currently owe more than they initially borrowed on two-thirds of the college loans made in the past decade!
Many of those former students kept current on their payments but took advantage of various income based payment plans that lowered their monthly cost. However, the interest on the outstanding balance kept accruing! That’s truly an example of being buried in debt.
Refinancing either private or federal student loans is almost impossible unless you have good credit and a high income. Then you can go to Credible.com or Sofi.com and perhaps get a lower rate. But if you refinance federal loans, you can never again use benefits like deferral or forbearance. And bankruptcy is not an option for discharging student loans.
The only possible way to significantly lower the rate on a student loan, is for the parent to refinance a home mortgage and pull equity out to pay off the loan. That portion of the mortgage interest won’t be deductible, but the savings on interest will be significant.
The Potential for Deductions and Credits
CollegeFinance.com, a site dedicated to helping students and parents understand and compare loans, has an enlightening article about all of the ways to take advantage of existing tax laws to reduce the burden.
Here are the highlights:
—Student loan interest deduction: The federal government allows up to $2,500 of your federal and/or private student loan interest charges to be deducted from your taxable income for tax year 2020 if Modified Adjusted Gross Income is below $70,000 as a single filer. The deduction phases out for income between $70,000 and $85,000. To qualify, the loan must be in the tax filer’s name.
—Tuition and fees deduction: 2020 is the last federal tax year the tuition and fees deduction can be claimed. It reduces taxable income by up to $4,000 on single-filer returns with MAGI below $80,000 as a single filer. Next year, this deduction will be replaced with higher income limits for the Lifetime Learning Credit tax credit.
—Lifetime learning credit: A $2,000 credit against taxes per year for an unlimited number of years. MAGI must be below $69,000 as a single filer and the credit can be claimed by the person paying for higher education expenses.
—American opportunity tax credit: The credit gives back up to $2,500 per year for the first four years of higher education. The student must be attending a qualified college, pursuing a degree, with at least half-time status.
Note: You can take only one of these tax credits per student per year, and MAGI cannot exceed $90,000 as a single filer.
And, finally, if you’re fortunate enough to get a scholarship or grant, you should know that if you spend the money on tuition and fees, books, supplies and equipment, those dollars are tax-free. But if you spend scholarship money on room and board, it can be taxed.
Student loans are what I call the “roach motel” of personal finance — easy to get into and almost impossible to get out of! And that’s The Savage Truth.