Grads May Soon Repay Student Loans Based On Income

Use our new student loan calculator to see if your monthly payments will drop.


Borrowers drowning in high student loan debt will be thrown a life preserver on July 1. That's when a new program is scheduled to begin that will allow former students to make monthly payments based on how much they make, rather than the amount they owe.

The option to pay based on your income may sound promising, but there are a few catches.

First, income-based repayment will only be available for federal student loans that are in good standing. Under this plan, borrowers' monthly payments will be capped at 15% of the amount by which their income exceeds the federal poverty level (currently $16,245).

Let's say you have an adjusted gross income of $30,000. That means your pay exceeds the federal poverty level by $13,755 a year, or $1,146.25 a month. Under the new program, you would owe 15% of that amount, or $171.94, per month, regardless of your total outstanding loan balance.

If you left school owing $40,000 in federal loans, you would pay $460.32 a month under the standard 10-year plan. By choosing the income-based repayment plan, you would save 63% per month (by lengthening the life of the loan, however, you will end up paying more in interest over time.)

If your income rises, so will your monthly payments. Any debt that you haven't paid off after 25 years will be forgiven. However, the government will regard the forgiven balance as income for tax purposes.

Those who go into public service work will get additional benefits. Public health workers, law enforcement officers, public school teachers and other government employees can stop making payments on federal student loans after only 10 years. Then their loan balances will be forgiven with no taxes due on the unpaid balance.

As with all government programs there are catches. Here's how this program will affect certain borrowers:

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Married couples who file joint tax returns. Under the program, the income of both partners is considered when calculating the amount that a borrower must repay. Take a couple consisting of one high-paid corporate attorney and a low-paid public defender, both of whom are saddled with student loans. If both file for income-based repayment, the corporate attorney's earnings will bump up the amount that the public defender must repay.

One solution to this is to file taxes separately. However, by doing so, you could lose out on the lower marginal tax rates that come from spreading a high income over a joint return..

Students who are in deferment. Many lenders allow borrowers to defer making loan repayments if they lose their job or have another economic hardship, go back to school or join the military. If you filed for deferment, you are still eligible for an income-based repayment plan once your deferment period is over, says Mark Kantrowitz, publisher of FinAid. If the deferment was due to economic hardship, you may be able to end the deferment early. The best way to work your way through the details is to contact your lender and inquire about its deferment policy.

Medical students and residents. Budding doctors and dentists may be among the unfortunate few who owe more under the income-based repayment plan. Under previous rules, students who were either in medical school or residency could defer all payments on their often-sizable federal Stafford loans (becoming a doctor isn't cheap; the average medical student graduates with $140,000 in student debt).

Under the income-based plan, doctors and dentists will be required to make small monthly payments during residency if they earn more than $16,245. A resident making $56,000, for instance, would owe $503 per month under the income-based repayment plan.

Though some medical schools are lobbying Congress to allow residents to defer payments during residency, FinAid's Kantrowitz says that the federal government is unlikely to change the rules.

"It's very expensive to provide subsidized interest to medical students who don't really need it because they're going to graduate and get very high-paying jobs," he says.

If a resident can't cover the monthly payments, he can elect to apply for forbearance. Under this program--which lenders are obligated to offer--the resident won't have to make any payments, but the unpaid interest will be added to the principal that the student must start to pay off once the forbearance term ends. Choosing to go into forbearance won't affect a borrower's credit score, but it will mean you will pay more interest.

Sallie Mae offers a worksheet that can help medical students and residents work through their repayments options.

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Parents' Tough Choices For Repaying Student Loans

Talk to kids and lenders before raiding retirement savings or risking your home.


Earning a college education is a big financial risk, not just to the students working toward the sheepskin, but often to their parents as well. That's doubly true as the proportion of students financing their college years with loans rises, and many turn to private loans to pay for expenses that federal loans won't cover.

To offer their best student loan terms, most lenders require students to list a separate cosigner--a party who is legally on the hook to repay the loan in the event that the student doesn't. All too often, that cosigner is mom or dad, fast approaching retirement age and with a plethora of their own financial obligations.


Donna Martin, a 52 year-old city clerk in Victorville, Calif., faced the prospect of either cosigning for her daughter Jessica's $20,000 private loan three years ago or subjecting her offspring to heftier payments down the road. The elder Martin cosigned, and Jessica began working toward her psychology degree at nearby California State University, San Bernardino, where she is now studying part-time.

Meanwhile, even with a cosigner on the documents, the lender offered a variable interest rate that is currently at 7.65%. That, coupled with deferring payments, has sent the balance the Martins eventually must pay back to $28,000. With the loan balance rising, and the job market in the dumps, Donna is becoming increasingly fretful.

"I'm afraid that I will be stuck with this debt deep into retirement," she says.

Assuming the worst case comes to pass, and Jessica leaves school unable to repay her loan in full, her mother will face some very tough choices. Following are some guidelines for parents who find themselves in similar situations.

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Negotiate with your child. Launching a career is never easy, and that's especially so at a time when the job market is lousy and many starting salaries barely cover living expenses.

Still, it's important that parents begin early to manage a child's expectations regarding what is expected in terms of repaying a student loan for which they're both on the hook. First off, it's important to keep in mind that the child will be the primary beneficiary of the loan and will have four decades to pay it off before having to cover retirement expenses--a luxury parents don't have.

So start out by making it clear: Are you planning to repay the loan yourself or do you expect your child to cover all or part of it? Also make clear, possibly in writing, what sort of financial sacrifices and contributions you expect your child to make to repay the loan once they're out of school. And since half of entering college freshmen never graduate, make it clear as well what you expect if your child leaves school with debt, but no degree.

Negotiate with the lender. If you and your child are facing difficulty making student loan payments, call the lender, explain the situation and ask them to ease the terms. No, they're not likely to cut interest charges to zero or reduce the principal balance, but they may well be willing to share your pain.

"Lenders don't want to have to write things off," says Ted Beck, the president and CEO of the National Endowment for Financial Education, a nonprofit organization that focuses on personal finance.

Take out a home equity loan or second mortgage. Not all debt is created equally, and at least in terms of interest charges, loans that use a home as collateral tend to be among the least expensive.

Martin owns the home that she's lived in for 20 years outright, meaning she's paid off the mortgage. So taking out a loan against the property at a relatively low interest rate is an option. "This can be a reasonable approach, but it all depends on the interest rate on the home equity loan," says Mark Kantrowitz, the publisher of FinAid, a Web site that tracks the student loan industry.

Most home equity loans have fixed interest rates and 15-year terms. Borrowers can deduct the interest payment from their federal taxes if they itemize their deductions.

The downsides? Getting such a loan, for one, is tough unless you have considerable equity in your home. Second, you're putting up your house as collateral--meaning if you fail to make the payments you can lose your home entirely.

"Getting a home equity loan is good in theory," says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, a nonprofit group that helps consumers deal with debt, "but I'd eliminate a lot of other options before I considered this." Adds Kantrowitz: "If you default on a private loan, the worst thing they can do is garnish your wages. If you default on a home equity loan, the worst they can do is take your home."

Take out a home equity line of credit. This option is similar to a home equity loan, but with one key difference: Interest on home equity lines of credit (Helocs) are variable. As many mortgage borrowers have discovered, it's easy to jump at a teaser rate whose payments are within your reach only to have them ratchet up after you're on the hook. And once again, since the home is used as collateral, a failure to make timely payments can put it at risk.

Nor are Helocs necessarily in plentiful supply these days, due to the declining value of homes, and homeowners equity in them. A few years ago, Martin's home was valued at $450,000. Now, she would consider herself lucky if it were appraised at $170,000. A nearby home, which is owned by a bank, is on the market for $70,000.

Tap retirement savings as a last resort. If all else fails, it is possible for a parent to take out a loan from his or her tax-deferred 401(k). These loans are often available with minimum fees. The downside is that they have to be paid back within five years, and you're essentially required to repay your own account, plus interest that's typically a few points above the prime bank lending rate (currently 3.25%).

Restrictions abound. First off, most company plans allow participants to borrow no more than 50% of their vested 401(k) balance, or $50,000, whichever is lower. If you move to a new company, but keep your 401(k) savings in your old employer's plan, it's unlikely they'll permit you to borrow anything at all against it. IRAs, meanwhile, won't offer any help. The IRS forbids loans from most IRAs, and will only allow early withdrawals for medical or educational expenses.

"I'd never recommend using the money in a 401(k) for anything except retirement," says the National Foundation for Credit Counseling's Cunningham.


Have you had a problem paying a student loan? Please leave a comment below.

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Student Loan Repayment Options Explained

A crash course in repaying your student loans.

Taking out a student loan is as common among college students as posting pictures on Facebook. But as recent graduates try to find their place in an economy where finding any job is an accomplishment, monthly payments on student loans can prove a financial burden. Two out of every three students enter the workforce with student debt. Those with loans carry an average balance of $23,000, which results in bills of about $250 a month.

Though the Department of Education requires that students sit through a counseling session before taking out a federal loan, these sessions often amount to little more than a 10 minute tutorial on a Web site and a multiple choice quiz. By the time students reach graduation day, many have forgotten what little they may have learned.

With that in mind, here's a crash course in repaying your student loans.

Why Repay? Quite simply, because you have to. That's not a moral statement but a factual one. Student loans are one of the stickiest types of debt around. Unlike credit card debt, mortgages and most business loans, the money you owe on your student loans won't be forgiven, even if you file for bankruptcy. That means it's easier to walk away from a mortgage than it is to erase the debt you took on as a 19-year-old.

If you don't pay, your credit score will haunt you for years. You'll find it hard to get a mortgage, a car loan or even a credit card. What's more, lenders can go after your tax refunds or garnish your wages. If your parents co-signed for your loan, their assets may be in jeopardy too.

Here, then, are the most common ways to repay your loan, in increasing order of unpleasantness:


Option 1: Repay as Scheduled. This is the best-case scenario. You get a bill every month, pay it and eventually the entire balance is gone. In the meantime, you'll likely get a generous tax deduction for the interest you're paying. Some lenders, like Chase and Wells Fargo ( WFC - news - people ), will cut your interest rate after you make a certain number of payments on time. Others will reduce rates if you sign up for automatic withdrawals from your checking account. Few private student loan lenders charge pre-payment penalties, so you can pay off the loan early and save on interest payments.

Option 2: Consolidate Your Loans and Lengthen the Payment Schedule. Consolidating your loans is a way to package multiple loans into a single payment. Unfortunately, it is unlikely to lower the interest rate you pay on federal loans. If you have private loans, you'll need to consolidate those separately.

The standard repayment plan for federal loans is 10 years. If you consolidate, you'll be able to qualify for extended repayment, which is exactly what it sounds like. You can stretch out the payments on federal loans to as much as 30 years, depending on how much you owe (You'll need to owe more than $60,000 for the 30-year plan; owe less than $20,000, and you'll only have 15 years.) The downside: You'll pay more interest over time.

Here's one case of how extending the repayment period works. Say you owe $25,000 and are paying 6.8% interest. For a standard repayment plan, you'll owe $287 a month and will pay about $34,000 over 10 years. Stretch it out to 20 years, however, and you'll owe $190 a month but will end up paying about $45,000 overall. If you want to see how extending the repayment option will affect you, check out this calculator from FinAid.

If you're having trouble making your payment now, you may want to extend the schedule, and then pay more than your monthly bills once you start making a higher salary.

Option 3: Income-Based Repayment. This is only available for federal loans. Under this option, your monthly payments will be capped at 15% of the amount by which your income exceeds 150% of the federal poverty level (that works out currently to $16,245 for a single individual).

Let's say you have an adjusted gross income of $30,000. That means your pay exceeds 150% of the federal poverty level by $13,755 a year, or $1,146.25 a month. Under income-based repayment, you would owe 15% of that amount, or $171.94, per month, regardless of your total outstanding loan balance.

Any debt that you haven't repaid after 25 years will be forgiven. That's not as great as it sounds. The federal government will consider the balance that is forgiven as income. If you have $10,000 forgiven, Uncle Sam will see it as a $10,000 raise and tax you accordingly. Those who work in public service can have their debt forgiven after 10 years and won't have to pay taxes on it. (For an estimate of how much you'll owe under income based repayment, check out this calculator from Forbes.)

Option 4: Deferment or Forbearance. Now we're getting to what happens if you can't pay your loans back easily. The first and best thing to do is talk with your lender and explain your situation. You may want to ask for a deferment, which can be granted for reasons like economic hardship, unemployment or if you go to graduate school. Under a deferment, your lender will allow you to skip payments, generally for up to a year at a time. Interest may accrue during this time, however, and can be added to the principal once you start making payments again.

Forbearance is similar to deferment, but it's important to know the difference between the two. Like deferment, going into forbearance means that you're reaching an agreement with your lender that will allow you to skip payments for a set period of time. Interest will continue to accrue on all types of loans during this period.

The most important difference is that the time you spend in forbearance counts toward the total number of years counted in your repayment period. Why should that matter? Say you agree to repay the loan in 10 years, but go into forbearance for your first year out of college. Even though you aren't paying, the date that you agreed to finish your loan payments by hasn't changed. Your payment schedule will be adjusted with the aim of having you pay off the entire amount by the original deadline. To get there, you'll have to make bigger monthly payments or a large payment at the end.

Option 5: Defaulting on Your Loans. You will default on your federal loans if you haven't made any payments in the last 270 days (private lenders have their own dates, but they are generally half those of federal rules). Avoid defaulting at virtually all costs.

Should you default, your loans may be turned over to a collection agency, your wages may be garnished, your credit score will drop dramatically, you'll be ineligible for deferments and you may be barred from renewing a professional license.

Despite such nasty consequences, the weak economy is forcing more former students to default. The Department of Education currently expects close to 7% of all federal loans to go into default, which is nearly double the rate of a few years ago. Sallie Mae ( SLM - news - people ) and Citigroup ( C - news - people ), meanwhile, have seen the default rate on their private loans almost double to about 3%.

If you have defaulted, you'll need to make arrangements with your lender for a loan rehabilitation plan. Lenders may offer to reduce your monthly payment. Generally, you'll need to make at least nine out of 10 payments voluntarily and on time during your rehabilitation period for your lender to consider your account in good standing.

If you aren't able to make those payments, your loan may be turned over to a collection agency. Then you'll be stuck not only paying the amount you owe, but also the collection agency's costs, which can be as high as 40% of the amount you owe.

Collection agencies are not all the most upstanding businesses. Despite what an abusive collection agency may tell you, you have rights to be treated fairly under federal law. For more, read "Six Consumer Rights Every Debtor Should Know."

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The Student Loan Scam

The federal college loan program that pays private lenders a generous subsidy to make loans that are guaranteed by the government is an enormous waste of money that has long served more to enrich lenders than to help students.

Nevertheless, the Republican leadership in Congress is opposing a House bill that would save the country nearly $90 billion in the next decade by ending this program and allowing students to borrow directly from the government through colleges.

The subsidy program was created when lenders were showing little interest in the college loan program and was intended to make sure that young people could get loans when times were tough. This expensive strategy failed outright during the credit crunch when the federal government had to buy outstanding loans to keep new loans available to students. The direct lending system, which was already known to be cheaper, needed no such rescue.

A bill introduced by Representative George Miller, a Democrat of California, would end the unnecessary private lending subsidies and plow the savings into important education programs. The bill, for example, devotes $40 billion to the all-important Pell grant program, which has allowed millions of poor and working-class students to attend college.

It would spend $8 billion on early-education programs and $10 billion on an initiative aimed at strengthening community colleges. It sets aside $4 billion for a school modernization and improvement program.

The consolidated program proposed in the bill would in no way expand government. The loans would be handled through colleges. They would be serviced and collected by private companies and nonprofits that are already lining up to get the work. By forcing the companies to compete, and to undergo periodic re-evaluations, Congress could get a good deal for taxpayers and better service for borrowers.

The arguments for passing this bill and ending the subsidy program are powerful. But the Republican leadership has distorted the debate by describing the bill as a plan for pushing private capital out of student lending. It would be more accurate to describe it as a plan for pushing corporate welfare out of student lending.

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The 4 Benefits Of Student Loan Consolidation

If you haven’t noticed it, education costs don’t come cheap nowadays. Many students are taking loans to support their way through college. It seems to settle their problem for the time being but things will start to get difficult when they graduate. They are already in debt before they even earn their first dollar. The tips below are to show you why you should consider the student loan consolidation.

1. Lower payment

This is by far the best reason for you to consider taking the loan consolidation. It is possible to reduce your monthly payment by 40% - 50% when you make a research on the lenders. Imagine freeing half of the financial load being lifted off your shoulders. You will feel that the air is lighter and your life is not just about paying for loans.

2. Lower rates

Besides lowering your payment, you can also lower your interest rates by looking for the right lenders. Again, it will prove beneficial to you when you run some researches on the various lenders’ offers.

And be careful for the fine prints and remember to ask for any hidden cost. You don’t want to suffer any extra payment when you are trying to manage your loan. And to help you on that, you can look for online consolidators to calculate your future student consolidation loan base on the current rate of your student loan.

3. Only one payment

Let’s say you have acquired a housing loan and other possible loans during your studies. And imagine you have to bank in different payments to different companies at different time. Isn’t that a lot of works to do? Wouldn’t it be great that you can make one payment and be free from all the annoying reminders? You can do that when you consolidate the student loan and get your loans taken care of.

4. Relieve stress

Please know that the financial companies will punish you for paying late and surely you don’t want that. It is a stressful job to remember the various due dates for the payments. What if you have more important tasks to attend to?

It is very possible that you will forget to pay the loan. And when you sign up for student loan consolidation, you only pay once to the company to cover all your loans. This frees your mind so that you can focus on your job or something more rewarding.

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Get a Break on Student-Loan Payments

A new plan bases repayments on income and can rescue borrowers buried in debt.
By Jane Bennett Clark, Senior Associate Editor, Kiplinger's Personal Finance
June 23, 2009

You have a mountain of student debt and a job you love in a low-paying field. Lately, you've considered ditching that job for a higher-paying gig just to get out from under.

Hang tight. As of July 2009, a new repayment plan for federal student loans, called income-based repayment, rescues borrowers buried in debt by slashing or even waiving monthly payments and forgiving any remaining debt after 25 years. "This is a big deal," says Edie Irons, of the Project on Student Debt, an advocacy group. "It's going to help a lot of people."

You probably qualify for the plan if your federal student-loan debt equals or exceeds your annual income. The new program caps monthly payments at 15% of the difference between adjusted gross income and 150% of the federal poverty level for your family size ($10,830 for singles in 2009). If you make less than 150% of the poverty level, you pay nothing at all.

Also, to qualify for the program, your new monthly payments must be lower than the amount you would pay under a standard ten-year repayment plan for federal loans. You can compare the two by using the calculators at IBRinfo and FinAid.
The 25-year plan

Say you are single, have $30,000 in Stafford loans with a 6.8% interest rate and make $20,000 this year. Under the standard repayment plan for Staffords, you would pay about $345 a month. In the income-based repayment plan, you would pay a much more manageable $50. Payments adjust annually according to income but never exceed the monthly amount you would pay in the standard plan. Whatever debt remains after 25 years disappears.

If your payments are too low to cover the interest, Uncle Sam picks it up for you for up to three years on subsidized Staffords (awarded to students with need). After three years, and on other loans, the interest builds but does not compound. Because the debt goes away at the 25-year mark, you don't have to worry that the accrued interest will extend your repayments into your old age.

Income-based repayment improves on but does not replace a couple of other income-related repayment plans, the most comparable of which is the income-contingent plan, for loans offered through the Federal Direct Loan program. You can see about switching to the new repayment plan by contacting your lender. (For a rundown of all the repayment options for federal student loans, see How to Repay Student Loans.)
A quicker way to delete debt

You may not have to wait 25 years for loan forgiveness. Thanks to the same legislation that created income-based repayment, anyone who works for a government agency, a nonprofit organization or AmeriCorps can qualify for forgiveness after making 120 payments over ten years. Only payments made after October 2007 count toward the ten-year time frame.

To get in on this deal, you must be in the standard, income-based or income-contingent program and have received your loans through the Direct Loan program. If you received your loans through a private lender participating in the Federal Family Education Loan (FFEL) program, as most borrowers do, you can switch to the federal program by consolidating your loans. To find out more, go to Federal Direct Consolidation Loans Web site.


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Starting in July, new ways to cut your student debt

College students face a dwindling job market and rising school costs. But July 1 will bring some financial reprieve for those with federal loans and grants.
(Seth Wenig/AP)


July 1 is shaping up as a big celebration day for college students and recent graduates. That’s when several perks for federal student loanholders take effect.

If you have student loans from the federal government, here’s how you may be able to lower your payments and, potentially, your interest costs.

Cut monthly payments

One of the big perks of the 2007 College Cost Reduction and Access Act is the Income-Based Repayment program. Taking effect next Wednesday, the IBR allows college graduates with federal loans, including Staffords, Grad Plus, and Perkins, to lower their loan payments if they have enough debt compared to their incomes. (If it takes more than 15 percent of what you earn above 150 percent of the poverty level to pay your loans off in a standard ten years, you’re in.) For most borrowers, the program reduces payments no more than 10 percent of their earnings.

For example, a single person earning $40,000 a year can expect to repay no more than $3,680 a year (9.2 percent) on their loans, according to IBRinfo.org. Here’s where it gets tricky. If those payments aren’t enough to cover interest costs, the unpaid interest will be added to the total amount owed. That would increase your debt. If you have Subsidized Stafford Loans, the federal government will pay the interest shortfall, but only for three years.

One of the big advantages of the program is that the term of the loan is capped. So as long as you make qualifying payments under IBR for 25 years, the rest of your debt is forgiven, no matter how big it is. If you work in public service – say, as a teacher or in a government job – the balance of the loan is forgiven after only 10 years.

Want more details? IBRinfo.org has more information, including a calculator to see if you meet the debt-income ratio.

Ready to switch? Contact your lender directly.

Lower interest rates

In addition to the new IBR program, other federal loan changes taking effect July 1 will increase the amount of grants available to needy students and reduce the interest rates on student loans.

For students who qualify for Pell Grants — usually reserved for families with incomes under $50,000 — the government is raising the maximum award from $4,731 to $5,350 for the upcoming school year.

Also, interest rates on new Subsidized Stafford loans (generally for families making under $80,000) drop nearly half a percentage point to 5.6 percent, starting Wednesday. Fill out the Free Application for Student Aid to see if you qualify for these forms of financial aid.

Consolidate, consolidate

Already graduated and have federal loans? Wait until July 1 to consolidate any variable-interest Stafford loans taken out before July 2006 — interest rates drop from the current 4.21 percent to as low as 1.88 percent for recent graduates still in their six-month grace period. The rate will be 2.48 percent for those who consolidate loans already in repayment.

Consolidation can make payments simpler and, sometimes, lower. For example, the financial aid site Fastweb calculates that a student who borrows a Stafford loan of $20,000 at a 6.8 percent interest rate with a standard 10-year repayment plan can expect to pay $7,619 in interest over the life of the loan; consolidating at a 2 percent rate would bring that down to $2,083.

To consolidate, fill out an online application at the Federal Direct Consolidation Loans site.

The caveat, of course, is that these new repayment options are for students with federal loans — not private ones, which an increasing number of students are using. According to the Project on Student Debt, 14 percent of undergraduates nationwide took out private loans in the 2007-2008 school year, up from 5 percent just four years earlier.