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The Government’s Student Bailout: Federal Loan Changes

It’s not the billions received by AIG and the car companies, but at least it’s something

The following is a guest post by Emily, a 20 something single gal who writes about navigating her way through her finances and the world, at Musings and Ruminations of a Single Gal.

Like so many other graduate students, I’m facing the probability of an enormous amount of student loan debt (upwards of $100,000 in my case, since I’m a law student) and not such a large starting salary. While it is possible for some law grads to start out with a six-figure salary, those grads are usually the exception and not the rule. In this economy, where big law firms are laying off lawyers by the hundreds and deferring new hires, the prospect of a six-figure starting salary is even less likely.

This debt load is enough to make anyone anxious, stressed, and overwhelmed. Most of the time I try not to think about it and focus on the present, but that’s not always easy. Luckily, as of July 1, 2009 people like me will have reason to celebrate (at least somewhat). On that date, the Federal Government is implementing a new repayment option, Income-Based Repayment (IBR), and a low interest rate for loan consolidation.

Income-Based Repayment – What is It?

IBR works differently than the previous option of Income-Contingent Repayment (ICR). While both IBR and ICR base monthly payments on a percentage of discretionary income, IBR defines discretionary income differently and requires a smaller percentage. IBR caps monthly payments at 15% of the amount by which adjusted gross income exceeds 150% of the poverty line. Here is an example of the calculation for a single person:

.15% *[(AGI – 150% Poverty Line)/12] = Maximum amount of monthly loan repayment under IBR

Adjusted Gross Income: $40,000
2009 Poverty Line in US: $10,830
150% of Poverty Line: $16,245

.15%*[($40,000.00 - $16,245)/12] = $296.94

Under the IBR plan a person making $40,000/year would only be required to make a monthly loan payment of $296.94. The payment would be adjusted each year based on federal income tax returns filed by the individual.

IBR is available to both direct loan program participants and the federally backed loan programs.

Other Great News About IBR

  • During the first 3 years of IBR, the federal government will pay the unpaid interest on subsidized loans. This is because the monthly payment could be less than the amount of interest accumulating.
  • Remaining debt is forgiven after 25 years (regardless of where you are employed).
  • If you work full-time in a public service career, the remaining debt is forgiven after 10 years.

Interest Rates Also Set to Drop – Time to Consolidate

The other exciting change scheduled for July 1, 2009 is the annual interest rate adjustment.Now is excellent time to consolidate student loans – especially those that were borrowed with variable interest rates before 2006. Loans having a fixed interest rate, including all borrowed after 2006, are not affected by this change. The interest rate for variable rate loans will be reduced to 2.00-3.38%, depending on the type of loan. You can check out the Loan Consolidation website run by the Federal Government for more information:

When you consolidate your loans you lock in a new lower rate. Even those loans borrowed after 2006 can be consolidated with the earlier loans. Although those loans won’t yield the 2.00-3.38% interest rates, they will lead to an overall reduction in interest rates because the Federal Government will use a weighted average in calculating the interest rate. The rate cannot exceed 8.25% and is fixed for the life of the loan. The federal Loan Consolidation website has information on calculating the weighted average.

You can determine how much loan consolidation will save you by using the loan payment calculator, and comparing it to the loan calculator.

Here is a simplistic example of the savings. I have left the current interest rate the same on all loans (which is unrealistic given that those before 2006 would be variable) and have chosen a standard 15 year repayment.

John Doe currently has the following loans:

2003-2004: Undergrad year 1, Stafford loan: $2,625 @ 6.8%
2004-2005: Undergrad year 2, Stafford loan: $3,500 @ 6.8%
2005-2006: Undergrad year 3, Stafford loan: $5,500 @ 6.8%
2006-2007: Undergrad year 4, Stafford loan: $5,500 @ 6.8%
Total: $17,125 @ 6.8%

Without consolidating he will be required to make 4 separate payments per month (if the loans are held by different servicing companies) totaling $152.02 per month for 15 years. His total interest costs will be $10,237.31.

Until 2006, the interest rates were variable rates and they are eligible to be locked in at anywhere from 2.00-3.38%. This example will assume John Doe’s loans from 2003 to 2006 would be eligible for the 2.00% interest rate (for the sake of simpler calculations). The actual determination of the interest rate for consolidation depends on numerous factors such as the types of loans you have and whether you have entered repayment. John Doe’s loan for 2006-2007 would remain at 6.8% because the loans were no longer variable interest rate loans. Consolidating these loans will produce an overall interest rate of 3.625%.

2003-2004: Undergrad year 1, Stafford loan: $2,625 @ 2.0%
2004-2005: Undergrad year 2, Stafford loan: $3,500 @ 2.0%
2005-2006: Undergrad year 3, Stafford loan: $5,500 @ 2.0%
2006-2007: Undergrad year 4, Stafford loan: $5,500 @ 6.8%
Total after consolidation: $17,125 @ 3.625%

If John consolidates his loans, his monthly payment would total $123.48 for 15 years. That is a monthly savings of $28.54. John will only have to pay one loan servicing company (rather than 4 separate payments) and he will only pay $5,100.81 in total interest – a $5,136.50 savings!

You can submit your application for consolidation at anytime. Loan consolidation applications that are submitted now are placed on hold until July 1, 2009, when processing will resume with the new lower interest rates. The processing of your consolidation application will generally take 60 – 90 days. This is what you need to know to begin the consolidation application process:

You need information regarding all of your student loans, even if they are not federally backed. Although the consolidation application will not allow you to consolidate non-federal loans it still requires information concerning total debt load.

The requisite information includes:

§ The contact information for all loan servicing companies
§ The interest rates for all your loans
§ The principle amount of all your loans
§ Your Federal Student Aid PIN (the same one that is used in completing the Free Application for Federal Student Aid “FAFSA”)

Student loan consolidation is a good thing to look into. While it may not be for everyone, it could end up saving you a lot of money in the long run. All information (and the application for consolidation) can be found at the Federal Government’s website.

Disclaimer: The content of this article is for general information and does not constitute advice. While the author has written from both personal experience and research that was both true and accurate at the time of writing, she gives no assurance or warranty regarding the accuracy or applicability of any of the contents. The author of this post and the website accept no responsibility for and excludes all liability in connection with utilizing the above information. Complete and current information on student loan consolidation can be found by visiting http://www.loanconsolidation.ed.gov/.

25 responses to “The Government’s Student Bailout: Federal Loan Changes”

  1. philip

    I have some fixed and some variable loans. Just so you know, whether you consolidate or not the interest rate will be brought down until July of 2010 and then they will be changed again. You have until that time to consolidate it.

    I can’t say that I think it is good about spreading the payments out over 25 years then getting them forgiven. I think if you are taking out the loans then you should have reasonable expectation of paying them back as well.

    1. Stephanie

      I have to say I agree with you, philip, on the idea of waiting to consolidate. In fact, you could wait as late as the end of May 2010, when they announce what the change in interest rates will be. If it stays the same or goes down (down is unlikely, since this current change is pretty much rock bottom), you could continue waiting to consolidate. If the interest rate is set to go up, you could consolidate then.

      I understand what you’re saying about not drawing things out and waiting for the remainder to be forgiven, and I partially agree with you… but not all of us made smart/informed decisions when we were 17/18 and getting our student loans. “Reasonable expectation of paying them back” when you’re 18 might consist of “Well, student loans are just a part of life! I will get as much as I need and somehow pay it back later!” That turns into a very different picture after graduation.

      I’m going to make a good faith effort to pay off my loans, but I’m not going to do it in any hurry. Since it seems like I’ll be able to lock in the (weighted) interest rate at <5%, I fully plan to take the full 25 years (no more or less!). Although I’m not likely to use the IBR or ICR repayment methods – they sound like too much headache to me personally.

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  3. Sam

    Wait a minute… you can’t change the interest rates on three of the loans then claim consolidation is what saved you $5,000 in interest. The lower interest rates saved that much money!

    Side rant: for those of us with entirely 6.8% fixed loans, the government’s not doing much. *grumble grumble grumble*

    1. Stephanie

      True. But the idea here is you’re locking in that interest rate before it can jump back up in the future. It would be very hard to do an actual comparison, since neither Emily nor I can see into the future to know what the actual rates of variable loans will be ;). What’s here is a simplified calculation that shows the potential savings. This is probably the lowest these interest rates are ever going to go, so I think the savings calculation is a valid demonstration.

  4. Griffin

    I always rave about how great the government’s loan consolidation program is. I had loans at 8% before I consolidated at 6.8% two years ago.

    Income-contingent repayment is a godsend. I barely make any money right now, and they set the payment at $0 without me having to defer. I’ll be consolidating again in the fall to take advantage of the new rates. =)

  5. philip

    Um… you can only consolidate the loans one time. You can not do it over and over again.

    Are you serious that you make a payment of $0 on your loans? If you did that for 25 years then you would not have to pay anything back at all! Keep up the good work, and make that government subsidized loans that are geared towards making more productive individuals to pay more taxes work for you!

    1. Stephanie

      philip, I think you’re right about only being able to consolidate once – sorry Griffin!

      But please don’t be too harsh about the $0 payment. Although Griffin said the payment was set to $0, he (I assume Griffin is a he?) didn’t say he was only going to pay $0/month. You can always pay more than the minimum payment on federal student loans. I would advise people like Griffin, who have their min. payments reset to $0, to try and at least pay the interest that accumulates.

  6. Sam

    The possibility of paying $0 a month for 25 years and having ALL your loans forgiven is kind of ridiculous… I call shenanigans. You could get married, file taxes separately, and be a stay-at-home parent (making $0 and thus having to pay $0 loans) for the entire childhood of your children, then the children go off to college right about the time all your loans are forgiven (assuming I know how married filing separately and loans work) at which point you could go to work and never have to worry about the loans again.

    These are supposed to be LOANS, not grants, and while I do think there should be more grants available and lower interest on these loans, that’s a separate issue. Signing your loan promissory note is a promise to pay it back. Short of dying first, you should always be responsible for paying off what you borrowed in the first place plus, at minimum, inflation UNLESS there is an across-the-board forgiveness for everybody that has student loans (fair is fair).

    1. Stephanie

      I don’t think “Married Filing Separately” works that way, actually. And I think that you’d lose more in paying extra taxes by filing MFS than you would gain in not having to make student loan payments. MFS would put the other spouse in a higher tax bracket, and make them ineligible for several tax benefits: Married Filing Separately Tax Status. Plus, it might not even get you that coveted $0 minimum payment, because you might be asked for both tax returns even if you file MFS. (I don’t know about that last part for a fact, I’m just speculating.)

      IBR is not a workaround to allow people to not pay their student loans. Most people are not going to make next to nothing just to avoid student loan payments. Will some people commit tax fraud in order to do so? Maybe. But those people will likely get busted by the IRS.

  7. Griffin

    @Phillip

    I am still in school (gasp!), so I can consolidate my new loans with the existing federal loan consolidation. That’s per their office, if you feel like sitting on hold for two days to verify. At any rate, doing it online will automatically allow you to include -any- federal loans (including consolidations) when you re-up.

    I took an LOA for a semester and this semester I went 3/4-time (not full time), so they required that I use up some of my deferral time -OR- send them in my stubs. Well, since I was making less than $500/month, it was a no-brainer. Next semester, my loans will automatically use the in-school deferral system.

    @Stephanie & Sam,
    If you file separately, it makes no difference. If you’re married you have to provide 1040s for both of you.

    They don’t forgive lots of loans currently, even though the system is set up to make teaching more desirable by forgiving some loans. The idea originally was that teachers in low-income areas would get their loans paid off — that almost never happens. People move, school districts have status changes, the list goes on. The crux of the issue is that bureaucracy gets in the way of it’s original purpose. Now, they are offering loan forgiveness for another category, knowing full well that very few people will qualify again.

    I personally wouldn’t be willing to make $0/yr, every year, for 25 years, just to save a couple hundred per month. Why cut off your nose to spite your face?

  8. Sam

    I’m not saying that masses of people are suddenly (over the course of 25 years) going to have all their loans forgiven, I’m just annoyed by the fact that someone could, potentially, stick the government with the cost of their education, which, with some people’s loans in the hundreds of thousands, could be a lot of money.

    For instance, say I have $150,000 in fixed rate 6.8% student loans. Not unheard of. My salary ends up being $56,245, also not unheard of (weird number because it makes the math easy). This means that, under IBR, I’ll have $500 a month payments and, over 25 years, I’ll pay exactly $150,000 (told you it made the math easy). This is, of course, assuming I don’t get a raise and the poverty line never moves (’cause it makes the math easy). While it looks like I’ve paid off my loans, only the principle got paid off. Over $160,000 in interest disappears (this number gotten from the student loan calculator which is assuming $1,041.11 a month payments, so the number will actually be much higher).

    For practical reasons, I’ve got a fixed salary for 25 years and a constant poverty line, both of which are unrealistic, but even with regular raises and a moving poverty line, it’s certainly possible for someone to ditch vast amounts of debt with IBR.

  9. Emily

    I admit I’m a fan of the new programs.
    1. It will provide needed help to a lot of people who (are not trying to finagle the system) wanted to go to college in order to have greater prospects of finding a decent job but whose parents couldn’t write a check for the full tuition amount.
    2. Expectations of starting salaries do not always match up with reality. The current economic situation demonstrates not only how difficult it can be to find a job at times, but also how difficult it can be to find a job that pays enough to make ends meet when you have student loan payments. Having the payments based on your income would relieve a lot of stress.
    3. As Stephanie pointed out, most people are not going to intentionally make less money just so they can avoid paying student loans.
    4. Even though the IBR plan allows loans to be forgiven, the loan forgiveness is not automatically applied – people have to apply.
    5. 10 years is a long time to be making student loan payments – 25 years is a very long time to be making payments. Even if the overall burden of loans is going to be alleviated that is a long time to deal with making payments, etc.
    6. I recommend the books Strapped by Tamara Draut and Payback by Margaret Atwood for interesting perspectives on the current system. Strapped focuses on how difficult it is for Generation X and Generation Y to make ends meet due to the costs of college (especially in comparison to previous generations). Payback focuses on the concept of debt – basically we are indebted from the time we are born and when we start out on our own the debt is tremendous.

  10. Griffin

    @Sam,

    What you’re saying overall is “this program will be abused.” I get that.

    The wage assumption is (you mention) unlikely and unrealistic. 25 years ago, $56k/yr was a LOT of money. And it’s not “no money” nowadays either. A $1’000/month payment would only be 21% of someone’s income. And $100’000 in debt would have to come from a master’s or doctoral program due to the limits in place. Which means that their income would typically rise up to match their qualifications. And if you take a vow of poverty (homemaking etc), you would not be approved in the end for the loan forgiveness.

    You HAVE to make a good-faith effort to earn income in order to qualify for any loan forgiveness, you have to meet the criteria, you have to qualify and maintain your eligibility, and you have to make 300 on-time payments.

  11. Griffin

    PS: I have known dozens of people who wanted to go to college to pull themselves out of poverty, but who thought that debt would haunt them forever. So instead, they more or less stay in poverty forever. Our tax dollars are paying for their groceries because they can’t afford to feed themselves, when it could be going to making sure that they pay taxes for the next 40+ years. I know which I’d rather pay for.

    PSS: Your (and my) tax dollars have given me about $16’000 in pell grants so far, so your cut comes out to about $0.00004. When I leave college with my doctorate, I’ll have about $150’000 in debt and will wind up having $0 of it forgiven by the government unless my work (20% charity) would be considered “public service.”

  12. Sourav

    Hello,
    Just wanted to ask you that how much is it safe to invest money in stock exchanges.

    1. Stephanie

      Sourav, what do you mean by “safe?” All investments inherently carry risk, including keeping your money in cash (cash carries the risk of inflation). If you’re looking for advice on investing, especially in stocks, I suggest you check out The Bogleheads’ Guide to Investing.

  13. AmandaLP

    For Sam:

    Debt forgiveness after 25 years is actually taxed as income. So, of someone has 100k worth of debt left over at the end of 25 years, they have to pay taxes on that amount.

    If one is doing the 10 year public service forgiveness program, the money is forgiven without tax penalty. But, without that program, and under the current rules, taxes would be owed on the remainder.

    The program is not designed for people to not pay back their loans. It is designed to encourage people to seek public service jobs without worrying about paying back their loans.

  14. Jerry

    These new programs will lead to a big change for me when I graduate with HUGE school debt. However, I am going to try to get a job at a hospital that will pay off my loans in exchange for an agreement to work there for a period of time. If they offer that and decent health insurance, I’ll stay for a LONG time!
    Jerry

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  16. V

    very informative post!
    Thank you for the providing the information in detail!

  17. E Williams

    Oh my gosh! $100,000! I feel for you. But at least your profession is high paying and well needed. I went into Business and my debt is about $20,000. i think education is a rip off anyway. I mean, I don’t even use my degree at all! I am an internet marketer, but there are somet things I learn at school.

    Also, if this is true (I doubt it), it would really help students out big time. They know education is overated and cost too damn much!, but they still live off the hog. Man, My best friend graduated the top of his class majoring in Business and communications and is working as a car salesman! It is so horrible! So much for an education. Good post. You really broke down the numbers big time. I won’t hold my breath on this “student bailout” though.

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  19. judith Rosenberg

    While I applaud Pres. Obama’s intent to help students out, these loans still don’t come close to covering real college costs. And even if the repayment is delayed, they are still loans!

    A different approach that will help create money for college is to start your own small business. Our site has all the detailed info you need to get started. Even if you have a job, the business tax benefits will put extra $$ in your pocket right away. Check out our free report, “how to Reclaim $$ from the IRS” to help pay for school.

    http://www.bigmoneyforcollege.com/report.html

  20. Spot Thedog

    I agree with Philip on that one. I know students who have consolidated their loans and got their minimum payment amount to zero or a very, very low figure. Some of them work the system this way when they actually CAN afford to pay their loan installments back with no problem. And I don’t think they plan on changing it for as long as they can get away with it (still possible; you can’t check on everybody!). Most people would choose not to give back money from a loan if they could defer; it doesn’t necessarily mean they are bad people though.