Student loan repayment plan promises forgiveness but rarely delivers
By Anna Helhoski | NerdWallet
Student loan forgiveness through income-contingent repayment sounds like the best of both worlds: a monthly payment matched to your salary that disappears — along with any remaining balance — after a certain number of years.
But new analysis from NerdWallet reveals that most borrowers are unlikely to ever see that debt forgiven, despite promising to do just that.
Projections show that even when federal borrowers make these income-contingent payments each month, most will pay off their loans before they reach their forgiveness date, and those who get their debt forgiven will still rack up thousands in interest. and will have to pay a high tax. charged.
Although income-oriented plans are still the best choice for borrowers who have to reduce their monthly payments due to unemployment or who want to reduce them as a safety net, they are not a long-term strategy for paying down debt, especially for borrowers earning more than $30,000 per year.
Federal student loan repayments are set to resume on May 2 after more than two years of pandemic forbearance. As millions of borrowers consider their best options for dealing with their debt, here’s how IDR could fit into their plans.
How is the income-based cashback discount supposed to work?
At the end of 2021, 33% of all federal student loan borrowers are enrolled in one of four income-driven repayment plans, according to federal data.
The IDR plan you are most likely to access is called Revised Pay As You Earn or REPAYE. It caps payments at 10% of your discretionary income and sets your new repayment term at 20 years for undergraduate debt or 25 years for those with graduate debt. If you haven’t repaid your debt at the end of your term, the rest is forgiven.
The IDR often reduces your monthly payment, but whether or not you see a forgiveness depends on your loan principal, interest rate, and income over time.
“We heard about the unaffordability of [IDR payments], but this is not the crucial point; it’s that promise that you won’t be stuck in a lifetime of debt — that’s the piece that didn’t quite hit,” says Persis Yu, director of policy and general counsel at the Student Borrower Protection Center.
The National Consumer Law Center and the Student Borrower Protection Center reported in September 2021 that only 32 borrowers had ever obtained a discharge through IDR since the program’s inception in 1995. The majority of borrowers currently enrolled in the ‘IDR participate in the REPAYE plan, which was launched in December. 2015, and are not expected to be released until 2035, at the earliest.
Forgiveness is not feasible for most borrowers
NerdWallet’s projections, for the sake of consistency, do not take into account several circumstances that could derail or delay repayment, such as payment pauses, loss of income, stagnant wages, or the addition of the income of a spouse in calculating a borrower’s monthly payment.
- Considers two debt levels, based on direct federal loan limits: $27,000 for undergraduates and $129,500 for those with undergraduate and undergraduate debt.
- Considers nine potential starting salaries ranging from $20,000 to $100,000 and assumes annual salaries will increase 3% year over year.
- Includes consolidated interest rates that reflect rates for past years that a borrower could reasonably expect to have.
- Measures the effect on federally taxed income for those who get loan forgiveness, using 2021 tax calculations.
The analysis shows that only two groups of borrowers – those with starting salaries of $20,000 and $30,000 – can expect to have their loans forgiven on $27,000 of debt. Additionally, the borrower with a starting salary of $20,000 would accrue $19,128 in interest and still pay $6,280 in income tax on the total canceled debt of $31,027. The borrower with a starting salary of $30,000 would accrue $15,164 in interest over time and only see $193 forgiven.
A borrower with a starting salary of $40,000 would pay off their loans in 149 months (about 12.4 years) while borrowers with a much higher starting salary of $100,000 would pay off their debt in 42 months – just three years and half.
Low-income borrowers are most likely to benefit from the IDR rebate. However, there is strong evidence that this group of borrowers is not the ones signing up. A July 2020 study by Third Way, a nonpartisan think tank, found that those with very low incomes ($12,500 or less) are less likely to enroll, even though they benefit the most. The research also found that borrowers with more than $50,000 in student debt are most likely to enroll in IDR.
Daniel Collier, one of the study’s authors and assistant professor of higher education and adult education at the University of Memphis, says most people who can afford their payments on a traditional schedule can use reimbursement based on income for their financial security.
“Forgiveness isn’t as generous as people like to think,” Collier says. “Most people who could pay off their debts on a traditional time and in a traditional way are just buying insurance, really.”
Obtaining forgiveness is expensive
Even if you see your loans canceled, you’ll rack up a ton of interest along the way.
At the lowest-paying end, a borrower with a starting salary of $20,000 and $129,500 in student loans would see $237,338 forgiven in principal and interest, but accrue $132,457 in interest only over the course of his term. 25 year repayment period.
For a borrower with a starting salary of $50,000 and the same amount of debt, the amount of principal and interest forgiven would be $162,708, but the borrower would have accrued $167,205 in interest alone over time.
For those with a starting salary of $80,000, the borrower would only see $26,727 of their principal and interest forgiven, but will have accrued $140,601 in interest over time.
Borrowers could face a high tax burden
For now, any amount remitted through an income-tested refund is not considered taxable income by the federal government until the end of 2025. But if you reach the rebate after that time, you could face a costly downside: a high tax bill.
The amount forgiven is added to your total taxable income, which would increase the amount you owe the government. And it could push you into a higher tax bracket.
“Once you’re down the IDR rabbit hole, there’s no incentive to jump, but borrowers know there’s going to be this huge tax bomb in a few years and they’ll have to pay that bill as well,” says Collier.
A borrower with a starting salary of $40,000 and high debt, for example, would be pushed from the 22% tax bracket to the 32% tax bracket upon forgiveness, assuming distributions of today’s tax brackets. Without the forgiven amount, this borrower would pay $13,637 (in current dollars) on his income; with the pardon, they would pay an additional $21,237 in income tax.
You should always use the income-contingent rebate if you need it
Plug your loan information into Federal Student Aid’s Loan Simulator to get an idea of what your monthly bills and costs might look like under an IDR plan. You can subscribe to an IDR plan at any time. You must recertify your earnings each year.
IDR may not offer effective forgiveness, but it is a safety net you should use when you:
- You have a low income or you are unemployed (you may see a $0 payment).
- Cannot afford payments on a standard 10-year plan.
- You don’t want to suspend payments and accrue interest.
- You have a high salary and want to pay off your debt quickly.
- Pursue the cancellation of civil service loans.
You should not use the income contingent rebate when you:
- Can afford your monthly payments on a standard 10-year plan.
- You want to avoid paying more over time.
You must recertify if you:
- You want to stick with the income-based reimbursement.
- See a drop in your income, at any time.
- You want to continue to seek forgiveness via PSLF or IDR.
You will need to submit an application on studentaid.gov or use a paper form. The application and a demonstration of the process are available on the Federal Student Aid website. Until July 31, 2022, borrowers can self-report their income without submitting tax documents when applying for an income-contingent refund. Your agent will notify you when your application is complete and inform you of your new monthly amount.