New Student Loan Repayment Option

[BrooklineBiker]

Hi everyone,
Those of us with student loans may find the linked article to be of interest. http://www.nytimes.com/2015/08/15/your-money/revised-program-will-reduce-student-loan-repayments.html?ref=education&_r=0. The article discusses a soon to begin student loan repayment plan. The plan features a pay-as-you-earn program available to anyone with federal direct loans, regardless of when students received the loans and what their debt-to-income ratio is. (The original pay-as-you-earn plan is available only to those who borrowed after 2007 and requires borrowers to have high debt relative to their income.) Of particular interest, any loan balance remaining after 20 years of payments will be forgiven, if the students have only undergraduate loans. If they borrowed money for graduate school, the forgiveness comes after 25 years.I haven't checked out the details beyond what is in the article.

[Bucksandreds]

I have casually looked in to income based repayments which sounds very similar to this and is not useful to someone who wants to fire due to the 20-25 year term and the large tax bill that comes with the forgiven amount.  It is great for a typical American who lives near paycheck to paycheck as they will still be mid career when the 20-25 year term hits and it will free up a larger portion of their paycheck for consumption.

[Thegoblinchief]

In past threads about PayE and IBR, very few people actually come out ahead, and often they come out far, far worse because their income goes up more than they planned but by that point interest capitalization has made their original balances run away.

The best recommendation is to stick with standard repayment unless you absolutely cannot make ends meet. And even then, refinancing via SoFi or other programs is a good bet as a first plan of attack because the federal interest rates are way above market rates.

[immocardo]

In past threads about PayE and IBR, very few people actually come out ahead, and often they come out far, far worse because their income goes up more than they planned but by that point interest capitalization has made their original balances run away.

I was curious about this and decided to make a spreadsheet to model most scenarios, and I have to say I disagree.

Consider this.  To give a conservative example.  For a student with 30,000 in loans at 3% interest the minimum payment is 289.12 per month for 10 years.

In order for a minimum payment to exceed that amount based on the salary calculation.  This person would have to cross $52,349 Annually.  (Not accounting for the increases the FPL which would increase this number)

While that number isn't huge, it is easily a salary high enough to raise a family of 5.

Here is the real kicker

Consider someone who graduates with 70k in loans @5% making 40k/year. Numbers may seem high but there are tons of people in a similar situation.  In fact I have extended family in this situation.

Using this new repayment method they will pay $55706 over 20 years (including the tax bill at the end).  A standard repayment would pay $88,369 over 10 years.  They save $33,000.  Yes, they will pay slightly more as their salary increases, but I would gladly take a salary increase.

The break even point for the minimum payment? $106,294.  There are tons of careers that will not cross that threshold.

A few caveats obviously.  Inflation can make this very dangerous.  But the single most dangerous thing is if the government removes this program.  And now you're suddenly way behind on a loan.

I agree that many people (Most people on this forum) will not be helped by this.  But there are plenty of people who will benefit greatly.

If anyone would like to see the spreadsheet or more specific numbers please let me know. 

[Sean Og]

IBR and PAYE are very attractive for those who qualify for PSLF (forgiveness after 10 years and tax free).

My wife, who is a first year teacher has about 60k in loans and we will be going for PSLF on an income based plan.

Our payments will be a little higher this first year as our AGI wasn't as low as it could have been last year. The new REPAYE would be nice with payments at 10% of discretionary income so I am watching that closely.

Now that she is working we are maxing out my 401k and tIRA for this year and as much of her 403, 457, tIRA and 6% to State Pension as her teachers salary allows.....should make the payments the following year quite low.

[Dezrah]

Don’t forget that when Federal Student Loans are forgiven as a result of IBR, the BALANCE forgiven will count as income for tax purposes.   If your payments are so low that you’re not even paying down interest, the balance can easily be higher than the original loan amount.  I admit I don’t know if it just counts as “ordinary income” or if it has other special tax treatment that would make a sudden $40k of taxable income a bit easier to handle (for people who are presumably barely making ends meet).  Some plans (like some teacher programs) are exempt from this.

My point is that simple spreadsheet math doesn’t do a great job of what would cost an individual the most overall without a slew of details—some knowable, some guessed.

[r3dt4rget]

IBR and PAYE are very attractive for those who qualify for PSLF (forgiveness after 10 years and tax free).

My wife, who is a first year teacher has about 60k in loans and we will be going for PSLF on an income based plan.

Our payments will be a little higher this first year as our AGI wasn't as low as it could have been last year. The new REPAYE would be nice with payments at 10% of discretionary income so I am watching that closely.

Now that she is working we are maxing out my 401k and tIRA for this year and as much of her 403, 457, tIRA and 6% to State Pension as her teachers salary allows.....should make the payments the following year quite low.

This raises an ethical question. I wouldn't feel good about having my federal loans forgiven while I am certainly able to pay it all back.

[Sean Og]

IBR and PAYE are very attractive for those who qualify for PSLF (forgiveness after 10 years and tax free).

My wife, who is a first year teacher has about 60k in loans and we will be going for PSLF on an income based plan.

Our payments will be a little higher this first year as our AGI wasn't as low as it could have been last year. The new REPAYE would be nice with payments at 10% of discretionary income so I am watching that closely.

Now that she is working we are maxing out my 401k and tIRA for this year and as much of her 403, 457, tIRA and 6% to State Pension as her teachers salary allows.....should make the payments the following year quite low.

This raises an ethical question. I wouldn't feel good about having my federal loans forgiven while I am certainly able to pay it all back.

I've seen this question raised a number of times and I don't really get it, why question IBR plans or PSLF when its is really no different than taking advantage of tax laws such as a tIRA - roth pipeline, if legislation permits it then I don't personally have an ethical problem, I see IBR programs being encouraged and it is an option offered to all, no ifs or buts.

In my wife's case she has an added benefit of PSLF for a 10 year forgiveness. The way I look at it, with our current AGI we will pay back a little more than the original principal balance in the 10 years making it basically an interest free loan. If she was on her own, without my income she would struggle with this debt.

Personally, coming from a country which provides tuition free education (Ireland) I feel it is unethical to make it necessary for so many to start their life with such a debt burden, let alone many with considerable interest rates. In addition, is it ethical to pay teachers, such qualified members of our society so little for such an important task?

There are many great things in the US, that's why we live here, but student loans are not one of them!

[Merrie]

That kind of stuff never ends up being a win for me. I don't really want to stretch out payments for 25 years and end up paying more. My income is too high for any amount to end up being forgiven.

I really doubt many (any?) Mustachians will benefit from this, though it's great for the average unfortunate soul who took out 80k in loans for a degree that pays 40k and is now drowning with a house and kids and has no plans to retire before SS age.

[Effervescent]

IBR can be great. Perhaps I can elucidate a bit through explaining my own situation.

I am on IBR and have been since finishing grad school three years ago. I pay about $300 in loan repayments each month. That's about $3,600 per year.

I have about $90,000 of federal loans, which will be forgiven after 20/25 years if I am still paying them back.

I have access to a 457b and I put money into that, enough to get my income down to about $47,000, which for me is the sweet spot as someone who files tax returns as single. With a $47,000 income, my taxable income is about $37,000, about the cutoff point for the 15% tax bracket. So my marginal tax rate is 15%.

Since my taxable income if about $37,000, my IBR payments are scaled accordingly - I will pay 10% of my taxable income, which is $37,000/10 = $3,700 per year. Divided by 12 months, $3,700/12 = about $300 in student loan repayments each month (really about $308 but we'll call it $300).

In this way I am contributing to financial independence slowly and surely through a 457b retirement account, and paying less than $4,000 each year in loan repayments.

Two other factors make IBR particularly appealing for my situation.

I will qualify for Public Service Loan Forgiveness after 10 years of these IBR payments. So that's about 10 years of paying about $3,600/$3,700 each year = about $37,000 in total student loan payments, for an original principal upon graduation of about $90,000.

The other factor that makes IBR appealing to me is that my graduate school allows for a Loan Repayment Assistance Program, so long as my income is below something like $55,000. They use adjusted gross income, not total income, meaning that even if my salary is above that amount, contributing to a 457b will knock it down so that I qualify. A Loan Repayment Assistance Program (LRAP) is a program in which your graduate school/undergrad gives you money to pay back your loans, so long as you work in public interest. For my adjusted gross income, they'll pay me a maximum of $3,000 per year to pay back my loans, for up to five years. So I'm only paying about $700 per year for my loans after the LRAP check comes in.

All in all I expect to pay less than $30,000 for my student loans.

So IBR can be great, especially for those who are in public interest and have a high student loan principal. I might have gone to a different (more expensive) law school had I known about it all that time ago. Actually it incentivizes people to go to expensive schools, and not be very frugal. They could end up paying about as much as someone who cooks at home and lives modestly. Had I known about IBR while in school, I may have even taken out more loans and invested some of it into a brokerage account if that would have been an option (I'm not sure if that would be legal).