It’s the end of the college year, and the specter of student loans that looms over the heads of students are an undeniable burden for millions of college graduates. The average holder of a bachelor’s degree has $23,200 in loans to repay at graduation, and students in specialty fields like engineering, law, medicine, and the creative arts can face debts of more than $100,000 at graduation. With discharge through bankruptcy blocked by Congress, what’s a struggling debtor to do?
Financial advisers often push for debtors to extend the terms on their student loans. This moves the repayment term from the standard 10 years to 20 or 25 years, which lowers monthly payments. However, this also subjects the borrower to years of additional interest payments, which can make the total bill much higher. For those with large loans to deal with, even the extra time is not enough, as they still face frighteningly large monthly payments.
A better solution for graduates with large debts is the newly effective Income Based Repayment (IBR) option. This repayment option was created in 2007 when Congress pushed through the College Cost Reduction and Access Act. However, the provisions of IBR didn’t become effective until July 1, 2009, and only a small percentage of borrowers have taken the time to explore them.
What is IBR?
IBR is an alternative repayment plan for student loans that is especially beneficial for individual who are going through financial hardship or have jobs that don’t generate enough income to pay loans and live comfortably. It extends the period of the loans to 25 years and caps monthly payments at a percentage of income. For most borrowers, the new repayment amount will be no more than 10 to 15 percent of gross monthly income.
IBR also contains a loan forgiveness provision. If at the end of the 25 years you still have a loan balance, the remaining amount owed will be forgiven. For teachers, public servants, and volunteer workers, some elements of the loan or even the full balance may be forgiven after 10 years.
Unfortunately, not every loan is eligible for an IBR plan. Loans need to be federal student loans such as Stafford, Grad Plus, or federal consolidated loans in order to qualify for the program. Private student loans and student loan programs where the money was lent directly to parents are not eligible. However, some consolidation packages that included Perkins loans are eligible.
There is no limit to how much can be rolled into an IBR plan. The program offers more benefits to those with larger loans. It also contains provisions so that married couples who are both struggling with loans may be able to combine their filings to get a better deal on the repayments.
The effects of IBR on a loan package can be dramatic. As an example, consider the case of BWH, a graduate of Full Sail University, a specialty music school in Florida. Currently, his loan debt is just over $113,000 with an average interest rate of five percent. He struggles to make the monthly payments of $850 on an income of $26,800 as an audio visual coordinator. Under the IBR formula, his monthly payments would drop to $130.
What’s the Catch?
Like all student loan relief payments, the IBR plan does come with its own set of fine print. The two biggest places where borrowers can get tripped up in the system have to do with the way payments are figured and with being late on payments.
In terms of lateness, the catch with IBR is that it is based on timely payments throughout the life of the program. Miss a payment or be late with your payments once, and you jeopardize the possibility of loan forgiveness. As a result, at the end of the 25 year repayment period, if you’re late you could owe the balance of your debt.
In terms of the way payments are figured, it is critical to remember that payments are based on income earned and that they are refigured yearly. Going back to BWH: if his income jumps to $45,000, his payments for the next year jump to $360 per month. This can be challenging for borrowers trying to maintain stability in their debt repayment options, and the shifting payment amounts increase the likelihood of being late or missing payments.
Still, even with these caveats to consider, IBR does provide another path out of an endless tunnel of hefty student loan payments. Given that the federal government has little incentive to reform student loans, it is up to you to pursue every avenue possible to balance your finances and minimize your student loan expenses so that you have money for other opportunities in life.