Student Loan Debt: New Income-Based Repayment Provides a Safety Net

With the fiscal cliff looming, at least one financial compromise has been reached and settled: President Obama's Pay as You Earn plan for federal student loans, proposed in October 2011, was approved on November 1. For people whose loan bills are too high for their income, the new repayment plan could be a lifesaver.

Pay As You Earn, or Income-Based Repayment, allows borrowers to pay 10% of their discretionary income (that's the difference between your salary and the poverty line for your family size). The monthly payments are adjusted each year, as needed, based on changes in income and/or family size. This is a big difference from the standard 10-year repayment plan, which spreads the total loan amount over 10 years, with no control for whether or not that translates into a manageable monthly bill. The original plan called for payments of 15% of discretionary income, but the final version, approved by the Department of Education, is an even more manageable 10%.

The benefit, of course, of paying loans quickly, even if that means larger-than-ideal monthly payments, is that the faster they're paid off, the less interest builds up. But even with the ever-increasing rates, interest buildup isn't a deterrent to enrolling in the Income-Based Repayment plan. As long as payments are consistently made on time, any remaining balance after 20 years is forgiven. The original plan promised forgiveness after 25 years, but again, the final version is even more generous.

This forgiveness after 20 years, in effect, adjusts the cost of education to the salary payoff; it's a way to protect people from education investments that end up outweighing the returns. And it's a way to ensure that everyone can strive for the best education possible, without spending the rest of their lives keeping what they've learned on the back burner while they run endlessly in the rat race.

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