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A new proposal by the Biden administration would dramatically cut monthly payments in half, with monthly payments as low as zero for many borrowers, while completely wiping out the remaining balance for some borrowers after 10 years of payments.
Unlike the administration’s previous plan granting selective student-debt forgiveness, this is merely a generous reworking of the Revised Pay As You Earn (REPAYE) plan, a type of income-driven repayment plan for federal student loans. Thus, it is less likely to make its way to the Supreme Court, which will hold hearings at the end of February on the legality of Biden’s original $10,000 forgiveness plan.
Here are some of the specifics:
Current programs base payments on 10% or 15% of the borrower’s discretionary after-tax income. The new program would lower that calculation to 5% of the borrower’s discretionary income. In effect, that would at least cut payments in half for most borrowers.
Currently, borrowers who earn less than 150% of the federal poverty level (around $21,900) qualify for the REPAYE plan. Under the new proposal, borrowers wouldn’t need to make payments until income earned hit 225% of the federal poverty guideline, or about $32,800.
Anyone earning less than that $32,800 level would have a zero monthly payment.
But according to student loan expert Mark Kantrowitz, even those with much higher incomes will save under the new formula. He explains that someone earning more than $90,000 and currently paying $568 per month would see her monthly payment drop to $238.
And a borrower earning $40,000 could see a monthly payment drop from the current $151 per month to as low as $30 per month!
As in the current programs, if you successfully make 20 years of these new lower payments, the balance will be forgiven. And for those who have loans initially totaling less than $12,000, and who make regular payments under this plan, the loan will be forgiven after 10 years of payments. For every $1,000 of initial additional borrowings, the time until forgiveness is extended by one year.
There are some other important features of the program:
As long as the payments are made on time, no unpaid interest will be added to the balance, eliminating the “snowball effect” of interest-on-interest adding to outstanding balances.
Previously, family income was used to calculate the required payments in these income-driven plans. Now, only the income from the actual borrower will be counted — a relief to many young married couples.
As it is written, this new program does not apply to PLUS loans that parents of students take out.
It hasn’t been determined whether federal income taxes apply on the amount forgiven, which is the current case until 2025. And states can make their own tax determinations.
What would all of this cost the government? Estimates range as high as $200 billion over 10 years. But that pales in comparison to the $1.5 trillion in student loans outstanding — many of them still carrying their original interest rate of 7% or higher, with interest compounding.
Many borrowers are stuck not only with the high interest rates but also with the compounding of debt — which means they may have paid off their original borrowings but still owe twice as much in unpaid interest!
Kantrowitz says: “By ending the capitalization of accrued but unpaid interest, the new income-driven repayment plan will prevent the loan balance from increasing. This has been a major source of stress for many borrowers, even though they know that the remaining debt will be forgiven in the end.”
And Rae Kaplan, a Chicago attorney who specializes in guiding borrowers to choose the best repayment plans, says if the proposal goes into effect, many borrowers will still need guidance in consolidating their loans to take best advantage of this deal. The details are yet to be released.
This new proposal is not scheduled to go into effect until at earliest July 2024 — if it manages to make its way through legal and political challenges. In the meantime, the current student loan forbearance, which requires no payments, will stay in effect until June 1, 2023 — or two months after the expected Supreme Court ruling on the initial forgiveness program.
The government has been able to refinance its debt to lower costs. Now it’s time to adjust the burden of student loans. And that’s The Savage Truth.
(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)