Here's a sobering statistic: Two-thirds of four-year college graduates left school this past year with an average of more than $23,000 in student loan debt. But what if these students can't find a well-paying job, let alone afford their monthly student loan payments? Have they mortgaged their future before they've really even begun?
Perhaps not. According to new "Income-Based Repayment" (IBR) rules for 2009—as well as a proposed enhancement of these rules suggested by President Obama is his recent state of the union address—help for student borrowers may be on the way.
First, let's explore existing IBR rules. Under current guidelines, IBR helps borrowers keep their loan payments manageable by capping monthly payments at 15 percent of their discretionary income (defined as any income above 150% of the poverty level for your family size). For most borrowers, this usually works out to less than 10 percent of their total income.
Better yet, after 25 years of repayment the government will forgive any remaining loan debt. This doesn't mean that the student is off scot-free: Any amount that is forgiven is treated as taxable income. However, because this tax only becomes payable 25 years in the future, the actual present day cost of the tax to the student is actually quite small.
So what types of student loans are eligible for this special IBR cap? The program covers most types of federal loans made to students (including Stafford loans, Grad PLUS loans, and consolidation loans), regardless of whether the federal loan was direct from the government or via a government-backed private lender (such as your favorite bank). Unfortunately, federal loans made to parents like the Parent PLUS loan do not qualify.
What is notable about President Obama's recently announced plan is that it would enhance the benefits of the IBR: It would do this by lowering the cap on federal student loan payments—from 15 to 10 percent of discretionary income—and forgiving remaining debt after 20 years of payments, rather than the current 25 years. The White House estimates that hundreds of thousands of students would benefit from the enhanced rules.
To see how all of this can help you or your child, let's crunch a few numbers. A recent college graduate with a $30,000 annual income and $33,000 in accumulated federal student loan debt, for instance, would need to pay $380 each month under a standard 10-year repayment plan. But under the current IBR rules, the required monthly payment for a single student would only be $170 per month. What about under President Obama's proposal? The student's monthly payment would be further reduced to about $110. The bottom line is that for students with very high debt-to-income ratios—especially those pursuing careers that may be rewarding, but not lucrative—these types of income-based loan repayment programs can provide some much needed relief.
The information provided is for informational purposes only and should not be relied on as tax or legal advice. Please discuss you particular situation with your tax advisor.
Known as "America's Scholarship Coach," Ben Kaplan is publisher of the www.CityofCollegeDreams.org website and the winner of two dozen college scholarships worth $90,000. For more details on this topic, visit his Financial Aid information page.
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