One of the trendiest and most pressing topics in personal finances is the devastating amount of debt graduating with college students. Large debt loads saddle new graduates with large monthly payments. Couple this with sometimes unmarketable degrees that do not translate well in the workforce and a wavering economy, and we see that some students are taking a two-punch to the chin.
My Student Loan History
I remember my own exit interview with the financial aid office just before graduating in 2005. For weeks I had felt that intangible peace and excitement that comes when you know that exams and papers are all behind you, you have a job lined up with a decent salary, and life just seems completely conquerable. Then I opened up my packet to find various loans adding up to the sum of around $36,000. Yikes! That heady feeling turned into a dollop of panic. The term of loan repayment that my creditors had chosen was 11 years. I looked around the room at everyone else’s reactions, determined to never be in debt for such a long amount of time. And I wasn’t; I managed to pay everything off within 5 years of graduation by making extra payments.
Even though I suffered through two lay-offs in those five years, I was never unemployed for more than three months at a time. In the summer that I graduated, interest rates for student loans were at an all-time low. I was able to consolidate the majority of my loans to lock in a 2.65% interest rate, and after 36 consecutive payments, the interest rate decreased to an amazing 1.25%. Also, my federal student loans had been subsidized, meaning that while in college the interest accrued on the loans was paid for by the government. But some graduates have not had it so well.
Let’s take a look at a new program that may help ease federal student loan payments for college grads in the future.
New Pay As You Earn Student Loan Program
As of December 21, 2012, a new program called Pay As You Earn (PAYE) is available as an alternative to the standard repayment plans of loans from the Direct Loan Program for eligible people. This program goes even further than other federal loan income-based repayment programs by reducing the maximum monthly payments from 15% to 10% of discretionary income as well as accelerating loan forgiveness from 25 years to 20 years.
The Juicy Details
So what exactly is the federal government offering in this new plan?
- Decreased Monthly Repayment Amount: If you qualify for this plan, your monthly repayment amount will be 10% of the difference between your AGI and 150% of the Poverty Guideline for your family size.
- Debt Forgiveness: After 20 years of payments, the remainder of your loan will be forgiven.
- Credit towards the Public Service Loan Forgiveness Program: PSLF, another federal student loan repayment program, can be earned after 120 qualifying payments through the PAYE program (FYI: PSLF is not taxable as income, whereas debt forgiveness under the PAYE program is taxable income).
- Potential Interest Subsidies: It turns out that there is a way to get your loans subsidized outside of college again. If your monthly payment amount does not cover the full amount of interest that accrues on your loans each month, your unpaid accrued interest on any subsidized loans (and on the subsidized portion of your consolidation loans) will be paid for up to three consecutive years from the date you began loan repayment.
- Capped Interest Capitalization: The capitalization of interest is capped to 10% of the original principle balance.
There appear to be two potential tax consequences of enrolling in this program. First of all, student loan interest is generally deductible, so if you are paying off your loans for an extended period of time, then you can benefit from a tax deduction over many years (though be careful, as you are also paying more interest than you would under the standard repayment plan). Also, if you reach 20 years and have the remainder of your loans forgiven under this program, then the forgiven loans will be taxed like income.
Eligibility Requirements and How to Apply
Each year you will need to prove your eligibility in order to take advantage of this program. This means that, along with the first year, you will need to complete the electronic Income-Based (IBR)/Pay As You Earn/Income-Contingent (ICR) Repayment Plan Request. This process includes providing your previous year’s federal income tax documents, being a “new borrower” as defined by this program (someone who both did not owe any money on any federal student loans as of October 1, 2007, and also received a disbursement of a Direct Loan on or after October 1, 2011), having loans under the Direct Loan Program, and demonstrating partial financial hardship in repaying these loans.
Student loan debt is not something to take lightly. While other debts may be written off in bankruptcy (though not recommended), your student loan debt is very difficult if not impossible to discharge in bankruptcy. The only real option you have is to confront it, and to pay it off in manageable chunks. Good luck to you!
Stay tuned! Next up we’ll discuss if there really is a student loan crisis!