My guest on my radio show this past week was Alan Collinge, founder of Student Loan Justice. It was perfect timing to have Alan on my show as I wanted to get an expert's reaction the President's latest executive order. Alan's book is a must read for anyone with student loans (or contemplating applying for them).
In a nutshell, President Obama extended the Income Based Repayment program (or as the Obama Administration calls it, Pay As You Earn) to loans that were taken prior to 2007.
Consider these shocking statistics (source: CNN) -
- There is presently $1.2 trillion in student loans.
- It is the second largest for of debt in the United States, only surpassed by mortgage debt.
- Nearly 15% of borrowers are currently in default.
1. What Is It?
Income Based Repayment reduces student loan payments based on the income of the borrower. The idea is that the payment should represent no more than 10 to 15% (depending on program) of discretionary income. Being a government plan, nothing can be simple or straightforward. To their credit, FinAid has a free online calculator that will give you a rough idea of what your required minimum payment would be under one of these plans. The government also has a calculator of its own you can use.
2. When Will It Go Into Effect?
Income Based Repayment is already in effect for loans taken out as far back as 2007. The new executive order signed last week would go back and include loans prior to 2007. From what we have been able to gather at ChristianMoney.com, pre-2007 deal would not become effective until December 2007.
3. What Loans Does This Program Apply To?
Another mistake that the financial media makes (including yours truly) is lumping student loans into one broad category. The reality is that there are quite a few different student loan programs. Here is a list -
These qualify for IBR
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Direct PLUS Loans made to graduate or professional students
- Direct Consolidation Loans without underlying PLUS loans made to parents
- Subsidized Federal Stafford Loans
- Unsubsidized Federal Stafford Loans
- FFEL PLUS Loans made to graduate or professional students
- FFEL Consolidation Loans without underlying PLUS loans made to parents
These loans do not qualify
- PLUS loans made to parents
- Consolidation Loans that include underlying PLUS loans made to parents
- Private education loans
4. How much of the loan can be forgiven?
Depending on the program, after 20 to 25 years the entire remaining balance is forgiven by the government. Another option is go to work for a non-profit. After 10 years of service in a qualifying non-profit you can also receive complete loan forgiveness in this shortened window of time. There is a helpful government worksheet to review here.
5. What are the tax consequences?
Well, this one is a shocker. From FinAid -
"Public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs and the National Health Service Corps Loan Repayment Program are not taxable. Loan discharges for closed schools, false certification, unpaid refunds, and death and disability are considered taxable income. The forgiveness of the remaining balance under income-contingent repayment and income-based repayment after 25 years in repayment is considered taxable income."
It seems that the issue of the taxability of loan forgiveness is the fly in the ointment that no one is really talking about. The issue is a substantial one. Based on a borrower's income, the amount they end up owing after years of artificially reduced payments could be more than the original loan balance. That's right, some borrowers will not even be making payments that cover the interest accruing on their loan. So, this would be akin to a negative amortization mortgage. In the case of loan forgiveness, the amount forgiven is considered income to the borrower in that tax year. You could owe income taxes on tens of thousands of dollars. What's more, you would also likely be pushed into a higher tax bracket as result of this windfall of 'phantom income.'
Some solutions to consider -
It seems to me that those with larger student loan balances should definitely consider working with a non-profit for the required ten years. There is a misconception that non-profit equals less pay, but that is not generally the case. Today, non-profits typically pay the equivalent of what their for profit counterparts would offer to a similarly qualified candidate. It should also be noted that there are a wide variety of non-profit organizations that are significant and financially very stable.
I can also personally recommend a couple of expert consultants that you might want to get in touch with. I get no compensation for recommending either of these men and they have both been wonderful resources for our readers.
Recommended Consultants -
Jan Miller is a Student Loan Consultant and is an absolute wizard at making sense of all of this (Miller's recent Jim Paris Live appearance). Dan Pilla is an IRS problem solver and has a new book on loan forgiveness. Pilla's book even shares how the tax consequences of loan forgiveness can be negotiated down to pennies on the dollar. Of course, I want to make clear here that my recommendation is not to borrow money to go to college. There are plenty of ways to be a 'pay as you go student.' But, for those that have tens of thousands in debt already, this article was for you.
Please use the comments section below to add your own ideas, strategies, and opposing views to this article.
Helping you make the most of God’s money!