Are You in the Income Based Repayment Plan?

If you are in the Income Based Repayment Plan (IBR), I would like to ask you to do a little homework about your financial situation and the potential damage you might be doing to yourself in IBR.

IBR provides a fairly small monthly payment if you have a large student loan relative to your income. It helps you when you are in a tough spot financially. The problem is it can also tempt you to get into the program when you have large student loans even when you are making pretty good money.

Question #1 – Are you in IBR because you are experiencing a serious income problem?

IBR can be a great way to address a temporary financial crisis. If you cannot make the normal monthly payment on your student loan, IBR can reduce the payment to a level that is manageable. It can basically buy you some time while you are working on getting your income back up. On the other hand, if you are making pretty good money but you have a large student loan balance, you may just be making your debt problem worse by being in IBR.

Question #2 – Is your monthly payment in IBR covering the monthly interest?

Look up how much interest is due on your loans each month. If your monthly payment is less than that amount, you are basically digging yourself a deeper hole every single month. The amount of principal plus interest due on your loans is going up every month. That’s a recipe for disaster if you allow it to go on for long.

IBR can be a blessing or a curse. It all depends on your current situation and whether you have a well thought out plan for getting the debt paid off.

Don’t go into IBR without knowing how it works. You need a plan that takes into account the reality of your current situation and how you plan to eventually get your student loans paid off.


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Is a small student loan payment wise or foolish? Part 2

In my last post on the new Pay As You Earn (PAYE) program from the federal government, I asked the question “Is a low monthly payment on a student loan smart”?

I walked through an example that shows how the government (the primary student loan lender) is advertising low monthly payments as “saving you money”.

Now let’s look at the program from a little different perspective.

How About a 40-Year Amortization?

If your child came out of school with $25,000 in debt and an income of $35,000, their monthly payment under PAYE is $152. The calculator at says they save $1,628 a year with their low “Payment under Obama” as compared to the $288 per month payment under the standard 10-year payment plan.

So how many years did the government use in this example to get to the $152 monthly payment? The answer is 40 years! Ah, no wonder the monthly payment is less than a 10-year amortization.

How About an 89-Year Amortization?

Here’s another version of that example.

Let’s say your child had the same $25,000 of debt but their annual income (adjusted gross income) was $33,750. That would create a monthly payment of $142. So how many years would it take to pay off a $25,000 loan making a $142 per month payment?

The answer is 89 years. Holy cow! You would be on an 89 year amortization schedule. That’s three times as long as a 30 year mortgage.

Does that seem weird to you? Does that seem downright dumb (for both the lender and the borrower)?

And the government says you will be saving money by making this low monthly payment?

Now the rest of the story…

The government doesn’t really want you to take 89 years to pay them back (they know you’ll probably be dead by then). So they created a new wrinkle. The new Pay As You Earn program says that if you make all your monthly payments on time for 20 years (240 monthly payments without fail) they will forgive the balance at the end of the 20 years.

They know there is likely to be a balance at the end so they will just forgive it for you. The government will erase your debt.

No mention that they will also send you a 1099 since the amount forgiven is treated as taxable income. And the tax is due immediately – in full. Kind of like getting a beautifully wrapped Christmas present – only to find a financial bomb inside.

What’s Up?

The government wants more students going to school. Offering student loans with low monthly payments and the promise of debt forgiveness is the carrot they are using to get more people to say yes to college (no matter how much it costs).

They also want people to spend more of their money after they graduate on buying cars, buying houses, and participating fully as a consumer. That’s one reason they are providing the super low monthly payment.

They are also assuming that your income will go up over time and you will be able to pay more than when you first get out of school.

But encouraging a person to stay in debt for 20+ years is more likely to hurt them financially rather than help them become financially independent.

It teaches the opposite of don’t buy things you can’t afford. It teaches the opposite of get out of debt and save money.

So back to the question: Is a small student loan payment wise or foolish?

Send me an email and let me know what you think.


The new Pay As You Earn student loan repayment program – a blessing or a curse? Part 1

Big changes are on the way in how student loan repayment works. And they are going to make your job of parenting even harder (in a twisted sort of way).

If you’re a big believer in the value of debt, you’re going to love these changes. If you’re the kind of parent who teaches your children that debt, at least generally speaking, is not a good idea, then you may struggle with how to advise your children when college time approaches.

The changes are part of an executive action president Obama announced called Pay as You Earn.  It is very similar to the new changes coming in the existing Income-Based Repayment (IBR) program.

Pay As You Earn (PAYE)

PAYE redefines how student loan repayment will work. Its provisions are generally effective at the end of 2012. In PAYE, your monthly student loan payment is based almost exclusively on your income after college, regardless of how much student debt you owe when you get out of school. Then any balance, including accrued interest, that is still due at the end of 20 years is forgiven by the government.

The program has its roots in President Obama’s State of the Union address on January 27, 2010, where he said this:

“Let’s tell another one million students that when they graduate, they will be required to pay only 10 percent of their income on student loans, and all of their debt will be forgiven after 20 years – and forgiven after 10 years if they choose a career in public service, because in the United States of America, no one should go broke because they chose to go to college.”

The program is designed to reduce the required monthly payment on a borrower’s student loan based on their income. Generally speaking, if your monthly payment under a 10 year repayment period is greater than the monthly payment PAYE calculates, then you qualify for the program and you make the lower monthly payment.

The monthly payment under PAYE is calculated as 10% of your discretionary income. It defines your income as your Adjusted Gross Income on your federal tax return. It defines discretionary income as 150% of the poverty line for a family of your size. For a single person with no children, the poverty line in 2012 is $11,170. 150% of that number is $16,755. (Those amounts go up if you have children.) So it looks at the difference between your income and the $16,755 to calculate what the government feels you can use to make a monthly payment.

A Borrower Example

A single person with no children making $30,000 (assuming AGI is also $30,000), that comes out of school with $25,000 in student loans, would have a monthly payment of $110. Under the 10 year repayment plan your monthly payment would have been $289. Since the $110 is lower than the $289, you qualify for the plan and would make the lower monthly payment. Any balance still remaining after 20 years would be forgiven by the government.

Here’s a biggie…

The $110 monthly payment in this example would not change even if you graduated with $50,000 in debt (rather than $25,000). It wouldn’t change if you graduated with $100,000. You could graduate with $250,000 in student debt and it would not change the monthly payment as long as the student loans are all loans made by the government. (Note: to get student debt that high through the government would mean you went on to graduate or professional studies after your undergraduate degree.)

Private student loans are not eligible for this program. Parent PLUS loans are not eligible either.

PAYE is setting the monthly payment based almost entirely on your income.

The Good, the Bad and the Ugly

Stay tuned for Part 2 (and beyond) on this subject.

I will list all the good and the bad points that the new Pay As You Earn program and the new IBR program create.

Some are really good… and some are really bad.

The key is for you to determine how this will impact you and your children. That’s what’s most important. I’ll help you accomplish that.

Even very smart people are burying themselves in student debt – Part 2

My first post in this series quoted from a great article about a person going to college and how she racked up over $100,000 in student loans.

In the article, she posed a brilliant question that you really need to consider as a parent. She asked “what leads a (relatively) smart person to make almost ten years’ worth of poor financial decisions”?

I love that question. It gets to the heart of how so many parents and children are throwing caution and basic common sense out the window when it comes to paying for a college education.

There were lots of comments posted about that article too.

Here is a quote from someone who wrote one of the comments.

“I have a B.A. in Philosophy (really), an M.Ed in teaching English as a Second Language to Adults, and an M.A. in Translation — spread out over decades. I owe $86,000 in student loans.

I was the first person in my family to attend college (my father dropped out in 8th grade and my mother had a HS diploma). My parents insisted that I attend college so I could have a better life. They did not have any money to send me, so I took out loans.

As a kid I really wanted to learn a trade — carpentry or plumbing or something like that. I had NO idea what I was getting into — I really didn’t understand the concept of college — I had no points of reference as no one I’d ever known had attended. I didn’t understand the loans and I didn’t understand how to navigate any of the systems.

I loved college, though, (obviously, since I kept going back) and loved learning, and am really happy with my education. I work in human services earning a pittance (about $35k between my full-time and part-time jobs), and I love the work I do. Because I work in a non-profit, I am eligible for forgiveness of my loans after ten years of paying them, and I pay the Income Based Repayment plan — currently $123 per month. I think that’s a fair amount and I think the forgiveness plan is fair.

I guess I would like to see colleges/admissions offices do a better job of counseling people about what their student loans entail, but it’s so incomprehensible when you’re that young — the amount of debt people take on is really difficult to fathom.

It’s kind of like winning the lottery (in reverse) — we might daydream about what we’d do with a million dollars, but there’s no way to prepare for the actuality of that when your lived experience has been so different. And when you’ve just been a kid, living at home in a working class household, there’s really no way to understand what it’s going to mean to take on such a substantial amount of debt.”

You would be shocked at the thousands and thousands of true stories like this one throughout the U.S.

And whether the “forgiveness” programs actually come to fruition is still to be seen.

There are lots of strings attached to those “gifts”. And the entire student loan program is very disorganized. So she has to cross her fingers and stay very close to the whole process to have a real shot at actually meeting their criteria for a full ten years.

The Income Based Repayment Plan (IBR) can be a blessing (sort of) or a curse, or both. And it is a very new program so there are lots of open questions about how it will actually turn out for borrowers in the coming years.

I will write much more about IBR in future posts.

For now, please read the article she wrote because there are so many great lessons in there for all of us.


Life, student loans, and freedom

In my recent post on choosing freedom, I mentioned how student loans can go horribly wrong when life throws you a curve ball along your path from attending college to ultimately paying off your student debt.

A reader made a great comment on that blog post that I will respond to in more detail here.  Here’s the comment:

“Great post!! I have had a curve ball thrown at me, and it has left me with what once was 19k in student loans to now a little over $25k. Since I am on an income contingent plan, my minimum payment is $0. At the end of the 25 year repayment period I can finally discharge the loan but it will be counted as income on my taxes.

A family I know had $50k in student loans, that quickly accumulated to $150k in debt due to their son having autism and them not being able to afford his medical needs, house loan, daily living needs, etc. Their financial life is ruined. The government started to take automatic deductions from their paychecks to cover the costs of their defaults, and once you default the amount of remedies is significantly reduced.”

One of the huge downsides of taking on student loans is that your plan to attend school, complete school with your degree, get employment in your field of study, make good money, and pay off your student loans afterwards, have to all generally work out exactly as you planned in order to clear the debt.

And of course, most people don’t generally plan exactly when they are going to fall in love, or when they are going to get married, or when they are going to have children, or any of the major events that life has in store for you.

Not to mention which ailments, family troubles, or other surprises will happen along the way.

Life Throws Curve Balls

It’s just a fact; life often throws you a curve ball.  The more flexible you are, the more freedom you have created (and chosen) financially, the easier it is to roll with the punches.

The reader had $19,000 in student loans that grew to $25,000 when life happened along the way.

When their income took a hit, the interest grew and maybe other penalties or maybe even collection fees were added on.  The income contingent and income based repayment plans are programs available to those with federal student loans whose debt is large but their income is small (at least relative to their debt).

Income Based Repayment (IBR)

So let’s talk about the income based repayment plan, or the IBR.

Once eligible for the IBR, your payment is set based on your income, regardless of how much you owe.

So in the reader’s case, their income is such that there is no payment required.  The good news is the government, or whoever the loan servicer is on behalf of the government, considers the loan to be in good standing because no payment is due based on their income level.

The bad news is that interest on the loan will continue to accrue in most cases and the total amount of the student debt will grow as a result. The IBR program says that whatever balance remains after 25 years in the program will be forgiven.

Current law says that debt forgiveness income is taxable.  You basically get a 1099 for the debt forgiven and now you owe the IRS the taxes on that amount.  Holy cow!  Now you’re out of the pot and into the frying pan.

Who knows what politicians will do to make the IBR program better or worse over the next 20 to 25 years. That’s a long, long… long time.

The Debt Grew and Grew and…

The reader also writes that they know a family whose student loans grew from $50,000 to $150,000. They had a son with autism and that created a whole new component to their life in addition to normal living expenses, a home mortgage, etc.

“Their financial life is ruined.”

The government then exercised its right to garnish their wages and collect huge collection fees and other penalties and interest.

They can even take your tax refunds and a portion of your social security as you age.

You agree to all that when you take on student loans.

That’s why my advice is to work super hard at becoming free from student loans by:

  1. Avoiding student loans altogether, or
  2. Paying your student loans off aggressively. Then go back to step 1 as you plan and save for your children’s education!

It’s a very important choice/decision. Choose well!