Student loan debt burdens are becoming a major policy concern. The Federal Reserve Bank of New York estimates that student loan debt reached $1.08 trillion in 2013, and you can find plenty of news stories about crushing debt burdens for recent college grads.
There has been a recent expansion to the federal government’s Pay As You Earn (PAYE) program for federal student loans, which has brought this and several other Federal loan repayment programs into the news.
What can you do to ease the load of your loan payments? Here’s the critical information.
Remember: This Only Applies to Federal Loans
It’s important to first note that the government’s relief programs are only applicable to certain loans. Loans covered by programs like PAYE include the following:
• Direct subsidized loans
• Direct unsubsidized loans
• Federal Stafford loans (both subsidized and unsubsidized)
• Direct consolidation loans
• FFEL consolidation loans
• FFEL PLUS loans
• Direct PLUS loans
Remember, not all loans are eligible for all programs — we’ll cover a few here, but for detailed information about which programs apply to your specific loans, please take a look at the Federal Student Aid website.
A final note on eligibility: Perkins loans are not covered by the programs we’ll describe here, and the Federal Student Aid site recommends that you speak directly with your school for options.
The major change in policy concerns the PAYE program. Prior to the change, only borrowers who took a loan between October 2007 and October 2011 were eligible, but this has now been extended to include loans taken prior to that period. This change will go into effect in December 2015.
PAYE allows borrowers to pay just 10% of their discretionary income towards their loans. After 20 years of successful payments, whatever remains of your loans will be forgiven — this can come down to 10 years if you work in certain public sector jobs.
But how does it work? This is where it gets more complicated. The payment amount is calculated as 10% of the difference between your Adjusted Gross Income (AGI) and 150% of the poverty guideline for your state of residence and family size.
Loan Payment (PAYE) = 10% * (AGI – Poverty Line)
This means that you have to meet certain income guidelines in order to qualify.
You submit your financial information every year to regain eligibility; if your income goes too high, you’d obviously no longer qualify.
Income-Based Repayment (IBR)
The IBR program is very much like PAYE, except that it caters to those who make a little bit more discretionary income, giving a maximum payment of 15% of your discretionary income. The formula looks like this:
Loan Payment (IBR) = 15% * (AGI – Poverty Line)
IBR also has a forgiveness option, only remaining balances are forgiven after 25 years of payments instead of PAYE’s 20 years.
What if I Don’t Qualify?
These are the two most generous repayment programs in terms of monthly payment, but there are other options available for those who aren’t eligible or who prefer not to enroll in these programs. In addition to the standard repayment plans for your federal loans, you also have the following:
• Graduated Repayment Plan: Your loan payments start smaller, and increase incrementally over time (usually every two years) up to 10 years.
• Extended Repayment Plan: Your payments can be fixed or graduated, and the life of your loans is extended up to 25 years.
• Income Contingent Plan: Applies only to Direct Loans. Your payments are newly calculated every year based on AGI, family size, and the loan amount outstanding.
• Income-Sensitive Plan: Your payment is calculated based on your annual income, but the formula’s used by each lender might be different — so your Subsidized Stafford Loan might have a different payment rate than your FFEL PLUS Loan.
A great tool when making a decision about any of these programs is the Federal Student Aid Office’s payment estimator. It can help you determine the amount you’d pay under each program and help see whether you qualify.
What are the Downsides to Loan Repayment Programs?
The major downside to these and other Federal programs is that extending the life of your loans means paying more interest.
As a general rule, it’s better to avoid anything that costs you more over time, even if it means a little bit less pressure in the short-term. Of course, each situation is different — for many people, it’s an enormous relief knowing that if you need these programs, they’re available.
The other key to remember is that if your loan is forgiven in the future, you may still need to pay income taxes on the amount that’s forgiven. Don’t forget to include this detail in your planning process!
Written by Bradford Pine with Anna B. Wroblewska
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Written by Bradford Pine
Bradford Pine Wealth Group – New York City Financial Advisors
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