If you’ve got a diploma hanging on your wall, chances are it didn’t come cheap. About two-thirds of the 3 million or so college seniors who donned a cap and gown this year took on an average debt of $22,500 for the privilege of earning that diploma. The debt graduate and professional students incur is often tens of thousands more.
As graduates struggle to find jobs during the worst economic crisis of their lifetime, an adviser to the secretary of education expects a rise in the default rate on student loans, which cannot be easily renegotiated or discharged in bankruptcy.
But a provision of the College Cost Reduction and Access Act of 2007 that reduces monthly payments for hundreds of thousands of borrowers who qualify for the new Income-Based Repayment plan took effect July 1.
Borrowers who work in certain public service jobs could also have the balance of their loan erased after making qualifying payments for 10 years. (Supposedly, this costs the government nothing, since it will now change the way it subsidizes student-loan lenders.)
So, will your student loan be bailed out? In a word: maybe.
At the very least, the IBR program will lower the monthly payments of people who accumulated significant federal student loan debt but don’t have the income to make the payments on the standard 10-year repayment plan. This relief may reach as many as 1 million people, according to the Project on Student Debt. And despite lower payments, the former students won’t be paying off their loans indefinitely — any remaining balance will be forgiven after payments are made for 25 years.
Basing loan payments on income isn’t a new concept. For years, graduates with federal student loans had options to reduce or eliminate their payments, depending on how much money they made. But IBR is intended to be more generous.
IBR caps monthly payments at 15% of earnings above 150% of the poverty line, or $10,830 for a single-person household. Online calculators at the free public service site FinAid.org can help you compare what your income-based payments, income-contingent payments and income-sensitive payments would be.
There are situations in which an IBR payment would be zero. If your payment is so low it doesn’t cover the interest accruing on your loan, the government will pay the interest for three years on subsidized Stafford loans, which are government-backed loans given to financially needy students that do not accrue interest while the borrower is in school.
After that period, and for all of the other kinds of unsubsidized federal loans, unpaid interest will accrue but will not compound. In other words, you won’t be charged interest on top of interest.
Borrowers who think they could benefit from IBR should contact their lender and ask for an application that will authorize the release of their adjusted gross income from the Internal Revenue Service each year.
The news is even more promising for people working in public service jobs: government employees, teachers in public schools and universities, workers at public hospitals and anyone working for a 501(c)(3) nonprofit would qualify. Anyone working in a qualifying job who borrowed from the Direct Loan Program is eligible for loan forgiveness after 10 years, down from 25.
To qualify for forgiveness, borrowers who work in a public-interest position must either have an existing Direct Loan or consolidate a federal loan with a private lender into the Direct Loan Program and make 120 payments after Oct. 1, 2007. The payments do not have to be consecutive, can be made while at different eligible positions and must be made on the income-based or standard repayment plans. (See “Ask for student loan forgiveness.”)
At this point, the burden is on borrowers to document where they were working during their repayment period. The Department of Education is planning to develop a more definitive system to confirm eligibility, but right now borrowers should keep pay stubs and tax documents that verify their work history.
IBR and public-loan forgiveness won’t be the best options for every borrower. Some borrowers — those able to make higher monthly payments — would be better served by sticking with a traditional payment plan to avoid accruing years of additional interest. Graduates who financed their education with private loans are ineligible entirely.
But for an MBA grad who borrowed $150,000 planning to be an investment banker but ended up in government service, IBR will result in payments that are affordable on a civil servant salary.