For those that are struggling with student loans, Pay As You Earn can be life-changing. Currently, this repayment plan is helping borrowers who started borrowing after October 2007 and were still borrowing as of October 2011. The plan doesn’t apply to a wide swath of borrowers and due to lack of awareness, many aren’t taking advantage of the plan that could sorely use it. And now, in President Obama’s latest budget proposal, there are changes to PAYE that will expand the program for many and limit it for some. Here are the 5 critical changes you need to know about now:
#1 Open up PAYE to all borrowers
This is the one suggestion that is awesome. While Income Based Repayment has long been available to all borrowers, PAYE has been accessible only to those more recently in debt. This suggestion would make PAYE open to everyone and would greatly benefit struggling borrowers. The chief difference between the two is that IBR caps payments at 15% of discretionary income and PAYE at 10%, and IBR allows forgiveness at 25 years of repayment while PAYE does so at 20. The bottom line is that opting for PAYE over IBR will see you paying less and for fewer year. If passed, this change would kick -in as of 2015.
#2 Remove the cap on payment amounts
As the plan is written now, payments under PAYE will never be higher than they would be under the 10 year standard repayment plan. The calculation is to deduct 150% of the poverty line from your adjusted gross income to get your discretionary income. This is then multiplied by 10% to determine your monthly payment amount, but this would not exceed the standard plan repayment. Under this new plan, it wouldn’t exceed it. I’m not sure when this scenario would come into play. This change is aimed at high earners that are taking advantage of PAYE to try and score forgiveness and lower payment when they could realistically afford to service their debts normally.
#3 Extending the forgiveness repayment years for some borrowers
For high debt borrowers – i.e. those who owe more than $57,500 – the repayment term to get forgiveness under PAYE would now be the same as under IBR. If this budget line item is approved, only after 25 years of payments under PAYE would those owing a big pile of money have their balances forgiven. This makes sense but will prolong the student debt agony of many students, so we say “boo hiss” to this one.
#4 Married borrowers won’t be able to separate income
We wrote recently about getting the most out of income based repayment and PAYE based on your tax filing status. Currently, married debtors filing under married filing separate status only have their income considered for PAYE. If you file jointly, both incomes are considered. This budget change would wipe out the ability to finagle your payments by changing your filing status. This actually seems like a fair change we can support. Plus, you’ll have some offset because if you do file jointly, you’ll be able to claim the student loan interest deduction.
#5 End taxability of loan forgiveness
This is the most exciting piece of President Obama’s proposed budget. One of the major downsides of both IBR and PAYE is that no matter how much of your debt is forgiven, the result is taxable. For many that are overburdened with debt they can’t pay and whose monthly payments don’t even cover the amount of interest, their forgiven balance can be significantly higher than what they originally borrowed, resulting in a tax bill that could equal or exceed their initial loan amount. This is deplorable. Not only does the new budget propose to cap the amount of interest that could accrue for those making payments that are lower than their monthly interest, but it would wipe out the remainder of your debt without a tax penalty. This would be huge!
Once the budget battle between POTUS and Congress is done and the fiscal dust settles, we’ll give you an update on what (if any) changes are coming down the student debt pipeline that can affect your financial future. In the meantime, sign up now for Tuition.io’s free student loan tool and be sure to keep an eye on our blog to stay in the loop on legislation, reforms, activism, news, tips and lots, lots more!