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Grads to Get a Break on Student Loan Payments

Grads to Get a Break on Student Loan Payments

Mark Kantrowitz

May 26, 2009

Best for Borrowers with High Debt, Low Income

Income-based repayment is best for borrowers who have high debt relative to their income. Borrowers with a debt-to-income ratio of 1.0 or higher will be most likely to benefit from income-based repayment, but even borrowers with a lower debt-to-income ratio may benefit, depending on their income and family size.

The income-based repayment plan can provide significant repayment relief to borrowers who are struggling to repay their student loans. Most borrowers will have a monthly payment under income-based repayment that is less than 10% of gross income. This includes single borrowers who have less than $50,000 in income and married borrowers with two children who have less than $100,000 in income. Borrowers with lower income will have to devote even less of their salary to repaying debt.

The income-based repayment plan compares favorably with other options for borrowers in financial difficulty, such as the economic hardship deferment and forbearances. The economic hardship deferment and forbearances suspend monthly payments for up to three years each. A borrower whose income is less than or equal to 150% of the poverty line will have a zero monthly payment under income-based repayment, but without a three-year limit. However, a borrower earning more than 150% of the poverty line will have a monthly payment under income-based repayment. Making a monthly payment, albeit a small one, helps avoid a key problem with using deferments and forbearances for more long-term financial problems, where the suspension of payments just digs the borrower into a deeper hole.

Monthly payments can be less than the interest that accrues. During the first three years of income-based repayment the federal government will pay any accrued but unpaid interest on subsidized Stafford and Perkins loans. (This subsidized interest benefit applies to the part of a consolidation loan that repaid subsidized Stafford loans, but not a consolidation loan that repaid Perkins loans.) Any other unpaid interest is defered and will be capitalized when the borrower no longer qualifies for income-based repayment (i.e., when the income-based repayment cap exceeds the payment under standard ten-year repayment). This differs from the treatment of interest under the economic hardship deferment, where the federal government will pay all the interest, not just the unpaid interest, on subsidized loans for up to three years. During a forbearance the borrower is responsible for the interest that accrues on all loans, not just the unsubsidized loans.

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