Will You See Any Relief?

Today, the President reveals some changes to existing student loan provisions that were put forth in recent years. The aim is to ease the burden that many recent graduates face: substantial student loan debt, high monthly payments, and little income.

Obviously, student loan debt is a major problem in this country and it is exacerbated by the weak economy and struggling job market. So any changes that could help these borrowers out has to be a good idea, right? Yes, there are plenty of people this will help, but there are potentially many more who will not be helped.

The original student loan changes proposed a while back had initially put a “pay as you go” cap on payments at 15 percent of your income. In addition, there was a period of 25 years before the remaining debt could be forgiven. These plans were set to begin in 2014.

The changes are essentially as follows:

• New payment capped at 10 percent of income.
• New forgiveness period is 20 years.
• Rules take effect on payments starting in 2012 (two years sooner).

The new proposal also mentions being able to consolidate federal student loans, but I’m not sure how that differs from the old plan because you could consolidate loans starting in 2012 with that as well.

It’s Good News for Some

Anything that can help ease the pain new graduates face with student loan debt is welcome, but will it really make a difference? Let’s break it down and see what the real world implications are.

The most significant aspect of this plan is the two year head start. Under the old rules, those looking to take advantage of most of the proposed changes would have to wait until 2014, which in terms of a financially struggling graduate, is an eternity. So the fact that these new rules go into effect in a matter of months instead of years will help a lot, especially during these difficult financial times.

In addition, the new cap on payments tied to income and shaving five years off of the forgiveness period is nice, but keep in mind that artificially lowering payments and dragging them out just means you’re also paying far more in interest.

Calculating What Your New Payments Might Be Under the Plan

Let’s start with the “pay as you go” payment cap. This plan caps your payment based on your discretionary income, which is defined as your AGI minus the poverty level for your state of residence and family size, divided by 12.

So for example, let’s say you just graduated college, have $50,000 in federal loans, and you found an entry-level job paying just $30,000 a year AGI. Under a standard 10-year plan your payment would be about $492 per month. Your discretionary income would be $19,110 ($30,000 – $10,890 1-person poverty level). Divided by 12, that’s $1,593. This means that under the old plan of a 15 percent cap, you would pay no more than $239 per month on your student loan debt. Under the new plan your maximum payment would be around $160. A difference of $79 each month.

The new plan will clearly save money over the old plan, and compared to the original payment there is a savings of a few hundred dollars each month. But don’t let that fool you. This is huge benefit for a single person with low to modest income, but what about couples or families where there may be dual incomes?

Take a family of two where the person in the example above has the same loan and same job, but instead also has a spouse earning $40,000 a year AGI. Now, the discretionary income available is $55,290 ($70,000 ‒ 2-person poverty level of $14,710). Under the old plan you wouldn’t have even qualified to take part in the pay as you go plan because 15 percent of your discretionary income is $691, which is higher than the original 10-year monthly payment amount. The good news is that under the new 10 percent cap you would be able to take part, and your payment would be set to $461 a month. A savings of $31 each month.

You can see how drastic these two situations are. A single person with a modest job and modest loan gets significant help. That same person who is married to someone else that also has a modest income means virtually no benefit at all. Clearly, these new rules will help a lot of people, but like the proposed mortgage changes meant to ease the mortgage payment pain, there are going to be even more people out there who could use the help but simply won’t qualify.

This is not a simple black and white calculation, because there are countless factors in play here. The amount of student loan debt you have, the interest rate you’re paying, your family size and any additional income, and where you stand in the repayment of your loan will all play a huge role as to whether or not this new cap will reduce your payments. The larger the loan and higher the interest, the more help you’ll receive. But the more money you make, or couples with additional income may still find themselves with tens of thousands in student loan debt and still can’t catch a break even with this plan. So you’ll want to run the numbers on your own situation to get an idea as to whether or not you would be eligible.

Finally, let’s not forget that this is for federal loans only. Private loans do not qualify. This is not going to help the many millions of borrowers who have taken out some, or all of their loans out through private institutions.

Problems Going Forward

As with most financial regulations and changes dished out by the government, they are more or less a band-aid and don’t aim to address the fundamental problem at hand. This is no different. Will this plan ease the pain for many borrowers? Absolutely, but it will still leave many struggling families left out in the cold. Furthermore, this does absolutely nothing to address the real problems.

Tuition prices are still a runaway train and increase year after year while the value of that education continues to become diluted. As long as universities are allowed raise tuition without regard to the value a degree provides and the government is willing to let students borrow as much as they want, this problem won’t go away. In fact, it will only get worse.

But in the meantime, if you’re one of the few who can take advantage of the government’s new student loan reduction plan, you can be thankful there. For the others, and for our children who will be attending college in the future, let’s hope some serious changes are on the way.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

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