Escape Student Loan Debt — Slowly

Philip Brewer — Wed, 26 Oct 2011 22:49:43 +0000

If you've got student loan debts that you'll never be able to pay off, you've now got a better chance to escape. It's still going to take a while. (See also: Wage Slave, Debt Slave)

Under new rules that Obama announced today, students who can't afford to pay off their student loans will be able to cap their payments at 10% of their discretionary income. If they make those payments for 20 years, any remaining debt owed will be written off.

This is a modest improvement to an already existing program that our own Xin Liu wrote about back in 2009. The older version only wrote the remaining debt off after 25 years, and it required payments of 15% of discretionary income.

For people with low incomes — or people with moderate incomes, but a lot of student loan debt — this will be a huge change. One of the examples in the White House fact sheet is of a nurse earning $45,000 with $60,000 in federal student loans:

Under the standard repayment plan, this borrower’s monthly repayment amount is $690. The currently available IBR plan would reduce this borrower’s payment by $332 to $358. President Obama’s improved ‘Pay As You Earn’ plan will reduce her payment by an additional $119 to a more manageable $239 — a total reduction of $451 a month.

This isn't a new idea. At least as far back as 1980, there was serious talk of letting students pay for their whole education on these terms: They'd sign a note promising the college or university 10% of their income for 20 years, and in exchange the school would provide their education. (I remember reading later that there had been some experiments along those lines, but that they'd been pretty unsuccessful because people who expected to earn a high income — doctors, lawyers, business majors — never signed up. It was only people getting degrees in social work, elementary education, theology, and such who went with the plan — and 10% of their income for 20 years didn't come close to covering the cost of their education.)

I've complained before about how debt traps people in the money economy. On a temporary basis, most people can cut their expenses almost to zero — except that they can't, if they have debts. Paying your debts requires fixed-dollar payments.

That's the big win of this program — the amount people need to pay isn't fixed in dollars; it's fixed in terms of income. If your income is very low, the amount you need to pay back will be very low as well.

There are a few other changes. In particular, it'll become easier to consolidate student loans (and the consolidated loans will get a small interest rate reduction.

Perhaps more important in the long run, the new Consumer Financial Protection Bureau is teaming up with the Department of Education to offer a "Know Before You Owe" financial aid shopping sheet.

I've always been unhappy about the way parents, teachers, guidance counselors, and college admissions officers lead kids (juniors in high school, often only 17 or even 16 years old) to commit themselves to pay back tens of thousands dollars in debt. It makes me unhappy even though the adults have the best intentions, and even though a good education is very important. Yes, other decisions made at that age (such as the decision to have a child) inevitably have life-long consequences — but you don't see students' adult advisors encouraging them to follow that path. I think the decision to take on tens of thousands of dollars in debt is a decision of the same magnitude, and yet many students blithely sign up for it, with little consideration of the consequences or the alternatives.

You're better off avoiding excessive debt in the first place — and maybe the new sheet from the CFPB and the DoE will help. But if that choice has already been made, and student loan debt is a burden, here's a way to reduce that burden significantly.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

New Income Based Federal Student Loans Repayment Plan - Can You Benefit?

Xin Lu — Mon, 06 Jul 2009 22:01:36 +0000

This month a new repayment plan for federal student loans is going into effect that allows borrowers to base their monthly payments on their income after graduation. Here are some details on how the new Income Based Repayment Plan (IBR) affects loan payments for borrowers, and some pros and cons of participating in the plan.

First of all, this plan only applies to borrowers with federal student loans including Stafford, Grad PLUS or Consolidation loan made under the Direct Loan or FFEL programs. The loan also cannot be in default and can apply to any type of education.

The monthly amount required is based on income, family size, and state of residence and the Federal Student Aid websites provides an IBR calculator here for you to figure out what monthly amount you would owe. Borrowers who earn less than the poverty level have a minimum payment of zero, and others do not have to pay more than 15% of their discretionary income. It is possible that your current repayment plan is less than the amount required under the IBR plan. For example, if you are a single borrower who currently owes $5000 at 6.8% and earns $25,000 a year, the new plan would peg your payments at $109 a month, but the amortized 10 year repayment plan would only require a $57 monthly payment. In this case it is probably easier to just stick with the original10 year repayment plan.

If a borrower chooses to enroll in the IBR plan because the monthly repayment amount is lower, then the loan may be stretched out due to interest. Basically, any interest payment not covered by the monthly payment will be rolled into the principal. So it is possible that the loan will get bigger. If the borrower has a Subsidized Stafford Loan, the government will pay the unpaid interest for three years. But after that all unpaid interest will be capitalized.

There are a couple ways the loans can be forgiven. One method is for the borrower to make repayment under the plan for 25 years, and the other is to work in public service for 10 years and make all 120 loan payments through the IBR.

The main purpose of the new repayment program is to help many recent graduates who are having trouble finding a job that pays well. It could also help families who have suffered a job loss and have high student loan obligations. Borrowers will have to record their income and family size every year to redetermine the payment amount. When you get a higher income job, the loan will adjust accordingly. However, since the loan will be stretched out and interest added, it is not recommended to join the plan if you currently have no trouble paying your current loan amount.

If you could benefit under this program you should contact your student loan lender directly to apply.

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: