In September 2007, the College Cost Reduction and Access Act of 2007 (CCRAA) was signed into law (PL 110-84). The new law allows individuals to more readily enter careers in government and the nonprofit sector, as it (a) places an annual ceiling on loan repayments for borrowers with high educational loan obligations compared to their incomes and (b) enables such borrowers to make affordable monthly payments for ten years while in the public service, after which the government will forgive the remaining obligation.
Sections 203 and 401 of PL 110-84 introduce Income-Based Repayment (IBR) and a Public Service Loan Forgiveness Program (PSLF) for federal loans. While separate, these programs can be combined to make a career in government or the non-profit sector possible for many. IBR and federal loan forgiveness can be incredible benefits to those who choose low paying careers in government or public service, but they can have a huge cost to those who initially choose IBR but earn too much later or choose a career that renders them ineligible for forgiveness. It is an “all or nothing” forgiveness. Beware of things that seem too good to be true. As folks say, “The devil is in the details” and the details are very important here.
Section 203 of the Act takes effect on July 1, 2009. It will allow borrowers of Federal Direct, Stafford, Grad PLUS and Federal Consolidation loans to repay their loans on the basis of their income at the time of repayment (Income-Based Repayment or IBR). IBR is not available for PLUS Loans made to parents or Consolidation loans that include Parent PLUS loans or private loans, state loans and other loans not guaranteed by the federal government. IBR essentially sets a cap on federal loan repayments at a percentage of your discretionary income where discretionary income is the difference between adjusted gross income (AGI) and 150% of the federal poverty line that corresponds to your family size and the state in which you reside. If the annual payment on a loan amortized on a 10-year basis exceeds 15% of the amount by which your Adjusted Gross Income (AGI) exceeds 150% of the poverty level applicable to your family size, you are considered to be experiencing economic hardship and are eligible for IBR. If you earn below 150% of the poverty level for your family size, your payment will be 0. If you earn more than 150% of the poverty level for your family size, your loan payment will be capped at 15% of whatever you earn above that amount. For married borrowers, if they file their federal taxes as “married- filing separately” only the AGI of the individual borrower counts. This is a major “technical amendment” made by PL 110-153.
The formula would look like:
Maximum annual payment = AGI (Adjusted Gross Income) minus (appropriate poverty level x 1.5) x 0.15 Maximum monthly payment = Maximum annual payment divided by 12
The Federal poverty level for a family of one in 2008 is $10,400. Therefore, 150% of the poverty level for a family of one currently is $15,600. Let’s see what the borrower would have to pay, first using the standard repayment plan, and then using the new IBR Plan.
In NYC, a single resident taxpayer grossing $50,000 annually will net about $3,000 monthly. If the borrower borrowed $100,000 at a weighted average rate of 7.5% ($61,500 in Stafford and $38,500 in Grad PLUS), annual payments would be about $14,244 on a regular 10- year repayment schedule or $1,187 per month.
Now, using the new IBR Plan, the repayments for that same borrower with the same income of $50,000 would look like this:
|Adjusted Gross Income||$50,000|
|(150% of poverty level for family of 1)||-$15,600|
|Earnings above 150% of poverty level||$34,400|
|(annual loan repayment)
or $430 per month
This seems to be a great deal and is the lowest available federal repayment option for this particular borrower. It may not be for every borrower, though. At higher incomes and/or lower debt levels there may be better options.
At the end of 25 years, any outstanding principal and accrued interest is forgiven on all loans, except Parent PLUS loans. The forgiveness may not create a new income tax liability. A bill to this effect has been introduced in Congress. We will keep you posted.
What happens as income increases? What if the borrower with $100,000 eligible debt earns more than $110,275?
The annual payment would revert to $14,244 ($1,187 monthly) – the original 10-year amortization amount. The length of time in repayment would depend on the amount of the outstanding principal balance plus any capitalized interest at that time. The capitalized interest would come from negative amortization. Negative amortization occurs when the monthly payments do not even cover the interest that is outstanding on the loan. In the example above, the interest that accrues annually on $100,000 at 7.5% is $7,500. If the total annual payments are $5,160, the difference – $2,340 annually – would be added to the loan principal and the borrower now owes $102,340 at the end of the first year. If the borrower above had been paying $5,160 annually for seven years, she still owes $116,380 – the outstanding principal and negatively amortized interest. It will actually take an additional 13 years to pay off this debt at $1,187 per month. (The Act instructs the Secretary of Education to forgive any unpaid interest on the subsidized federal loans for three years of IBR payments, but the details have not yet been released. For purposes of the above example, this forgiveness has not been reflected.)
Section 203 applies to borrowers with high debt and low income, regardless of the nature of the job or jobs. Section 401 of the CCRAA creates a Federal Public Service Loan Forgiveness Program (PSLF) designed to help borrowers who plan to work in public service for ten years or more.
PSLF applies to Federal Direct Loans, including Ford Federal Direct, Federal Direct Grad PLUS and Federal Direct Consolidation Loans. Graduates who have borrowed through FFELP (Stafford, Grad PLUS, Consolidation) would have to consolidate their FFELP Loans into a Federal Direct Consolidation Loan in order to be eligible for this program. Graduates who have already consolidated through the FFELP Federal Consolidation Loan Program may “reconsolidate” into a Direct Consolidation Loan after July 1, 2008 to take advantage of this program.
A public service job is defined as : “(i) a full-time job in emergency management, government (excluding time served as a member of Congress), military service, public safety, law enforcement, public health (including nurses in a clinical setting, and full-time professionals engaged in health care practitioner occupations and health care support occupations, as such terms are defined by the Bureau of Labor Statistics), public education, social work in a public child or family service agency, public interest law services (including prosecution or public defense or legal advocacy on behalf of low-income communities at a nonprofit organization), early childhood education (including licensed or regulated childcare, Head Start, and State funded prekindergarten), public service for individuals with disabilities, public service for the elderly, public library sciences, school-based library sciences and other school-based services, or at an organization that is described in section 501(c)(3) of the Internal Revenue Code of 1986 and exempt from taxation under section 501(a) of such Code; or (ii) teaching as a full-time faculty member at a Tribal College or University as defined in section 316(b) and other faculty teaching in high-needs subject areas or areas of shortage, including nurse faculty, foreign language faculty, and part-time faculty at community colleges), as determined by the Secretary.” This is a very broad definition of public service employment.
Under this loan forgiveness program, the Department of Education will cancel the balance of principal and interest due for any borrower who is employed in a public service job and has been employed during the time he or she has made each of 120 payments on the Direct or Direct Consolidation Loan. If the borrower has made 120 payments either under a standard 10-year repayment plan, under the Income-Based Program described in section 203, or under an Income-Contingent Plan (ICR) under direct consolidation, and has any principal and interest outstanding, that amount is forgiven. Loan payments made under the Graduated, Extended or Income Sensitive Repayment Plans do not count toward the 120 payments. Further, for the first three years under IBR, any interest payments due on the subsidized loans (the subsidized portion of the Federal Stafford Loans) that are not covered by the borrower’s payments are forgiven by the federal government.
This section of the law also takes effect July 1, 2009, but allows for tolling of loan payments made after October 1, 2007. The Treasury Department confirmed that participating in PSLF will not create a new income tax liability for borrowers.
Again, on the face of it, this looks great, and may be for some. The IBR lowers the payments required. After 120 of these payments, made when the borrower is in an eligible job, the entire amount remaining is forgiven. The concern is that the graduate with the best intentions may not make the 120 payments while in an eligible job. The graduate may stay in the same organization and get raises faster than expected, may change organizations, may get promoted or may leave the workforce; many things can happen.
One might think that this is not a problem, given that the student would have borrowed anyway and still would have to pay off the loans. However, there is a danger that a student, thinking that he or she won’t have to repay more than a set amount will borrow more than really needed. This will result either in the government giving away more loans than necessary or in the graduate having to pay back more in the end. The Income-Based Repayment Plan and the Public Service Loan Forgiveness Program are two excellent programs that may make public service easier and more attractive to any number of graduates. There are real costs to the programs, however, and graduates who look to them as a panacea may be mistaken. For borrowers who do not benefit from the forgiveness after 25 years or the public service forgiveness after 10 years, there may be real surprises in the amount needing to be repaid after the IBR eligibility term.
Although the details may seem complicated, the advice for taking advantage of this program is more straightforward.
The public service loan forgiveness program is targeted at students who pursue public service careers and who have high debt and low income. Borrowers with low debt or high income will not benefit as much.
As a back-end loan forgiveness program, the public service loan forgiveness is an all-or-nothing benefit. If a borrower stops working full-time in a public service job, even with just a few of the 120 payments left, they get no forgiveness.
To obtain a federal direct consolidation loan, call the US Department of Education at 1-800-557-7392 (TDD 1-800-557-7395).
If you have not yet consolidated, you can seek a federal direct consolidation loan in order to obtain an income contingent repayment plan. Federal direct consolidation loans are available if you haven't been able to obtain a FFEL consolidation loan, or if you haven't been able to obtain income sensitive repayment terms acceptable to you or if you have defaulted on your FFEL loans. If you have already consolidated, you may find it more difficult to consolidate into direct loans. Borrowers who have already consolidated can obtain a federal direct consolidation loan with income-contingent repayment terms, but only if their loans have been selected for default aversion by a guarantee agency.
Starting July 1, 2008, you will also be able to obtain a federal direct consolidation loan in order to qualify for public service loan forgiveness, regardless of whether you have already consolidated or not.
If the direct consolidation loan people say that you must have defaulted on your FFEL loans to consolidate into direct loans, remind them that this restriction was repealed by sections 7015(c) and 7015(d) of Public Law 109-234, the Emergency Supplemental Appropriations Act for Defense, the Global War on Terror, and Hurricane Recovery, June 15, 2006. If they still give you trouble, ask the FSA Ombudsman for help.
Be sure to ask for income-contingent repayment or income-based repayment. The consolidation loan application does not currently include a checkbox for requesting these repayment plans, so you must ask for it separately.