Graduate Borrowers Could Be Hurt by New Loan Forgiveness Proposal

March 17, 2018
By: Mason Gallik

The Trump Administration recently stated in a proposal that it wants reforms to the income-driven repayments plans for federal student loan borrowers. While the proposal could benefit undergraduate borrowers as shown in an article here, there is bad news for graduate borrowers. The proposal for graduate borrowers calls for a repayment period of 30 years and payments of 12.5% of discretionary income. Under one of the popular current plans, Revised Pay As You Earn (REPAYE), loan forgiveness occurs after 25 years and payments are 10% of discretionary income for borrowers with graduate loans. Not only is this proposal calling for a larger percentage of income to be paid, but it is calling for a longer time frame until forgiveness occurs. Below is an example of a graduate student and what effects the new policy will have on him.

Mike just completed his master’s degree and is making $50,000 per year. He has $78,000 in loans with an average 5% interest rate from his graduate studies that he is worried may take up too much of his income. Under the Standard 10-year repayment plan, he would be paying $827 monthly, which he does not believe he can afford. Mike thinks an income-driven repayment plan would be right for him.

His discretionary income is calculated by subtracting 150% of the federal poverty line from his income. Since he is single, this number is $18,210 for 2018 in the contiguous 48 states of the United States.

$50,000 – $18,210 = $31,790 in discretionary income

Under a current plan, REPAYE, Mike would be paying 10% of his discretionary income monthly or about $265 per month. Under the proposed plan, he would be paying 12.5% or about $331 per month. For this example, let’s assume he only has Stafford unsubsidized loans. This is because in the first few years of REPAYE, Mike’s balance is growing since his payment does not cover all of the accruing interest. Since he has unsubsidized loans in REPAYE, the government will pay half of the accruing interest. In the proposed plan, the $331 payment covers the accruing interest, so we do not have to speculate whether or not this will still be a benefit of the proposed plan.

Under REPAYE, Mike’s payment would gradually rise to about $426 after 25 years assuming both his income and 150% of the discretionary income increase by 2% annually. He will still have a balance of $72,134 after his 25 years of payments, which would be forgiven. However, loan forgiveness is taxable so if Mike’s marginal bracket is 25% he will have to pay $18,033 in taxes when his loans are forgiven. Over the course of this plan, Mike paid $119,858, which equals an effective interest rate of 2.94%.

Under the proposed plan, Mike’s payment would rise to $588 after 30 years using the same assumptions as above. His loans would almost be paid off with a balance of $1,872 after his last payment. This means that assuming a 25% tax bracket he would only have to pay $468 in taxes on the forgiven loans. However, over the life of the plan he will have paid $161,675 with an effective interest rate of 4.9%.

Mike would be worse off under the proposed plan since he pays more each month over a longer period of time and his effective interest rate is higher. There are situations where some graduate borrowers under the new plan would pay less in total since they are contributing more of their income than REPAYE, but the effective interest rate will usually be higher under the proposed plan. This is because the proposal calls for a longer repayment period and a higher percentage of income than REPAYE currently offers for graduate borrowers. This is in contrast to the undergraduate proposal, which is often beneficial since loan forgiveness occurs earlier despite the higher percentage of discretionary income required in payments.