How I borrowed a lot and paid back a little: A writer’s take on Income Based Repayment
In May of my senior year at Union College (See photo), the only thing I was thinking about was passing finals and completing papers with pretentious titles. Postgraduation plans, like a job, were nothing more than vapors momentarily wafting in the way of those footnotes buried in my textbooks. I had no idea what kind of job I’d get, but I did know one thing for certain: I’d wrap up my college education with roughly $17,000 in federally subsidized debt.
With no internships and just a smattering of semi-professional experiences (think: school paper, student government, a few clubs), I opted for graduate school. Few were accepting applications that late in the spring, but the London School of Economics admitted me a day after graduation. Factoring in the exchange rate then, tuition and the cost of utterly unposh living to attend the university required a $60,000 loan—two Staffords and a PLUS Graduate.
Enter the global recession. After a period of playing factotum at wine bars and pizza shops, I faced the reality check that a degree from the LSE was no cure against the millennial job slump—and the student loan payments were serious business. Fortunately for me, Congress in 2007 passed a law called Income Based Repayment, which starting in 2009 allowed student borrowers to pay their lenders back based on a formula that took into account how much they actually earned. Monthly payments—once the deferments expired— that would have set me back at least $1000 a month would be reduced to less than a tenth of that.
Since 2009, two more versions of IBR have been introduced, with one recently rolled out and the other slated to debut in July of 2014. While the three versions have slight differences, they are similar in function. The programs take into account the size of the borrower’s family, federal loan balance, and income. Lenders use a sliding scale to determine eligibility and later the new amount the borrower owes monthly. Undergraduate and graduate school Stafford loans, as well as Grad PLUS loans for graduate students, can be rolled into IBR. Payments are capped to either 10 or 15 percent of the borrower’s discretionary income—defined by the federal government as the money left over after basic living expenses are met—and any remaining balance, include the amount that accrued from interest, is pardoned after 10, 20 or 25 years, depending on the type of IBR program and employment the borrower maintains.
But the program has been slow to attract an audience. Despite the relief it can offer to borrowers with modest incomes, only 1.3 million people have signed up for the 2009 version of IBR as of January of 2013. For analysts, that number is surprising because nearly any borrower with the right federal loans that aren’t in default can qualify for IBR if their incomes are low enough.
During a webinar hosted by Education Writers this week, Lauren Asher of The Institute for College Access & Success (TICAS) and Jason Delisle of New America Foundation discussed IBR’s benefits and its limited popularity.
One of the explanations they offered for the low turnout is how onerous the application process was in the program’s early days. I can certainly speak to the burden factor. There was a one-page form I had to fill out by hand listing my adjusted gross income (AGI) and federal loan balance. I also had to fax a copy of my tax returns, a tall order in 2010 if I had questions because Sallie Mae and ACS—my loan handlers—had long call wait times. Once the applications were submitted, I remember needing to wait 60 days before IBR could go into effect, provided that the loan handler had received the correct information. And borrowers have to reapply for IBR each year because their incomes might have changed.
Nor is IBR necessarily the most financially prudent recourse for every borrower. Even though the program reduces the monthly payment on qualified loans, interest that builds can still increase the balance of the loans. If over time a borrower’s income exceeds the level necessary to remain in IBR, he might face a larger balance because his repayment plan will kick back to the original term of the loan. Most student loans have a set repayment plan elapsing ten years, though they can be adjusted to lower the monthly balance. For borrowers considering enrolling in IBR, the uncertainty of how much they’ll owe as their careers progress was a deal breaker, Delisle says.
Since 2009, the federal government has made strides in simplifying the application process for IBR. Borrowers can enter their information online and upload their tax returns. As more lenders have become familiar with the intricacies of IBR, the wait time before the program kicks in has decreased on average. The Department of Education has also set up a website that informs borrowers whether they’re eligible for any version of IBR by answering a few questions.
For borrowers, the difference between the 2009 IBR and Pay As You Earn can be substantial. PAYE places a cap on capitalization at 10 percent, meaning loan balances don’t inflate as much as they would with the 2009 or 2014 IBR versions, which don’t have capitalization caps, according to Asher. Also, monthly payments for borrowers in PAYE are one-third lower than they would be under the 2009 IBR version.
Delisle believes Pay As You Earn is too much of a good deal for many borrowers with graduate school loans, who tend to borrow more and can therefore qualify for PAYE even if they have relatively high incomes. While undergraduate Stafford loans are capped at $31,000 for dependent students, there’s no limit on Grad PLUS loans—though students won’t receive more than they need for tuition, room and board, and other education expenses. In 2012, he offered this hypothetical during an interview with Bloomberg Businessweek:
We have one example of someone who might look similar to an MBA student. He starts out with a starting salary of $90,000 and by the end of 20 years is making $243,360. Under the old IBR program, he’ll have paid $409,445 by year 25 and be forgiven $23,892 of his loan balance. Under the new IBR repayment plan he’ll pay less than half of that, or $202,299, and be forgiven $208,259 by year 20. The old IBR plan was punitive if you borrowed a lot of money, made you pay more over time and trapped you…which is why you didn’t see people borrowing without regard to how much it will cost. The new plan essentially eliminates any downside or risk for that type of behavior, and cuts payments in half and then some.
Still, not all graduate students pursued lucrative careers—like yours truly—and the Department of Education estimates that only 1.6 million borrowers will qualify under Pay As You Earn. Forecasts for the 2014 IBR program are premature, though it too will discount monthly payments by a third compared to the original 2009 version.
Asher and Delisle would like to see the Department of Education provide more specific numbers on who is enrolled in the IBR programs. If more graduate students are taking advantage of the payment reductions, it might mean that borrowers who don’t need the assistance are tapping into it more than cash-strapped borrowers who have undergraduate loans.
In the late summer, New America Foundation plans to release a research paper that will estimate the salaries of borrowers with graduate loans using IBR. The findings, Delisle hopes, might put pressure on the government to be more transparent about the type of individual relying on this expanding safety net.