Student Loan Repayment Plans

With far too many graduates facing onerous levels of student loan debt, the availability of student loan repayment plans that help reduce the stress involved in paying off student loans needs to be brought into broader awareness.

Although the default standard repayment plan involving ten years of timely monthly payments can work for those who can afford it, many recent graduates simply do not generate the monthly cash flow necessary to include such a payment in their budget.

This article will therefore address and discuss the various options available to graduates who face the grim reality of paying off high levels of Federal student loan debt while also attempting to lay the foundation of a prosperous adult life.

A Few Basics

As discussed in a separate article related to student loan debt forgiveness, if you are a full-time public service employee, consider applying for the Public Service Loan Forgiveness (PSLF) program, through which you may get your remaining student loan balance forgiven tax-free after making 120 monthly payments over a ten-year period.

If you’re not eligible for the PSLF, evaluate whether you can afford the standard repayment plan (also 120 monthly payments over a ten-year period), as it will minimize overall interest expense over the life of the loan. However, if the standard repayment plan is not feasible because of budgetary constraints, it’s time to consider other available options.

Federal Income-Driven Repayment Plans

There are four types of Federal Income-Driven Repayment plans: Income-Based Repayment (IBR); Pay as You Earn Repayment (PAYE); Revised Pay as You Earn Repayment (RPAYE) and Income-Contingent Repayment (ICR). It is important to understand that the benefits of federal income-driven repayment plans come with a price.

While each of these plans do result in a significantly lower monthly payment calculated at between 10%-20% of monthly discretionary income, the loan duration extends substantially – to either twenty or twenty-five years.

This doubling (or more) of duration results in substantially higher interest expense over the life of the loan as compared to the interest expense associated with the ten-year standard repayment plan. Note that these repayment plans apply to Federal Direct subsidized and un-subsidized student loans only – private student loans are ineligible.

Income-Based Repayment (IBR)

For those borrowers with Federal student loan bills that are more than 10% of monthly discretionary income, IBR can make sense for loans originating after July 1, 2014. Under IBR, the monthly bill will drop to 10% of discretionary income, and remain at that percentage for twenty years. Participants must demonstrate financial hardship in the original application and re-certify income level and family size each year to determine the appropriate payment level as income levels fluctuate over time.

Following 240 monthly payments over a twenty-year period, any remaining loan balance will be forgiven, though the amount forgiven is federally taxable. For loans with origination dates prior to July 1, 2014, monthly payments are capped at 15% of discretionary income and 300 monthly payments must be made over a twenty-five year period. Accordingly, for this group of borrowers, it usually make sense to pursue either Pay as You Earn (PAYE) or Revised Pay as You Earn (RPAYE), as monthly payments will be lower here than with IBR.

Federal Perkins Loan Cancellation

This program is particularly useful for full-time educators including teachers, librarians, speech language pathologists and professionals within HeadStart programs. Additionally, full-time firefighters, nurses, members of law enforcement and the military also can qualify for Perkins Loan Cancellation.

Under this program, it is possible to have 100% of a remaining Perkins loan obligation forgiven within five years, with forgiveness granted at 15% in years one and two, 20% in years three and four, and the remaining 30% in year five. Since Perkins loans are administered by the school and not the federal government, applicants contact the student loan office of the issuing institution for proper application forms.

Student Loan Forgiveness for Teachers

The Teacher Loan Forgiveness (TLF) program awards qualifying teachers a tax-exempt reduction ranging from $5,000 to $17,500 in principal owed on student loan debt. To qualify, a teacher must have worked full-time for five consecutive years at a certified low-income elementary or secondary school included on a list published annually by the U.S. Department of Education.

Applicants apply for the TLF by completing the Teacher Loan Forgiveness application, with only Direct subsidized and un-subsidized loans qualifying for forgiveness under the program – PLUS loans do not qualify. However, some teachers can successfully qualify for the TLF after five years, and then again qualify for the PSLF in a subsequent five years.

Pay as You Earn (PAYE) and Revised Pay as You Earn (RPAYE)

PAYE is specifically designed for those graduates who initially borrowed Federal student loans after September 30, 2007, and then took out an additional loan after September 30, 2011.

PAYE was, in fact, initially specifically designed for 2012 graduates, and also for those students who attended graduate school later. Similar to IBR, it caps monthly payments at 10% of monthly discretionary income and leads to any remaining balance being forgiven on a taxable basis after twenty years of successful monthly payments.

Under PAYE and IBR, applicants must prove that they cannot afford the monthly payment associated with the standard ten-year repayment plan. However, under RPAYE, graduates of all income levels can participate – including those who first took out loans prior to September 30, 2007. Therefore, RPAYE significantly widens the playing field of borrower eligibility in terms of loan origination dates and income levels.

RPAYE also limits monthly loan bills to 10% of discretionary income and offers taxable forgiveness on remaining undergraduate loan balances after twenty years and taxable forgiveness on remaining graduate school loan balances after twenty-five years.

Income-Contingent Repayment (ICR)

Though ICR does not offer borrowers the lowest monthly payment as compared to the other available plans, it is the best choice for those seeking to lower their monthly payment slightly, and ICR is the only choice for lowering monthly payments related to Federal Parent PLUS loans.

Under IBR, the monthly payment is determined by income level, tax filing status, and number of people in the household. The monthly payment is capped at 20% of monthly discretionary income or the amount of fixed monthly payment on a 12-year term loan, whichever is lower. Any remaining loan balances will be forgiven on a taxable basis following three hundred monthly payments spanning a twenty-five year period.

Once again, applicants must re-certify income level each year to continue qualifying under the repayment plan, and total interest expense will be significantly higher over the extended 25 year period when compared with the standard ten-year repayment plan.

This is the important trade off that must be remembered when considering any of the repayment plans discussed in this article – the monthly cash flow benefit that results from lower monthly payments comes with an associated price of higher interest expense over the life of the loan.