Friday, June 5, 2009

New Option for Federal Student Loan Repayment

Borrowers graduating from college with student loans are about to get some relief from the federal government starting on July 1. Those in good standing on their student loan payments will be able to take advantage of a new program that will allow them to tie their monthly loan payments on federal loans to what they make, rather than to what they owe. Monthly loan payments will be capped at 15% of the amount by which gross income exceeds the federal poverty level (now $16,245 annually). Furthermore, if the loans are not fully paid off after 25 years, the unpaid balance will be forgiven. While this is generally great news for graduates starting out with modest post college incomes, there is some fine print of which borrowers should be aware.

As income rises, so will your monthly debt payments. That’s not a reason to turn down a raise, but don’t be surprised when the required loan payment suddenly increases.
Income used in the calculation is household income, not just the borrower’s; if a person is married, the spouse’s income will factor into the formula to determine the maximum payment amount, provided the couple files jointly. Filing separately will get around this issue. However, the taxpayers will forfeit other tax benefits such as student interest deductions which are only available to married couples who file jointly.
Payment reductions will slow down debt amortization. The not-so-desirable result is higher interest charges over the life of the loan.
Any debt that is forgiven after year 25 will be treated as income and therefore subject to taxes.
And as noted, borrowers must be in good standing to take advantage of the payment option.
This program applies to federal loans only. In other words, payments on high interest private student loans cannot be tied to income.

In an earlier post I discussed the advantages of the federal, or Stafford loan program, over other types of borrowing to finance one's education. The new income-based repayment program will provide another reason to exhaust this borrowing source before resorting to other types of loans.

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