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Obama Wants to Halt Soaring Student Loan Default Rates

By Amanda Alix - Sep 28, 2013 at 10:31AM

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The government will soon start contacting troubled borrowers in an attempt to forestall defaults

This past August, President Barack Obama took to the road to speak publicly about the need to control college costs. Embedded in his new plan -- which includes ranking colleges and universities according to their success at launching students into the working world -- is the acknowledgement that student loan defaults are skyrocketing.

Obama, in concert with the Consumer Finance Protection Bureau and the Dept. of Education, want student loan recipients to be aware of their payback options well before default becomes an issue. Beginning in October, the DOE plans to do just that: reach out to troubled college loan borrowers to apprise them of ways they can make their monthly loan payments more affordable.

Defaults rising
The CFPB found that, of students that have subsidized or unsubsidized Direct Loans from the DOE, 5% are currently in default. That doesn't sound too awful, but much of the loan-repayment problem resides in those students that are on the edge of default.

Many find keeping up with payments a hardship. Adding in those that are currently part of a deferment or forbearance program boosts the percentage of borrowers of college loans not currently paying the full amount on their debt to 26%. Deferment and forebearance programs can help borrowers avoid defaulting on their loans, but they are only temporary solutions at best.

The U.S. government is trying to get the word out regarding programs that help loan recipients choose a method of repayment that aligns monthly payment amounts on Direct Loans with the borrower's income. Here are three of the options currently available to those struggling with their student debt.

1. Income-based repayment
Using the standard 10-year repayment plan as a benchmark, IBR considers a borrower's income, family size, and state of domicile to calculate whether payments could be trimmed using this income-based plan. After 20 to 25 years of continuous payments, the balance of the loan, if any is left, will be forgiven.

A nice benefit of this particular plan concerns the accrual of interest. If payments made under this program don't cover the entirety of the interest portion of the payment, the government will pay the difference for the first three years -- which means the balance of the loan itself won't increase due to unpaid interest.

2. Pay as you earn
This plan is targeted to those with more recent federal loans, and caps monthly loan payments at 10% of income. For those who qualify, monthly payments would be one-third smaller than what they would pay under IBR. Loan balance forgiveness kicks in at 20 years of continuous payment.

Those approved for the program must have first taken out a federal loan after October 1, 2007, among other requirements, and applicants must prove financial hardship. Generally, PAYE programs are reserved for those who were in college between the years 2008 and 2012.

3. Income-contingent repayment
For those who can't qualify for either of the above programs, ICR may be able to help. The plan caps payments to 20% of a borrower's monthly income, minus federal poverty guideline amounts for family size.

After 25 years, loan balances are forgiven, but if payments don't cover the entire interest amount, the overage is added to the loan balance. Once the original loan balance becomes 10% higher, however, interest is no longer added to the principal balance.

Not all federal loans qualify for all programs, though many borrowers may be able to consolidate their loans in order to be considered. Overall, these programs can be of great assistance to those mired in student loan debt. Not only is this good for borrowers, but those less constrained by debt and the credit-rating damage done by default will have more freedom to spend on economic boosters like homes and cars -- which will have long-term positive effects for us all.

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