Will Obama Save You?

Obama’s “new” student loan plan is a modification of the existing Income-Based Repayment Plan   for Student Loans. Instead of setting monthly payments at the current 15% of discretionary income, the new plan sets payments at 10%. If you qualify, this change may significantly reduce your monthly payments. The new plan should be available in January 2012.

To get an idea of what your payments would be, use this calculator for the old 15% plan here

Also, the forgiveness timetable in Obama’s plan is shortened from 25 years to 20. Additionally, the plan also offers borrowers who have a loan from the Federal Family Education Loan Program and a direct loan from the government to consolidate them at an interest rate of up to a half percentage point less.

If you are currently under employed (or over indebted) and struggling to make your student loan payments, this may help keep you out of default (which you should be doing everything possible to avoid). The 10% will be recalculated each year and as your income increases so will your payments. However, if you should remain  under paid relative to your student loan debt for 20 years (oh my, we certainly hope not) and faithfully make you payments, any unpaid balance will be forgiven.

This plan is not available to those who are already in default (Another important reason to do everything possible to stay out of default).

Your monthly payment will be lowered by extending the term of your loan. As we know, extending the term on a loan increases the amount of interest we will pay over the life of the loan. But this plan has an important escape. If after making twenty years of payments (again, I hope not – as it would probably mean you have never reached your employment potential) your loans are not paid off, the remaining balance will be forgiven.

Like with any other loan, you should pay as much as you can as fast as you can.

Here are a few real life examples:

Bill has a MBA from a good school and student loans of $85,000. He is unmarried and has been fortunate in this economy to land a job paying $60,000 a year. His loan payments under the normal 10 year payment plan would be about $978 a month. Under the current 15% Income based repayment plan, his payments would be about $545 and under Obama’s new plan $363 per month.

On the old plan if your monthly payment amount did not cover the interest that accrued each month, the government paid the unpaid accrued interest on only Subsidized Stafford Loans and only for up to three consecutive years. I expect the new plan to work the same, forgiving interest only on subsidized loans, but those details are not yet available.

For Bill, the 6.8% interest for the first three years will exceed $363 a month but all of his loans are not subsidized. For those loans that are not subsidized the interest will accrue; in other words the balance owed on those unsecured loans will continue to increase.

The longer you pay on the loan the more you will pay.

 Ann is a teacher with an income of $42,000, student loans of $55,000 and two children. Her 15% Income-Based plan puts her monthly payment at $180 a month as opposed to the $632 on a ten-year plan. The new 10% plan should drop the payments down to about $120. Since Ann works in the public sector as a teacher, her balance could be forgiven after ten years if she makes her payments for that period.

The “pay as you earn” plan can offer some real relief to those who have or will graduate with a bunch of student loan debt and inadequate income to make their loan payments.  As with all debt, BE VERY CAREFUL to understand all the rules BEFORE you agree to a new payment plan or consolidation. This stuff is incredibly complicated and it is easy to screw it up.

A call to the Federal Student Aid Center revealed that they have not yet been notified how the 10% plan will work, for example will existing 15% plans be convertible to 10% plans? This document answers many questions on the current plan but we’ll have to check back at a later date for more detailed information on the new plan.