President Obama unveiled a plan Wednesday that will ease the burden of student loan debt for millions of borrowers.
The plan will accelerate an existing plan to cap student loan payments at 10% of income to start in 2012 instead of 2014. It will also allow those with split loans from the Direct Loan program and the Family Education Loan Program to consolidate their debts into a single monthly payment. Borrowers that opt for this plan will get a 0.5 percentage point cut in their interest rate.
Obama will use his executive authority as commander-in-chief to enact these changes without needing Congressional approval.
Student loan debt is the second biggest household debt weighing on consumers, and the president’s plans comes on the same day the College Board released a report showing tuition costs continue to rise. According to its report, average in-state tuition and fees at four-year public colleges increased $631 this fall, compared with a year ago. Nationally, the cost of a full credit load has passed $8,000, a record high.
With tuition prices rising quicker than inflation, students are borrowing twice the amount in loans compared to 10 years ago. The average amount of loans a full-time undergrad borrowed last year was $4,963, according to the College Board.
The Federal Reserve Bank of New York reported earlier this month that loans will surpass $100 billion for the first time this year. What's worse is that there will also be more than $1 trillion in outstanding loans as well, also for the first time ever.
Default rates are also on the rise up to 8.8% in 2009 from 6.7% in 2007, according to federal data; the highest default rates are among graduates from for-profit schools .
"They're having trouble getting jobs, and aren't getting any form of financial relief," Kantrowitz says. "This announcement draws attention to things that are already available to them, that can help."
Here's five things Kantrowitz said borrowers should know about the president's new plan.
No. 1: Income-based repayment already exists. The IBR plan the president rolled out today is simply a new version of the old plan, Kantrowitz says, only it will be available for borrowers in 2012, rather than 2014 when it was originally slated, and caps monthly payments at 10% of discretionary income. The current plan caps payments at 15% of discretionary income.
"The new plan also accelerates loan forgiveness, after 20 years of payments, instead of 25," he says. "The existing plan is underutilized, only about 450,000 borrowers nationwide are using it."
Kantrowitz estimates about 10% of borrowers currently in payment could benefit from this IBR plan.
No. 2: The plan does NOT impact private loans. The president’s plan will not impact borrowers with private loans for college. For private student loans to be reconsolidated under the Federal student loan program, an act of Congress would be necessary, according to Kantrowitz.
No. 3: Consolidation will be available. Those who have split loans with the Family Education Loan Program and a direct loan from the government will be eligible to move into a Direct Loan program, Kantrowitz said. To give borrowers added incentive to do this, he is proposing to reduce the interest rate for federally-guaranteed portion of loans by a quarter percent. Borrowers who are already in the program are also eligible for a quarter percent interest rate reduction if they sign up for automatic debit payments.
"This will only be available through June 30 (of 2012)," Kantrowitz said.
No. 4: Interest rates will change. Currently, subsidized Stafford Loans have a 3.4% interest rate. However, starting in the 2012-2013 borrowing year, this will double to 6.8%, Kantrowitz says.
No. 5: Consolidation might not be the best option. While consolidation can save some borrowers money, Kantrowitz says it is important to keep in mind that this action will give borrowers a new loan with a single interest rate. This will be the weighted average of the current loans.
"The optimal strategy for saving the most money on loans is to make an extra payment on your loan with the highest interest rate first. If you consolidate, you can't do that."