You may not be aware of this but if you got a student loan after July 1, 2010, it is a Direct Loan. If you got your loan prior to this, it was most likely a type of Federal Family Educational Loan (FFEL). The difference between the two is that FFEL loans came from private lenders but were guaranteed by the Department of Education. In comparison, Direct Loans come directly from the US government. There are only four types of Direct Loans versus the many different types of loans available under the FFEL program. They are.
• Direct Subsidized Student Loans
• Direct Unsubsidized Loans
• Direct PLUS Loans
• Direct Consolidation Loans
What this change means to you
If you have a Direct Subsidized Student Loan or a Direct Unsubsidized Loan, you have several different repayment options.
Standard Repayment – This is where you have equal monthly payments over the term of your loan, which will be 10 years.
Extended Repayment – Gives you 25 years to complete repayment but you would need to owe more than $30,000 and not have an outstanding balance on a Direct Loan as of October 7, 1998.
Graduated Repayment –With this plan your payments would start out low and then go up every two years. The term of these loans is the same as Standard Repayment or 10 years.
Income-Contingent Repayment – This plan would enable you to meet your Direct Loan obligations without suffering an undue financial hardship. In this program, your monthly payments are recalculated yearly based on your AGI or adjusted gross income, plus your spouse’s income, the total amount of your direct loans and the size of your family.
If you chose Income-Contingent Repayment your monthly payment would be the lesser of these two:
1. Your monthly payment if you were to repay your loan in 12 years multiplied by an income percentage factor that will vary with your annual income, or
2. Twenty percent of your monthly discretionary income
Income-Based Repayment – This plan bases your monthly payments on your income if you have a partial financial hardship. It’s possible that your monthly payment will be adjusted every year. The term of the loan is the same as Standard Repayment or 10 years. In addition, Income-based Repayment caps your monthly payment at a percentage of your discretionary income. Also, if you choose Income-Based Repayment and you have a remaining balance after 25 years of qualifying repayment, that balance will be forgiven.
Pay As You Earn – This plan would likely have the lowest monthly payment of any repayment plan based on your income. However, your payment will increase or decrease every year depending on your income and family size. To qualify for this plan, you will need to show that you have a partial financial hardship.
Payments will be capped at 10%
Pay As Your Earn is where you might or might not get new help with your student loan debt. President Obama just signed a memo directing the Secretary of Education to propose new regulations that would give those with Direct Loans the opportunity to cap their payments at 10% of their income – rather than the current 15%. This change could affect nearly five million student loan borrowers. This action will also increase the President’s Pay As You Earn program by making it available to those who took out student loans before October 2007.
The President also called on Congress to pass Senator Elizabeth Warren’s bill that would allow students to refinance their loans at today’s lower interest rates. Raising the taxes of millionaires – the so-called “Buffet Rule,” would finance this. In addition, he announced that the Department of Education (ED) would begin renegotiating contracts with those companies that service federal loans to have them provide more incentives to help more borrowers keep from falling behind on their payments.
Here, thanks to National Debt Relief is a brief video with more information oabout President Obama’s executive order.
The push back
It seems unlikely that Senator Warren’s bill will pass as Republican lawmakers stopped previously attemps to pass the “Buffet Rule.” They also attacked Warren’s bill on other grounds. Senate Minority Leader, Mitch McConnell, pointed out that Warren’s bill does not make college anymore affordable, reduce the amount of money that students would have to borrow or do anything about the job market that college graduates face in today’s economy.
What you could do
If you are out of school and repaying your student loan debts but are not in the Pay As You Earn Program you might think seriously about switching to it. As noted above, this would cap your monthly payment at 10% of your discretionary income. The way you calculate discretionary income is by subtracting 150% of the poverty level from your total income. The idea behind this is that the 150% accounts for the money you must spend to pay for basic living expenses.
The Federal poverty level guideline for 2014 is $23,850 annually for a family of four. You would add $4060 for each additional person to compute the poverty level for larger families. You would also subtract $4060 per person for smaller families. As an example of this, a single-person household would be considered poor if his or her income was $11,670 or less.
Would you qualify?
This is just a rough example but let’s suppose yours was a family of four with an annual income of $50,000. Multiplying $23,850 by 150% yields $35,775. Subtract this from your annual income of $50,000 means your discretionary income would be $14,225. If your monthly payment were capped at 10% it would be just $142.
If you want to switch
If you want to make the switch you will need to contact your loan servicer. Its advisors will discuss your options with you and then help you switch to Pay As You Earn – if that turns out to be your best alternative.
Unfortunately, there are downsides to Pay As New Earn that you need to be aware of before you make the switch. For one thing, you will end up paying more interest because you’ll be repaying your loan over a longer period of time. Second, you will be required to submit documentation annually to set your payment for that year. If you don’t your monthly payment will be changed to whatever you would be required to pay under the 10-year Standard Repayment Plan and will no longer be based on your income. Plus, any unpaid interest will be capitalized – or added to your balance owed.
Third, only Direct Loans are eligible for the Pay As You Earn repayment plan. You can take into account any FFEL program loans you have to determine whether or not you have a partial financial hardship but these loans will not be eligible for the Pay As You Earn Program. If you have these types of loans and still want to make a change, you’ll need to choose another plan such as the Income-Based Repayment plan.
Finally, if you have any loans forgiven after the 20-year time period you will be required to pay taxes on whatever amount was forgiven.