An Income-Based Way to Tame Student Loans
The U.S. Department of Education is trying to give college grads some cred -- at least in terms of dealing with student debt. In 2009, the federal government introduced a way for student loan borrowers to reduce their monthly loan payments and potentially have their loan debt dismissed. All students with Stafford, PLUS or consolidation loans can use the income-based repayment, or IBR, plan. An IBR caps payments at a percentage of a graduate's monthly salary and dismisses all federal loan debt after a designated time period. But less than 2% of all eligible graduates opt for income-based repayment -- about 450,000 out of 36 million borrowers, according to reports from the White House.
How it Works
Regardless of how much federal debt they have, grads enrolled in income-based repayment will never have to fork over more than 15% of their "discretionary income," which is defined as any amount over 150% of the current poverty line. For 2012, "discretionary income" equals any earnings over $16,755 for a single-person household. Grads earning less than $16,755 will have payments capped at zero dollars, and those who make consecutive payments for 25 years will have their remaining debt dismissed. Grads who work in public service fields such as nursing, social work or public defense will have their debt dismissed after 10 years of consecutive payments, according to the Department of Education.
The problem is that many students don't know about IBR. "Income-based repayment is not promoted in the financial aid office as much as it could be," says Rich Williams, a higher education advocate for the U.S. Public Interest Research Group in Washington, D.C.
New Plan to Increase IBR Awareness
However, the Department of Education and the White House are working on a plan to make more grads aware of IBR and to make it easier for them to enroll in it. On June 7, the White House released details of a plan to streamline the online application process for IBR by October. The new process will allow borrowers to submit their tax information directly into the IBR application, which will shorten the process. The plan also requires, with a deadline of June 2013, the Department of Education to provide a sample exit counseling session to colleges and universities that explains IBR and students' repayment options.
A study by Young Invincibles, a Washington, D.C.-based advocacy nonprofit, showed that among high-debt borrowers, 65% didn't understand certain aspects of the student loan process and 20% misunderstood their repayment terms.
Jason DeLisle, director of the Federal Education Budget Project at the New America Foundation, a nonprofit public policy institute in Washington, D.C., adds that many students don't opt for income-based repayment because they don't need it. A study by the Federal Reserve Bank of New York shows that although the average student debt is $23,300, the median debt among student borrowers is just $12,800.
"The vast majority of borrowers with $12,000 in loans will have lower monthly payments under a standard 10-year repayment plan," he says. "Only those borrowers with incomes below $28,000 will be better off in IBR."
The upside of income-based repayment is that it can keep a federal loan from defaulting, which means avoiding the bad credit, wage garnishment, collection costs and legal actions that come with default. The downside is that, in many cases, it can increase the loan amount. Since income-based repayment lasts two and a half times longer than the standard 10-year repayment plan, IBR enrollees can end up paying thousands more in interest.
"For borrowers who fall financially behind and could face defaulting on their loan, income-based repayment is an excellent support program," Williams says. "Once the borrower regains fiscal footing, they will price out of the program."