Grads May Soon Repay Student Loans Based On Income

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Grads May Soon Repay Student Loans Based On Income
David K. Randall, 06.02.09, 04:00 PM EDT

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.

Calculate Your Monthly Payment Below:

Adjusted gross income:
(Line 37 on IRS Form 1040)
Your monthly payment:

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:


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 deductions of interest paid on all types of student loans, contributions to Independent Retirement Accounts and other tax credits.

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.

Write to David Randall: drandall@forbes.com.

See Also: Tips on Consolidating Student Loans

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