February 2016

Financial Aid Update: Income-Derived Repayment and Loan Forgiveness Programs1

By Drew Lautemann

Career Advisor, Pro Bono & Public Service Coordinator, California Western School of Law

According to U.S. News & World Report, the average law school debt for those who graduated from one of the three ABA-accredited San Diego law schools in 2014 was $150,706, and if you are among this group of students, hopefully you already know about the various income-derived repayment and forgiveness options. Those options, which only apply to federal student loans, come in a variety of formats, but all share the same basic purpose: to tie your monthly payments to your income and ensure that you won’t be paying off your loans forever. The idea is that no one should go broke because of educational debt. This article will give a brief overview of these programs. 

Income-Derived Repayment

For the last several years there have been two main income-derived repayment options: Income-Based Repayment (IBR) and Pay As You Earn (PAYE). For those who took out their first federal student loans before October 1, 2007, IBR was usually the best option, and it sets monthly payments at 15% of the borrower’s discretionary income. PAYE, on the other hand, is available for those who took out their first loans between October 1, 2007 and June 30, 2014, and it sets monthly payments at 10% of discretionary income (those who got their first loans after June 30, 2014 are eligible for a different program, called “new” IBR, which operates very similar to PAYE). Both IBR and PAYE have been godsends for many borrowers, but with monthly payments 33% lower under PAYE than IBR, older borrowers have long wished to take advantage of the benefits of PAYE. Their wishes may have become (partially) true.

In December 2015, a new repayment plan, Revised Pay As You Earn (REPAYE), became available for all borrowers. The original PAYE is still likely the best plan for those who qualify, but REPAYE is a significant improvement for most borrowers currently in the “old” IBR plan. REPAYE is similar to PAYE in that it sets monthly payments at 10% of discretionary income, a major benefit. It still isn’t quite as beneficial as PAYE, though, because forgiveness is after 25 years rather than 20 (keep reading for more details about forgiveness), and your spouse’s income will be used to calculate your discretionary income even if you file separate tax returns (under all other income-derived repayment plans, only the borrower’s income is used to calculate discretionary income for married couples who file separately). For many IBR borrowers, though, REPAYE is a better option and could help save hundreds of dollars each month.

Loan Forgiveness

While income-derived repayment plans can be immensely helpful in the short-term, what about the long-term impact? With monthly payments so low, you might not even be covering the interest on your loans, meaning they could grow over time rather than shrink. This does not mean, however, that you will be paying off your debt forever. 

For borrowers making payments under IBR or REPAYE, their loan balances will be forgiven after making 25 years of payments, and borrowers making payments under PAYE will have their loans forgiven after 20 years of payments. There is, however, a catch.  As the programs are currently written, the balances forgiven are considered taxable income, meaning while the borrowers won’t owe the Department of Education any longer, they will likely owe the IRS a large tax bill. The tax bill will be lower than the student loan balance, but a smart borrower working toward this goal should speak with a financial planner to make sure they are prepared for the bill.2

A second forgiveness program is currently available for borrowers working for many nonprofit and government employers. This program, called Public Service Loan Forgiveness (PSLF), seeks to encourage highly educated (and indebted) professionals to dedicate themselves to public service, and it does so by forgiving the balance of federal student loans after only 10 years for borrowers who work for qualifying nonprofit or government employers and make payments under any income-derived repayment plan. In addition to the shorter repayment period, under PSLF, the balance forgiven is non-taxable. This program, however, might be in jeopardy. 

Some in Washington have called for ending the program completely, and the President has suggested capping the amount forgiven at the undergraduate federal student loan limit. This shouldn’t cause too much panic for those who already took out federal student loans for law school and are relying on PSLF, because many financial aid professionals expect any changes to PSLF only to affect new borrowers (those who take out their first federal student loans after the date of the changes), but there are no guarantees that old borrowers will be grandfathered in. 

In conclusion, there are ways to make repaying your federal student loans manageable, no matter your salary, but these programs are in flux. You should speak with your law school’s financial aid office to make sure you are currently utilizing the most beneficial repayment option available to you, and visit this website to stay up-to-date on any changes: www.equaljusticeworks.org/ed-debt.

1 Please note that this article is intended to give basic information, and you should speak with your law school’s financial aid office or someone else knowledgeable about student loan repayment for details about your specific situation and options.

2 One unique benefit of REPAYE is that it subsidizes 50% of any interest that would otherwise be unpaid because the monthly repayment amount is lower than the accrued interest, meaning the tax bill under REPAYE may be less than it would be under the other plans.