President Obama signed a presidential memorandum on Monday, June 9, intended to make student loan debt easier to pay off for millions of Americans. Essentially, it limits the amount borrowers can be asked to repay on a monthly basis and sets a new time limit of 20 years for the maximum amount of time a borrower will be required to make payments.
While this program, known as "Pay As You Earn" is not exactly new, the recent action opens the program up to a group of borrowers that could really use the help.
So, what is the Pay As You Earn repayment option?
For those who qualify, it limits the amount of the monthly payment to 10% of "discretionary" income, which is defined as how much money you earn above and beyond 150% of the national poverty level.
Currently, this translates to any income over $16,500 for a single taxpayer, so someone with a $50,000 salary has $33,500 in discretionary income and could not be asked to pay more than $335 per month on their student loan debt, regardless of how much they owe.
Additionally, any debt remaining after 20 years of paying under the Pay As You Earn plan is forgiven. This is very important because it's very possible for a borrower's required payment to not even cover the interest on their loans, which after two decades could produce a rather large balance.
For example, let's use the $50,000 salary example and we'll say this person has $60,000 in student loans. Well, the interest alone would be around $340 per month, which is more than the $335 maximum this borrower could be asked to pay. So, while the balance will actually go up over time, the borrower can relax a little knowing there's a light at the end of the tunnel.
The best repayment plan for those who need it most
The Pay As You Earn program is not new. In fact, has been available since 2012, but has only been offered to a relatively narrow group of borrowers.
Specifically, the program has been available to those who took out their first loan after October 1, 2007 who also received a loan on or after October 1, 2011. In other words, this has been available only to recent graduates. What the new law does is remove these restrictions as of December 2015, opening the program up to all college graduates with Federal student loan debt.
While this may indeed be too little, too late for some borrowers who have been paying on their loans for a long time now, it does help one group of younger adults who could really use the help. – Those students who graduated into the worst job market in recent history.
For students who graduated during the peak recessionary years of 2008, 2009, and 2010, the most affordable repayment option has been the Income-Based Repayment (IBR) plan, which is similar to Pay As You Earn, but helps to a lesser extent. Under IBR, the repayment amount is capped at 15% of discretionary income and any remaining debt is forgiven after a 25 year period.
According to the Department of Education, the percentage of grads that entered repayment and defaulted within two years was 9.1% in 2009 and rose to 10% in 2010. When you consider that the overall loan default rate in the U.S. is just 3.3%, it's clear these graduates needed some help.
Not a permanent fix, but will definitely help those who need it most
So, what the new law will do is make student loans more affordable for many students who are struggling to pay their loans.
With more than 40% of recent college graduates considered underemployed, many simply don't have much income above and beyond the basic cost of living. For someone a few years out of school earning $35,000 per year, this reduces the maximum they can be required to pay from about $231 per month to $154.
This can really make a difference to someone on a tight budget, and make the difference between someone being able to make payments and having to request a deferment or forbearance of their loans..
Now, this isn't a permanent fix to the student debt problem facing our younger generations. The real problem is tuition and other costs of higher education increasing dramatically over the past few decades, which is the whole reason for the high level of debt in the first place.
The tuition issue is another matter, and even if tuition stops rising, it won't help those already in debt. However, the latest reform will go a long way toward improving the quality of life for millions of borrowers.