Saturday, September 20, 2014

An intro to the acronyms of loan repayment: ICR, IBR, PAYE, LOLZ.




I may not have written this blog if I only had $26,000 in student debt. I would instead be paying under standard repayment, merrily going along through life. Many undergraduates and graduate students have much more than $26,000 in student loan debt. For example, an undergraduate with a degree from a private university may have $50,000 in student debt. Students who pursue a M.A. or PhD may end up with $50,000 to $150,000 in total debt. Medical students and law students regularly accrue $200,000 and above. These large balances make it difficult (if not impossible) to repay under the standard repayment plan.

Most of these students are not living the high life: they live in modest apartments, drive old cars, rarely eat out, and forego putting money into retirement. I know this because my colleagues and I lived like this while in grad school. Time is the enemy since the interest rate for graduate and professional students often exceeds 6%. Compound interest that capitalizes increases the student loan burden far beyond what we initially borrowed. Advanced degrees can take 5-10 years to complete. Most federal loans are unsubsidized, meaning that interest accrues while the student is in school. I had the option of paying the interest while enrolled in school, but doing that and keeping a roof over my head was impossible.

 Standard and Graduated repayment plans are calculated based upon the amount owed. For someone with a balance of $150,000.00 (Unsubsidized, Federal Direct) and an interest rate of 6.8%, the Standard monthly payment would be $1,726.00. After 120 payments of $1,726.00, a total of $207,144.85 would be paid. That is the initial $150,000.00 and $57,144.85 in interest. Ouch, ouch, ouch. Per this loan calculator, one would need a job that pays $207,000 to ensure that this monthly payment is 10% of one’s income. Unless one is a doctor or lucky lawyer, that type of salary is very rare for an entry-level job.

So, what is a student with a high student loan balance and low income supposed to do? Some say, “Just pay it. Work three jobs if you have to.” True, that is one solution, although burning one’s self out hardly healthy. Thankfully, the government has in place loan repayment options that are calculated from one’s income, family size, and marital status. These payment plans are called income-driven repayment plans. The options are: ICR (Income-Contingent Repayment), IBR (Income-Based Repayment), and PAYE (Pay-As-You-Earn). So, so many acronyms to deal with!

I’m going to introduce these one at a time since each plan has unique qualifiers, benefits, and downsides. These programs are great, but also very complex. First on the docket is ICR. ICR stands for Income-Contingent Repayment. Under this repayment plan, your monthly payment will be calculated based upon your AGI (Adjusted Gross Income), family size, and total loan debt burden. The loans eligible for this are Direct Subsidized and Unsubsidized loans, Direct PLUS loans (made to students), and Direct Consolidation Loans. Per studentloans.gov, the “Income-Contingent Repayment (ICR) plan is a repayment plan with monthly payments that are the lesser of (1) what you would pay on a 12-year standard repayment plan multiplied by an income percentage factor or (2) 20 percent of your discretionary income divided by 12. Discretionary income for this plan is the difference between your adjusted gross income and the poverty guideline amount for your state of residence and family size.”

Let’s say that the same student above, with a high balance of $150,000 (with a 6.8 % interest rate) wanted an affordable monthly payment. One option is the Income-Contingent Repayment plan. If this person had an AGI (Adjusted Gross Income) of $35,000, and was single, his first 12 monthly payments would be $389.00. Assuming that his income increased by 5% per year (not likely in this economy!), his payments would rise accordingly for 300 months (25 years), for final payments of $934.00. Any remaining balance after 25 years is forgiven.

The total amount paid during this time would be $245,651.00, but these payments would have been going entirely towards interest! The projected forgiveness is $182,451.00. Forgiveness is a nice thing, but it comes at a cost. Per current tax law, this $182,451 will be considered as taxable income at the end of 25 years. Predicting that tax burden is difficult, but a person on ICR should save up about $40,000 to $60,000 to pay off this tax bill. Under ICR, this student will pay $245,651.00 plus tax (here estimated at $50,000), making a total of $295,651.00. The ICR plan costs an additional $88,506.15 than the Standard Repayment Plan.

For some, ICR sounds like a raw deal. Why pay an extra $88k over the life of the loan? The answer comes in the package of an affordable monthly payment. If a student can afford the Standard payment, then that’s great. However, if she cannot afford it, then it is necessary to go on an affordable payment plan to avoid default. Avoiding default is crucial! Under ICR, she could pay more (as she can afford) to reduce the amount of interest she pays over the 25 years.

There are many variables that could influence the monthly payments, total amount paid, and projected forgiveness. The scenario above illustrates the positive aspects of ICR as well as its possible downsides. The above example I encourage you to go to this site to play with the repayment calculator. You can either use hypothetical loan balances, or use your own by signing in.


Next up is IBR (Income-Based Repayment)….an option that is usually friendlier than ICR.

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