Two finance professors out of Appalachian State University, Jarrod Johnstone and Ivan Roten, took a look at Income Based Repayment (IBR) and Public Service Loan Forgiveness (PSLF) and the possible impact this may have on individuals, college tuition and the economy. IBR has been around since 2009 and capped payments at 15% of discretionary income but soon drop to 10%. After 20-25 years of payments, remaining balances will be forgiven, albeit the amount written off will be taxable.
The second program they looked at was Public Service Loan Forgiveness (PSLF) where after 10 years of on-time payments, remaining balances are written off tax free. PSLF can be combined with IBR to offer the lowest possible payments for the 10 years of payments. The discretionary income that payments are based on is the difference between adjusted gross income and 150% of the poverty level. So, that’s the basics of what they looked at, now let’s look at their theories and what this means for us.
While these are just theories, they are worth considering:
#1 IBR/PSLF make big debt seem more reasonable
Because of the forgiveness components of both of these programs, the professors theorize that these two programs make taking on larger amounts of student loans either more attractive or less problematic than before. This is a problem – people likely should be cautious about taking on a mountain of debt. And what’s more troubling is that people may not realize just how much of a tax hit they’re in for if they have a large amount of student loan debt wiped out under IBR. A $40,000 loan write off could cost you $6,000-$8,000 (or more) in taxes.
#2 IBR teaches you bad debt habits
With IBR, student loans can be the one form of debt where the payment amounts aren’t driven by how much debt you’re in, but rather by your income. Wouldn’t it be great if you could buy a $300,000 house and a $70,000 car and your payments be determined by your income and it would be okay that you bought these on a $35,000 salary? Sounds great, but that’s not how the world works and it’s a bad habit to get into. With this mindset, students may rack up credit card debt they can’t afford and adopt other poor financial practices.
#3 IBR makes bad school choices more attractive to poor students
Many online colleges, shady trade schools and less-than-reputable institutions market themselves to low income and poor students and promise them a “free” education. They can also now promise low monthly payments and loan forgiveness based on IBR. Schools process student loan applications for them and max out what they can borrow. Often, borrowers don’t even know what’s happening, how much debt they’re accumulating and may not end up with a degree or any licensing they can use to get a job. The good news is they can use IBR. The bad news is, they may get no results from their schooling.
#4 IBR can shift the costs of education to the federal government
While it may sound great that the government pays for college, in fact, it’s not financially feasible under our current system and economy. Instead, what happens is that if the government is offering sizable student loans and then writing them off, colleges take advantage and keep hiking up tuition rates. The more the government underwrites the debt, the more colleges will keep increasing the rates. At some point, this system will crumble and then student loans may not be possible for anyone anymore.
If you truly can’t afford your debt, IBR is definitely the way to go. And if you’re just starting to borrow, remember that accumulating the least possible debt is the wisest move. If you can afford your loan payments, we recommend making those plus a little extra to pay off your loans as fast as possible.
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