Repayment options grow for student loan borrowers
If you're a college grad who used federal student loans to
pay for college, you may be eligible for a new income-driven repayment tool: the
Department of Education's Pay
As You Earn Repayment Plan.
The plan, which launched Dec. 21, 2012, caps payments at 10
percent of a borrower's discretionary income. The Department of Education
estimates that 1.6 million borrowers could reduce their monthly payments if
Pay As You Earn joins the older Income-Based
Repayment Plan -- which caps monthly payments at 15 percent of your
discretionary income -- as a way for borrowers with "partial financial hardship"
to repay student loans. That means your monthly loan payments under the 10-year
Standard Repayment Plan must be more than 10 percent of your discretionary
The government determines discretionary income based on adjusted
gross income and family size. If you qualify for one of the income-driven
loans, you must submit income tax returns or other proof of income each year. As
long as you continue to have a partial financial hardship, you can stay in the program.
As your income rises or falls, your monthly payments will grow or shrink accordingly.
The bonus with Pay As You Earn is that any balance left after
20 years will be forgiven. That's five years fewer than the 25-year limit under
the Income-Based Repayment Plan, which means five fewer years of interest
charges. But you will end up paying more interest under either plan
than you would with the 10-year Standard Repayment Plan. (See chart.)
About 2.6 percent of borrowers are already enrolled in an income-driven repayment
plan, says Mark Kantrowitz, publisher of FinAid.org,
a for-profit financial aid help website. Pay As You Earn could expand that enrolment
to 10 percent of all borrowers.
Kantrowitz offers a quick rule of thumb: "If your debt
exceeds your annual income, you should be eligible for either of the two
plans," he says. To find out for sure, check out an income-based repayment
calculator, such as the one on the Federal
Student Aid website.
One of the key differences in eligibility for the new plan
is that it's only available to borrowers who have had at least one loan
disbursed after October 2011, and none before October 2007. The program will mostly benefit people who started their studies in
the 2008-2009 school year or later.
Even for grads in that group, though, not
every loan type qualifies for Pay As You Earn. Only federal loans made to the
student -- not the parent -- will be considered. There's a lesson, says
Kantrowitz: "Always borrow federal first."
You must be a responsible borrower too. With both the
Income-Based and Pay As You Earn plans, borrowers cannot be in default of a
loan (defined as 360 days of nonpayment). If you do default, you have one year
to rehabilitate your record by making nine out of 10 payments on time.
Kantrowitz warns that you have only one shot at rehab, so you have to get it
right the first time. (Story continues below chart.)
|COMPARE STUDENT LOAN REPAYMENT PLANS
||Pay As You Earn
||Direct Subsidized and Unsubsidized Loans; Direct PLUS Loans made to graduate or professional students; Direct Consolidation Loans that don't contain PLUS loans made to parents
|Direct Subsidized and Unsubsidized Loans; Direct PLUS Loans made to graduate or professional students; Direct Consolidation Loans free of PLUS loans made to parents; Subsidized and Unsubsidized Federal Stafford Loans; FFEL Plus Loans made to graduate or professional students; FFEL and Consolidation Loans without underlying PLUS loans made to parents
|Direct Subsidized, Unsubsidized and PLUS Loans; Direct Consolidation loans, Subsidized and Unsubsidized Federal Stafford Loans; FFEL Plus and Consolidation Loans
||At least one loan disbursed on or after Oct. 1, 2011; none before Oct. 1, 2007
|Monthly payment cap
||10 percent of discretionary income
|15 percent of discretionary income
|Fixed monthly payment; minimum $50
|Monthly payment for a $30,000 debt, based on 6.8% interest
||$194 for a single person making $40,000 a year
|$291 for a single person making $40,000 a year
Autopay is optional --
To further sweeten both deals, the government reduces the loan interest
rate by one-quarter of a percent for payments made via auto debit. "It's not required,
but it's a good idea," Kantrowitz says.
So good, in fact, that U.S. Rep. Tom Petri is looking to make it a
law. The Wisconsin Republican's Earnings
Contingent Education Loans Act, introduced to the House of Representatives
in December 2012, proposes a system in which employers withhold student loan
payments from a borrower's paycheck, just as they do with federal and state
income taxes. Deductions could not exceed 15 percent of wages.
The legislation would tie the loan interest
rate to Treasury market rates, and cap total interest payments at half of the
loan balance on graduation. For instance, a student who borrowed $30,000 would
pay no more than $15,000 in interest.
to pay for the interest rate cap, the legislation proposes eliminating some
student-loan subsidies that help low-income borrowers -- a provision likely to
rile Democrats. The bill died when the 112th Congress adjourned in January 2013; Petri's
press office says he plans to reintroduce it.
The bill's aim is not just to make things easier for some
borrowers. Petri argues it would boost loan repayments and cut the default
rate. An FAQ document from his office indicates that in the United Kingdom,
which has a similar plan, 98 percent of student-loan borrowers repay their
debt. In contrast, in the United States, 13.4 percent of borrowers default on
their loans within three years of graduating.
Default is a huge issue with student loans, and it is
difficult if not impossible to get a federal loan discharged via bankruptcy. To
do so, borrowers must prove that they cannot maintain a "minimal standard
of living" if they continue to pay off the loan, according to the Student Loan Borrower
Assistance Project, an arm of the National Consumer Law Center. "It's
extremely difficult to get student loan forgiven," says Deanne Loonin, a
Boston-based attorney and director of the organization.
The Fairness for Struggling Students Act of 2013 would extend
bankruptcy rights for private student loans. That would be good news, except
that private loans account for only an estimated 7 percent of student debt. And the
bill is expected to face considerable opposition.
"There is momentum building, even in the lending industry,
to come out in favor of some bankruptcy rights, but there's nothing concrete
yet," Loonin says.
See related: Steps to make good on a defaulted student loan, 4 steps to settling privately funded student loans, Debunking a myth about wage garnishment and student loans
Published: February 11, 2013