Should Borrowers Pay Off Old Student Loans to Qualify for the New 10% Version of Income-Based Repayment?
December 05, 2011
It is unclear whether a borrower who has loans from 2012 or a later year but also loans from before 2008 will be able to qualify for the 10% version of income-based repayment by paying off the loans from before 2008. The US Department of Education has not yet issued the final rules for the pay as you earn plan. A lot depends on how the US Department of Education defines new borrower as of 2008. The precedent is for the term ‘new borrower’ to exclude borrowers who had existing loans from before a particular date as of the date they obtained loans subsequent to that date, even if the borrower consolidated or paid off all of the old loans. See, for example, the regulations at 34 CFR 682.209(a)(6)(ix), 34 CFR 682.210(b)(7) and (s), 34 CFR 682.216(a)(1), 34 CFR 685.208(e)(1) and 34 CFR 685.217(a)(1). If the US Department of Education uses a similar definition, borrowers will not be able to qualify for the new income-based repayment plan by paying off all their old loans. However, in most of the regulations the US Department of Education was limited to basing the regulatory language on the corresponding statutory language, such as the language in sections 428(b)(9)(A)(iv) and 428J(b) of the Higher Education Act of 1965. With an executive action there are no such restrictions, providing the US Department of Education with more flexibility to use a different definition of new borrower.
Given the uncertainties with regard to the final rules for this proposal, it is best to wait until the US Department of Education provides more clarity concerning the pay as you earn proposal before taking any action such as paying off loans from before 2008. It is possible that the terms of the proposal will change depending on how many split borrowers consolidate their loans into the Direct Loan program.
In addition, the benefits to individual borrowers from income-based repayment will depend on their income and debt levels. While this proposal has been presented as providing forgiveness by both proponents and critics, many borrowers in income-based repayment will not get any forgiveness because they will end up paying off their loans in full before reaching the point of 20-year forgiveness. Income-based repayment reduces the monthly payment to an affordable level based on the borrower’s income, as opposed to the amount they owe. This stretches out the term of the loan. But unless the monthly payment under income-based repayment is less than the monthly payment under a 20-year amortization or the borrower qualifies for public service loan forgiveness (which cancels the remaining loan balance after 10 years in repayment instead of 20 or 25 years), the debt with be repaid in full before the 20-year mark. Generally, a borrower’s debt at the start of income-based repayment must significantly exceed the borrower’s annual income for the borrower to benefit from significant savings due to the 20-year loan forgiveness. Nevertheless, the new income-based repayment plan provides meaningful relief to financially distressed borrowers by cutting the monthly payments under income-based repayment by a third.
Before choosing income-based repayment (IBR), borrowers should use an IBR calculator to evaluate the benefits of this repayment plan based on the details of their particular circumstances. FinAid offers two IBR calculators, one for the 15% version of IBR and one for the 10% version of IBR.