The rising cost of higher education and the manner in which it is financed (particularly through student loans) have become common topics making headlines in numerous publications such as the New York Times and the Wall Street Journal. In 2015, the Federal Reserve Bank of New York estimated total student loan debt to be $1.16 trillion, greater than outstanding auto loans and credit card debt.  The reason for the growth in student loan debt is straightforward:  Many families are forced to borrow money to cover the cost of higher education.  If you find yourself faced with these financial obligations, knowing your options is imperative to making practical decisions.  A discussion of the income tax ramifications, as well as, the restructuring options related to student loan debt is included below.

Income Tax Considerations.  For eligible taxpayers, the Internal Revenue Service (IRS) allows a special deduction for interest paid on student loans used to pay for the costs of higher education.  In 2014, the maximum deduction for student loan interest was $2,500.  You should receive IRS Form 1098-E, Student Loan Interest Statement, for years in which you paid interest to the entity originating the loan (or another entity in cases where the original loan was sold).  Student loan debt, and the related interest paid on this debt, must meet the criteria and qualifications identified below.

The IRS defines student loan interest as interest paid during the year on a qualified student loan. A qualified student loan is described as a loan taken out solely to pay qualified education expenses (defined later) that meet the following qualifications:

• Paid on behalf of you, your spouse, or a person claimed as your dependent at the time the loan was initiated,
• Paid or incurred within a reasonable period of time before or after receiving the loan proceeds, and
• Used for education provided during an academic period for an eligible student.

For purposes of the student loan interest deduction, the IRS defines qualified education expenses as the total costs of attending an eligible educational institution, including graduate school.  They include amounts paid for the following items:

• Tuition and fees,
• Room and board,
• Books, supplies, and equipment, and
• Other necessary expenses (such as transportation).

Similar to other adjustments, credits, and deductions allowed by the IRS, the student loan interest deduction is limited to taxpayers with modified adjusted gross income (MAGI) below the following thresholds (based on taxpayer filing status):

Restructuring Options.  Educational loans offered by the federal government cannot be refinanced.  However, federal student loans can be combined (i.e., consolidated) into one outstanding loan.  Choosing consolidation can be an attractive option for taxpayers with numerous loans initiated at various times during the higher education experience.  Although it is not possible to achieve financial savings through refinancing (because the new interest rate on the consolidated loan will be a weighted average based on interest rates of the existing loans), the consolidation process can offer the following benefits:

• Simplifying the repayment terms by reducing the number of monthly student loan payments down to one,
• Presenting an opportunity to extend the loan term up to 30 years (which can result in lower monthly repayment amounts), and
• Understanding the lender’s qualifications, and the borrower’s eligibility, for entering into forbearance (i.e., a period of time for which loan payments are deferred to a specified time in the future).

While federal student loans are not eligible for refinancing, student loans offered by private institutions (i.e., banks, lending institutions, etc.) oftentimes allow borrower’s the opportunity to refinance the debt at lower interest rates. The refinancing process can result in financial savings when prevailing interest rates are lower than the current interest rate(s) of student loan(s).  In addition, refinancing student loans can also provide some of the benefits of consolidation, which include:

• Borrowing an amount sufficient to pay off existing federal and/or private student loans (assuming these loans do not include prepayment penalties), and
• Restructuring the terms of the refinanced student loan (such as interest rate, monthly payment amount, number of months/years for repayment, forbearance requirements/eligibility, etc.) to better accommodate the borrower.

In closing, borrowers should be aware that student loan debt cannot be discharged as a result of filing for bankruptcy.  Furthermore, it is important to note the following drawbacks of refinancing and consolidating student loans.  The most common pitfalls that can result from these processes include the following:

• The financial savings from debt refinancing oftentimes will be offset due to loan origination fees charged by private lending institutions,
• Private lenders that offer loan refinancing will require a credit check of the borrower. The interest rate offered to a borrower can be significantly impacted by their credit score, as well as, the amount of debt being refinanced, and

The processes of consolidating and refinancing student loan debt are permanent in nature (i.e., once completed it cannot be undone for the purpose of altering strategy). As such, it is imperative for a borrower to understand all the issues at play so that they can make the best decision given their unique facts and circumstances.

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