New Loan Forgiveness Proposal Could Help Undergraduate Borrowers
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March 11, 2018
By: Mason Gallik
The Trump Administration’s recent proposal to streamline the income-driven repayment plan offerings into one plan could have some good news for undergraduate borrowers. For undergraduate borrowers, the repayment period would fall to 15 years compared to 20 years in Revised Pay As You Earn (REPAYE) and then the loans would be forgiven. However, your monthly payments would rise to 12.5% of discretionary income as opposed to the 10% under REPAYE. Loan forgiveness is taxable though so the borrower will still have to pay a portion of the balance. In this article, we are going to go over a hypothetical examples of how this proposal could affect an undergraduate borrower.
Discretionary income is calculated by taking your income and subtracting 150% of the poverty line. For a single person household in the contiguous 48 states, 150% is $18,210 in 2018. Let’s say Camilla completed her undergraduate studies and is a social worker making $35,000 per year. Her discretionary income would be:
$35,000 – $18,210 = $16,790 or about $1,400 monthly
We’ll estimate she has $32,000 in federal student loans with a 5% average interest rate. If Camilla stayed in the Standard Plan (10 years of even payments), her payments would be about $339 per month. This is about 24% of her discretionary income, which she feels is too high. Currently, she can enroll in REPAYE where her payments would be about $140 a month. Assuming that her wages and the discretionary income threshold both increase by 2% annually, her payment will rise to $204 in year 20. At the end of year 20, she will still have a balance of $19,174. Assuming she made all her payments on time, the loan balance will be forgiven but she will have to pay taxes. If she is in the 25% tax bracket she will have to pay $4,794.
Over the life of the loan and including the taxes she will have paid $45,588.91. This makes her effective interest rate about 3.12% since some of her loans were forgiven. If she stayed under the Standard Plan, she would have paid $40,729.16 with an effective interest rate of 5%, but this is paid over a much shorter period of time.
Under the Trump Proposal she would pay 12.5% of her discretionary income for 15 years, and then her loans would be forgiven. Her payments would start out at about $175. Assuming both her wages and the discretionary income threshold both increase by 2% annually, Camilla would be paying $230 at the end of year 15. Her loan balance would be $14,723 at this time and assuming the 25% marginal tax bracket she would have to pay $3,681 when her loans are forgiven.
Over the life of her loan she would have paid $39,975 including taxes, which is less than both the Standard Plan and REPAYE. Additionally, her effective interest rate would be about 2.59% since some of her loans were forgiven. This proposal could benefit Camilla if she can afford the slightly higher payments. The tradeoff under the new proposal is that her payments are higher than REPAYE but over a shorter period of time. However, they are still much less than the Standard Plan.
This reform to the income-driven plans has the potential to benefit undergraduate borrowers depending on their situation. As you can see with Camilla’s hypothetical example, the Trump Proposal can benefit her since her loans would be forgiven earlier. There are still some details that need to be released like interest subsidies if your payments do not cover your accruing interest, but from the initial proposal the plan looks like it can be beneficial to many undergraduate borrowers. For graduate borrowers, it is a different story since the proposal calls for both higher payments as a percentage of discretionary income and a longer period until loans are forgiven.