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The Pros And Cons Of Pay As You Earn For Repaying Student Loans

student holding a past due envelopIf you graduated within the past few years, you probably owe on student loans. In fact, if you’re average you owe more than $25,000. And you’re probably on what’s called the 10-Year Standard Repayment program. This means you have fixed monthly payments at a fixed interest rate and a 10-year term – or 10 years to repay those loans. But there are other repayment plans available that you might not be aware of. One is called Pay As You Earn. When it was originally created payments under this program were capped at 15% of your discretionary income.

Did you know about this and would  you be  eligible?

Many recent graduates aren’t even aware that there are other repayment options such as Pay As You Learn. The upside of this program is that if you qualify your monthly payments would be much less then under 10-Year Standard Repayment and probably lower than those of any of the other available repayment plans. This raises the question of would you be eligible? The answer is that:

  • You must be a new borrower as of October 1, 2007
  • Have gotten a Direct Loan Disbursement on or after October 1, 2011 and
  • Must have a Partial Financial Hardship

In addition to these requirements not all loans qualify only …

  • Direct Consolidation Loans
  • Direct PLUS Loans (does not include Direct PLUS Loans made to parents)
  • Direct Stafford Loans
  • Perkins and LDS Loans (only if part of a Direct Consolidation)

How Partial Financial Hardship is calculated

The way that Partial Financial Hardship is calculated is that it exists when the annual amount due on all of your eligible loans, as calculated under 10-Year Standard Repayment, exceeds all of your discretionary income.

What’s discretionary income?

To calculate your discretionary income you would need to take your monthly Adjusted Gross income and then subtract 150% of the poverty line. If your adjusted gross income were $4280 you would then subtract 150% of the poverty line or $1480. This would yield a discretionary income of $2800. Multiply this by 10% and your monthly Pay As You Earn payment would be $280.

Pres. Obama’s recent executive order

As noted above, when Pay As You Earn was originally created payments were capped at 15% of your discretionary income. However, Pres. Obama’s recent executive order changed this to 10%. In addition, he ordered that some other changes be made so that more people would qualify for Pay As You Earn.

The pros of Pay As You Earn

This repayment program can definitely help low-income borrowers. Its primary benefit is that if you qualify you would have lower monthly payments. You would also have more time to pay off the loan and after 20 years your remaining balances would be forgiven. (Note: Pay As You Earn qualifies under Public Service Loan Forgiveness meaning that if you qualify you could earn forgiveness after just 10 years.)

Under Pay As You Earn there is also an interest payment benefit. In the event your monthly payment doesn’t cover the interest that accumulates on your loans each month, the federal government will pay the difference for as many as three consecutive years on:

  • Direct Subsidized Loans
  • The subsidized portion of any Direct Consolidation loans

In addition, capitalization of your interest would be postponed until a Partial Financial Hardship no longer exists and the amount of your capitalized interest would be capped at 10% of your original debt.

The cons of Pay As You Earn

Unfortunately, there are also some cons to this program. For one thing, if you take more time to pay off your loans, you will pay more interest. You must submit documentation proving your income annually so that your payments might go up or down every year. As noted above, only Direct Loans are eligible. And if you do earn loan forgiveness after 10 or 20 years, the money that is forgiven will probably be taxed and at your normal tax rate.

A bigger problemGraduation cap with money

Some experts believe that while repayment programs such as Pay As You Earn can make it easier for people to repay their student loans that they are basically just bandages and do nothing about the real problem, which is the ever increasing cost of college.

According to the Labor Department the price index for college tuition grew by almost 80% between August 2003 and August 2013. There are several reasons for this. First, most states have cut back on financial aid to their schools. In fact, states spent $2353 or 28% less per student on higher education in 2013 than they did in 2008, Every state but North Dakota and Wyoming are spending less per student on higher education than they did prior to the Great Recession. And in many states those cuts have been severe. Eleven states cut their funding by more than 1/3 per student and two of them (Arizona and New Hampshire) cut their spending on higher education per student in half.

Second, many schools have spent lavishly on new athletic facilities, dormitories that resemble upscale hotels, other new buildings and on big name professors so they can become “elite” colleges and universities.

What to do if you’re just starting out in school

If you will be starting college this or next fall, the best student loan is no loan at all. If you and your parents can figure out a way to pay for your education without borrowing money so that you could start life after college without a cloud of debt hanging over you this is the best option by far. However, if you’re like most students, you will have to borrow money to finance your schooling. So what should you do?

First, always be on the lookout for “free” money in the form of grants, scholarships, work-study options and work grants before taking out any student loans. Depending on your athleticism or field of study you might qualify for a sports or academic scholarship at your school. There are also many scholarships available from other sources such as your state and community groups. As an example of this where we live there is a scholarship for boys and girls who worked as golf caddies and another underwritten by a local foundation that pays for a full four years of college including tuition, room and board and even miscellaneous expenses.

Second, once you’ve gotten a loan and are in school be sure to meet with a financial aid counselor so you will understand your loan and how you will be expected to repay it. Third, create a budget to help keep your spending under control so that you won’t have to borrow any more than is absolutely necessary.

Finally, if possible get ahead on your payments while you’re still in school. If you can make interest-only payments on any unsubsidized student loans this will lower your overall balance and might even shorten the terms of your loan — or the number of years required to repay it.

College can be some of the best years of your life. And most experts believe that its cost is still a good investment as studies have shown that college graduates earn 84% more than high school graduates over the course of their lifetimes. This is up from 75% in 1999. In addition, Georgetown University researchers estimate that by the year 2018 a full 63% of American jobs will require some kind of postsecondary education or training. This means that if you don’t have a college degree or some type of specialized training you could be shut out of 63% of all available jobs.

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