Drowning in Student Loans? New Plan Offers Hope for Struggling Borrowers

Submitted by master on Fri, 08/14/2015 - 11:46

Student loans

Starting this Fall, millions more consumers with student loans will qualify for Pay As You Earn (PAYE), the most advantageous repayment plan for those with federal school debt. If you're struggling with student loans or are in default, this could be your chance to get current with an affordable payment plan. Getting into good standing with your student debt can boost your credit score, put an end to payroll or tax refund garnishment, and take a lot of stress out of your life. Here's what you need to know about the revised PAYE, called REPAYE, coming soon.

Who can use PAYE or REPAYE?
Formerly, only those who borrowed from the federal government after 2007 could use PAYE, and you also had to demonstrate financial hardship. If the negotiated rulemaking goes through as President Obama intends, both requirement would go away and most student loan debtors would be able to participate in the new program called REPAYE. It doesn't matter when you got your loans or whether they were used for trade school, undergraduate or graduate education so long as they are federal loans.

How much are payments under PAYE or REPAYE?
Payments cap at 10% of “discretionary income” no matter the amount of the debt. Discretionary income is the difference between the adjusted gross income (AGI) on your 1040 Tax Form and 150% of the federal poverty level for your family size. AGI is the number at the bottom of page one of your tax form after your income, exemptions for yourself, spouse and dependents, and certain deductions are factored. So if your AGI is $45,000, and you have a family of three, the poverty line is $20,090 times 1.5 = $30,135. From there, you calculate ($45,000 - $30,135) $14,865 in discretionary income x 10% = $1,487 = $124 monthly student loan payments (approximately).

What's the catch?
This low student loan payment amount means that you may be paying interest only and not chipping away at the principal. That can make the debt last longer. If you pay the standard loan payment, you will be done with your debt in 10 years. But if you can't afford to do that, PAYE can help you stay out of default. And, after 20 to 25 years of these lower, more affordable payments, the remaining balances will be forgiven. However, the amount forgiven will be subject to income tax liability.
So, for instance, say you owe $45,000 in student loans and can't afford the payments and you sign up for REPAYE. Your payments are low and affordable which helps you keep current (which is a good thing). But, because the payments were so low, interest accrued and the loan balance rose rather than fell. After 20 years of payments, you now owe $55,000. That amount is written off and it becomes taxable income in that year. That can represent a significant tax hit.
$55,000 in imputed income could result in an additional $10,000 (or more) in taxes that year - depending on your tax bracket. While that is a lot, when you compare the tax liability plus what you paid, to the total of payments you would have paid, you may find it's pretty comparable. And, the bottom line is, if you can't afford to pay your student loans under the standard repayment plan, getting onto REPAYE and in good standing is better than remaining in default or delinquent.
But if you are currently in IBR or PAYE, this expansion will mean one negative consequence for you that can be significant. The new plan will take into account both spouses' incomes for determining payments - even if you file taxes separately. In years prior, for spouses that filed separate tax returns, only the student loan debtor's income counted for purposes of PAYE/IBR payment plan calculations. This usually reduced the payments and now will very likely increase them. But, overall, the expansion will benefit more borrowers and so is likely a good thing. The new expanded REPAYE should be in effect within a few months. You can enroll by contacting your loan servicer. And if you are in default, this can rehabilitate your loans and bring you current.
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