Student Loan Repayment Alternatives

August 2015

With Colleges and Universities welcoming back students in the coming weeks, paying for college is in the forefront of students’ and parents’ minds. For many, this involves student loans. Student loan debt is reaching historic national levels, making repayment strategies a vital component to any borrower’s financial health. While the simplest advice is to borrow as little as possible, for many, a college education would not be possible without financing. This strategy can lead to a debt repayment schedule that is simply unaffordable for a recent college graduate. In addition, student loan debt is nearly impossible to discharge in bankruptcy, a strategy attempted by many young borrowers in the late 1970s. To ease the financial strain of student loan debt, the Federal Government, through the Department of Education, has created a variety of repayment plans that can lower monthly payments and even forgive remaining loan balances after a term of years.

Background/types of loans

To understand these programs, it is helpful to examine the different types of loans typically offered to students in their financial aid packages. Loans generally can be categorized as either private or federal loans. Historically, federal loan programs have had a variety of different offerings under the Direct Loan Program and the Federal Family Education Loan Program (FFEL). Under the FFEL program, private loans were guaranteed by the federal government. However, in 2010, that program was completely replaced by the Direct Loan program, whereby the Federal Government lends directly to students and parents.

The current Direct Loan program includes both subsidized and unsubsidized loans, Direct PLUS loans and Direct Consolidation Loans, similar to loans issued under the FFEL program. Government subsidized loans are a good choice for student borrowers, as the interest is paid by the federal government while the student is attending school at least half time, for the first six months after graduation and during a period of deferment. In contrast, unsubsidized loans continue to accrue interest while the student is in school and if the student chooses not to pay the interest while in school, the interest will likely capitalize, adding to the principal of the loan. Direct PLUS loans are available for parents of dependent students and student borrowers in graduate school. Direct PLUS loans are unsubsidized and generally have a higher interest rate. Finally, a Direct Consolidation Loan allows a student borrower to combine multiple federal loans into one loan, providing a single monthly payment and an average weighted interest rate. This is helpful for students that may have loans issued from multiple lenders under several programs.

The Direct Loan program provided by the Department of Education is distinguished from Perkins Loans, which generally involve amounts borrowed directly from a school, and private loans, which can take on any form. The balance of this article will focus on offerings within the Direct Loan program.

Repayment alternatives

Each repayment plan offered by the Department of Education has a variety of pros and cons and it is important to understand the specifics of each plan before choosing the most appropriate repayment strategy. Here is brief overview of each repayment plan:

    The Standard Repayment PlanLoans that qualify: Direct Subsidized and Unsubsidized Loans; Subsidized and Unsubsidized Federal Stafford Loans; all PLUS loans. The Standard Repayment Plan (SRP) allows a student borrower to pay off loans in the shortest amount of time - 10 years. In addition, enrolling in an SRP allows the borrower to pay less interest over the life of the loan, ultimately making the loan less expensive. The SRP would most benefit a student borrower having a low student loan balance and a high income after graduation, or some combination of the two.

    Graduated Repayment PlanLoans that qualify: Direct Subsidized and Unsubsidized Loans; Subsidized and Unsubsidized Federal Stafford Loans; all PLUS loans. Payments made under a graduated repayment plan allow a borrower to pay less at the outset of the repayment period, making up the difference throughout the remainder of the plan. However, many borrowers will pay less than the accruing interest throughout the initial repayment period, allowing interest to accrue and capitalize, making the loan more expensive than under the Standard Repayment Plan. This involved a 10 year repayment plan.

    Extended Repayment Plan - Loans that qualify: Direct Subsidized and Unsubsidized Loans; Subsidized and Unsubsidized Federal Stafford Loans; all PLUS loans. The Extended repayment plan allows student borrowers to extend the repayment period for up to 25 years. These payments may be fixed or graduated. However, these loans will ultimately be more expensive for the borrower, as interest will continue to accrue during the entire repayment period.

    Income Contingent Repayment PlanLoans that qualify: Direct Subsidized and Unsubsidized Loans; only PLUS loans made to students; Direct Consolidation Loans. The Income Contingent Repayment Plan allows student borrowers to make payments based on the size of their loan, income and their family size, forgiving any unpaid balance at the end of a twenty-five year period. This involves a fairly complex calculation that takes into account a variety of factors including dependents, spousal income and various deductions. The borrower is not responsible for the calculation, but for those interested, the Department of Education offers a helpful calculator to determine monthly payments under the ICRP and other plans. Payments will be recalculated every year as adjusted gross income either increases or decreases, and any debt forgiveness at the end of the 25 year payment period must be treated as taxable income.

    Income-Based Repayment PlansLoans that qualify: Direct Subsidized and Unsubsidized Loans; Subsidized and Unsubsidized Federal Stafford Loans; only PLUS loans made to students; Consolidation Loans (Direct or FFEL) that do not include Direct or FFEL PLUS loans made to parents. The Income-Based Repayment Plans (IBRP) operate in similar fashion to the ICRP but vary slightly by allowing a borrower to commit a smaller amount of discretionary income to student loan repayment and requiring that a borrower show a partial financial hardship. Depending on some detailed variables, payments may equal either 10 percent or 15 percent of discretionary income. The IBR plans qualify for loan forgiveness at the end of 25 years, and amounts forgiven are subject to income tax.

    Pay As You Earn Repayment PlanLoans that qualify: Direct Subsidized and Unsubsidized Loans; only Direct PLUS loans made to students; Direct Consolidation Loans that do not include (Direct or FFEL) PLUS loans made to parents. The Pay as You Earn Repayment Plan (PAYE) is another income driven repayment plan that requires a new borrower to have a partial financial hardship. To qualify as a new borrower under the PAYE plan, the borrower must have no outstanding federal student loan debt on or after October 2007 and must have received a disbursement of a Direct Loan on or after October 1, 2011. The PAYE program offers payments of 10% of discretionary income, calculated yearly, and any unpaid loan balance will be forgiven after twenty years. Loans forgiven under a PAYE program are also subject to income tax.

    Income-Sensitive Repayment PlanLoans that qualify: Subsidized and Unsubsidized Federal Stafford Loans; FFEL PLUS Loans; FFEL Consolidation Loans. This plan is available to low-income borrowers. Lenders have significant flexibility in creating repayment terms, with monthly payments dependent upon income. The loan period can extend to 10 years.

    Public Service Loan Forgiveness – Public Service Loan Forgiveness plans forgive certain federal student loans if a student borrower is employed full-time by a specific type of employer. Qualified employers include state, federal and local governments and not-for-profit organizations that are tax exempt under Section 501(c)(3). In addition, the borrower must have been enrolled in a qualified repayment plan (which includes all of the income driven plans mentioned above), and must have made qualifying monthly payments for a 10-year period. Unlike most other plans, generally loans forgiven under this plan are not subject to income tax.

Conclusion

Choosing a plan that is right for you depends on an assortment of present and future circumstances. The information presented above is intended to provide a bit of insight into available programs. With the rising cost of tuition and student loan debt serving as the subject of national debate, it is nearly certain these plans will be modified, added to or eliminated in the future. However, awareness of the current plans puts knowledge on your side when the time comes to contact your lender regarding a repayment plan.

If you would like to discuss further, please call your BNN advisor at 1.800.244.7444.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.