November 28, 2022

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How Student Loan Forgiveness Can Cost You A Fortune

After publishing my post on actions to take in a rising LIBOR environment, it dawned on me that besides refinancing your adjustable rate mortgage, you should also consider refinancing your student loans as well, if you have any. It feels like a lifetime ago, but I used to have ~$40,000 in business school loans that were paid off in 2008. Student loan forgiveness can actually cost you a fortune. 

During my time, there was no such thing as student loan forgiveness. Come hell or high water, you had to pay back what you owed with interest. You also couldn’t go straight to the corner office without paying your dues either. As our country has grown wealthier, softer, and more focused on instant gratification, student loan borrowers have pressured the government into giving them more options and it’s worked! 

Here are some various options borrowers have to repay their loans and how student loan forgiveness can actually end up costing a borrower more. I had no idea there were this many choices. I’m hoping by the time my kids go to college in 20 years, tuition will be free or highly subsidized, just like it is in Europe, Asia, Canada, and the rest of the world. It’s fun to have someone else pay!

How Student Loan Forgiveness Can Cost You

When it comes to managing your student loan debt, you may feel overwhelmed by all of your options. Federal repayment programs offer to make your debt more manageable, but they all have some drawbacks, too — including those that promise student loan forgiveness.

Some experts encourage income-driven repayment (IDR) plans for people struggling to keep up with their payments. Not only do these plans lower payments, but they wipe away any remaining balances after 20-25 years of repayment. Sweet deal, right? Not so fast.

Student loan forgiveness does work in certain cases. But you need to check the math, because there are many cases when it simply won’t. In some cases, pursuing student loan forgiveness by enrolling in an IDR plan may actually cost you tens of thousands more.

Summary Of Student Loan Repayment Plans

Before we look at various student loan forgiveness plans. Here’s a recap of the main student loan repayment plans.

1) Income-Based Repayment (IBR), caps your monthly payments based on a certain percentage of your discretionary income. This plan is a good option for borrowers who are struggling with monthly payments and need something more manageable.

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Payment amount: 10 – 15 percent of discretionary income, depending on the date of the first loan. The 10 percent amount is for new borrowers who never borrowed from the Direct Loan or Federal Family Education Loan (FFEL) Program) until July 1, 2014 or later. The 15 percent amount is for everyone who began borrowing before that date.

Repayment period: 20 – 25 years. It’s a 20-year term for new borrowers as of July 1, 2014 or later, and 25 years for everyone else.

2) Pay As You Earn (PAYE) was unveiled in 2012 and is similar to IBR but has stricter requirements. To qualify for PAYE, you need to demonstrate need and be a fairly recent borrower — you must be a new borrower as of Oct. 1, 2007 (meaning you didn’t have any student loans before this time) and must have received a disbursement of a Direct Loan on or after Oct. 1, 2011.

Payment amount: 10 percent of discretionary income.

Repayment period: 20 years.

3) Revised Pay As You Earn (REPAYE), which became available in December 2015, is the newest income-driven repayment plan. This plan is similar to PAYE with a few differences.

The most notable difference: anyone, regardless of when the started borrowing federal student loans. It’s estimated that REPAYE allows about 5 million more borrowers to qualify to cap their student loan repayments at 10 percent of discretionary income.

Payment amount: 10 percent of discretionary income.

Repayment period: 20 – 25 years.

Now that you understand the student loan repayment basics, let’s look at three scenarios and see how the numbers all shake out.

Three Student Loan Repayment Scenarios

1. The Average Borrower

Annual income: $50,561

Student loan debt: $37,000 in Direct Subsidized undergraduate loans at 3.76% APR

The 2015 median starting salary for a graduate with a bachelor’s degree is $50,561, a 5.2% increase over last year according to a survey from the National Association of Colleges and Employers. For this and all calculations, annual income is estimated to increase at 5% annually, which the Dept. of Ed. currently uses for their Repayment Estimator tool.

So if you have $37,000 in Direct Subsidized undergraduate loans at 3.76% APR, you will pay back a total of $44,532 under the Standard Repayment Plan.

Alternatively, under the Revised Pay As You Earn Repayment plan (REPAYE), you would pay $45,670 with no remaining balance to be forgiven.

And under Pay As You Earn (PAYE), which is effectively the same plan as Income-Based Repayment (IBR) for new borrowers, you would pay back $45,943. And as you can see, there’s no student loan forgiveness granted in this case.

Repayment Plan First Monthly Payment Last Monthly Payment Total Amount Paid Projected Forgiveness Amount Repayment Period
Standard $371 $371 $44,532 $0 120 months
REPAYE $273 $500 $45,670 $0 124 months
PAYE/IBR For New Borrowers $273 $371 $45,943 $0 134 months

2. Low-Income, High-Debt Borrower

Annual income: $35,000

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Student loan debt:

  • $37,000 in Direct Subsidized undergraduate loans at 3.76% APR
  • $38,000 in Direct PLUS loans at an interest rate of 6.31% APR
  • Total: $75,000

If you’re like many borrowers, your student loan debt might exceed your annual income.

Opting for an income-driven repayment plan can give you breathing room in your budget, but you might also spend substantially more on your debt overall. Plus, you could end up with a hefty tax bill.

For example, let’s say you’re a graduate school student loan borrower. You have $37,000 in Direct Subsidized undergraduate loans at 3.76%, as well as another $38,000 in Direct PLUS loans at 6.31% APR. You only make $35,000 a year.

On the 10-year Standard Repayment Plan, you would pay back a total of $101,280. On the other hand, you would pay back even more under REPAYE — $107,639 — and have $67,345 in debt forgiven at the end of the repayment term. However, that would be considered taxable income.

The best deal appears to be with PAYE, where you would pay back only $71,171 and receive forgiveness in the amount of $79,829. Not bad! However, according to IRS tax code, you will be on the hook for taxes based on the $79,829 in forgiveness.

Repayment Plan First Monthly Payment Last Monthly Payment Total Amount Paid Projected Forgiveness Amount Repayment Period
Standard $798 $798 $95,753 $0 120 months
REPAYE $143 $681 $107,639 $49,483 300 months
PAYE/IBR For New Borrowers $143 $507 $71,171 $79,829 240 months

3. High-Income, High-Debt Borrower

Annual income: $125,000

Student loan debt:

  • $37,000 in Direct Subsidized undergraduate loans at 3.76% APR
  • $113,000 in Direct PLUS loans at an interest rate at 6.31% APR
  • $40,000 in private loans at 7.5% APR
  • Total: $190,000

For borrowers who have a large amount of student loan debt, but also have a high income, income-driven repayment plans are usually not cost-effective.

For the federal student loans under this scenario (more on the private loans below), you would pay back a total of $196,987 on the Standard Repayment Plan. Under REPAYE, you would pay back $236,110 over the course of nearly 15 years and have no debt left over to be forgiven. Repayment under PAYE results in similar numbers.

Both income-driven repayment options fall well short of the repayment term required to receive forgiveness. And you’ll end up paying around $40,000 more over the 15 years of repayment if an income-driven plan is selected over 10-Year Standard repayment.

In this case, let’s consider an additional option: student loan refinancing.

Let’s assume you’re able to refinance all these loans into a new, private loan with a fixed rate of 5.0% APR.

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Repayment Plan First Monthly Payment Last Monthly Payment Total Amount Paid Projected Forgiveness Amount Repayment Period
Standard $1,642 $1,642 $196,987 $0 120 months
REPAYE $893 $1,858 $236,110 $0 179 months
PAYE/IBR For New Borrowers $893 $1,642 $234,895 $0 181 months
Refinanced federal loans at 5.0% $1,591 $1,591 $190,918 $0 120 months

By refinancing, you can save about $6,000 over the life of your federal student loans. But wait! We haven’t factored in the private student loans yet.

Refinancing the $40,000 in private loans at 7.5% down to a rate of 5% would save an additional $6,000 over 10 years, bringing the total savings between federal and private loans to about $12,000 when compared to the Standard Repayment for both federal and private loans.

If you had opted for income-driven plan, refinancing would result in about $50,000 less in total amount repaid than that option.

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Refinancing Your Student Loans To Save

As you can see, student loan forgiveness isn’t so simple; income-driven repayment plans that offer student loan forgiveness don’t work for everyone. So rather than blindly pursuing forgiveness, test out the math to make sure you aren’t going to be on the hook for more money overall.

Student loan forgiveness is one of the key items on President Biden’s financial reform plan. However, Biden says he plans to forgive only $10,000 in student loan forgiveness.

The $50,000 some Democrats are asking for is way too extreme. After all, people who have huge student loan forgiveness tend to be the upper-middle class.

Related post: The Best Strategy To Get Out Of Debt And Get Happier

Wealth Planning Recommendation

College tuition is now prohibitively expensive if your child doesn’t get any grants or scholarships. Therefore, it’s important to save and plan for your child’s future. Check out Personal Capital’s new Planning feature, a free financial tool that allows you to run various financial scenarios to make sure your retirement and child’s college savings is on track. They use your real income and expenses to help ensure the scenarios are as realistic as possible.

Personal Capital College Planning Feature

Once you’re done inputting your planned saving and timeline, Personal Capital with run thousands of algorithms to suggest what’s the best financial path for you. You can then compare two financial scenarios (old one vs. new one) to get a clearer picture. Just link up your accounts.

There’s no rewind button in life. Therefore, it’s best to plan for your financial future as meticulously as possible and end up with a little too much, than too little! I’ve been using their free tools since 2012 to analyze my investments and I’ve seen my net worth skyrocket since.

Personal Capital Retirement Planning Comparison Chart

Refinance your student loans today. Check out Credible, a student loan marketplace that has qualified lenders competing for your business. Credible provides real rates for you to compare so you can lower your interest rate and save. Getting a quote is easy and free. Take advantage of our low interest rate environment today!

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