An Alternative to Obama Student Loan Forgiveness

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You may know about the so-called Obama Student Loan Forgiveness program, officially known as Pay As You Earn or PAYE. Under this program, assuming you qualify, you can lower your loan payments and receive forgiveness of part of your loan after 20 years (10 years for certain public service occupations).

But what if you don’t qualify? To be eligible for PAYE, you have to be a new borrower. According to studentaid.gov, a new borrower is someone who did not owe on a federal student loan as of Oct. 1, 2007, and received a Federal Direct Loan on or after Oct. 1, 2011.

If you already have student loan debt that precedes Oct. 1, 2007, you are not eligible for PAYE. Fortunately, an alternative government program is available. It’s called Income-Based Repayment or IBR.

New Borrower Not a Factor Under IBR

First, there is no new borrower requirement under the IBR program. You can have older student loan debt (prior to Oct. 1, 2007) and still qualify. This factor alone opens up IBR to many more of the 38 million Americans who carry student loan debt, according to eCredit Daily.

More Loans Qualify Under IBR

Under PAYE, only Federal Direct Loans qualify for repayment. Under IBR the list is longer. In fact, most major types of federal student loans are eligible for IBR, based on information on the Federal Student Aid website. They include:

  • Direct Subsidized Loans
  • Direct Unsubsidized Loans
  • Direct PLUS Loans made to graduate or professional students
  • Direct Consolidation Loans without underlying PLUS loans made to parents
  • Subsidized Federal Stafford Loans
  • Unsubsidized Federal Stafford Loans
  • FFEL PLUS Loans made to graduate or professional students
  • FFEL Consolidation Loans without underlying PLUS loans made to parents.

As with PAYE, some types of loans are also not eligible for repayment under IBR:

  • PLUS loans made to parents
  • Consolidation Loans that include underlying PLUS loans made to parents
  • Private education loans.

Partial Financial Hardship

To be eligible to repay your student loans under IBR, you must demonstrate partial financial hardship. It’s not as terrible as it sounds. It’s all about debt-to-income ratio, but the easiest way to find out if you qualify is to calculate your monthly payment under IBR.

The Department of Education provides an online calculator useful for determining whether you qualify for IBR. The calculator also projects your monthly payment under the program.

If your monthly payment under IBR is lower than it would be under a 10-year Standard Repayment Plan, then you are eligible to repay your loans under IBR.

Payments

An attraction of PAYE is that loan repayment is only 10 percent of the difference between your adjusted gross income (AGI) and 150 percent of the Poverty Guideline for your family size (otherwise known as discretionary income).

For IBR, the amount is 15 percent. It is more than PAYE’s loan repayment rate, but still less than the amount you would pay under a standard repayment plan.

Forgiveness

Under IBR, if you make regular payments and meet certain other requirements, after 25 years the government will forgive (discharge) any remaining balance. The period for PAYE is 20 years, which is five years sooner than IBR.

Taxes on Forgiveness

As with PAYE, any regular forgiven balance under IBR is subject to income tax. (Public Service Forgiveness amounts are not subject to tax.) This means that any amount the government discharges is considered income to you, and you will have to pay tax on that amount.

Public Service Forgiveness

If you happen to work full-time for a public service organization and make full, regular, monthly payments for 10 years, under IBR you may be eligible for tax-free forgiveness of the remaining balance. This is the same as the rule for PAYE, and it’s especially helpful for you if you work in public service.

Interest Subsidy and Capitalization

Another advantage of the government’s student loan repayment program is the interest subsidy rule. Both Pay As You Earn and Income-Based Repayment include an interest subsidy.

Under both PAYE and IBR, if your monthly payment amount doesn’t pay all of the interest due on your loan for that month, the government will pay the unpaid amount for up to three consecutive years from the date you begin repaying your loans.

In addition, during the period when you have a partial financial hardship, interest not covered by your loan payments will not be capitalized (added to the principal resulting in “interest on interest”). This is true even if this happens during a deferment or forbearance. Once you no longer have a hardship, interest is added to principal and capitalized.

Documentation

As with practically any government program, under IBR you must provide documentation verifying your income and family size each year. If you fail to do so, unpaid interest on your loan will be capitalized.

In a larger sense, the documentation you provide helps determine any adjustments, up or down, in your monthly payment.

Downside

There are two main drawbacks to IBR. First, if you make a smaller payment over a longer period (25 years), you will end up paying more for your loan. Second, unless you fall under the Public Service Forgiveness rule, you will probably pay income taxes on any amount forgiven after 25 years.

Bottom Line

If you don’t qualify for Pay As You Earn, aka, Obama Student Loan Forgiveness, research the Income-Based Repayment. Lower monthly payments, loan forgiveness and the interest subsidy probably outweigh the downside of paying more over time and the possible income tax consequences – especially for you as you begin your career and probably have to keep expenses down.

If you think IBR might be for you, go to StudentLoans.gov, sign in and complete the IBR Repayment Plan Request.

Last Updated: May 3, 2013
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About Tim Parker Follow Tim on Twitter @buildmykingdom, @expositioncreat and @elem_finance.

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