Americans with college loans are expected to begin or resume making payments later this year after the U.S. Supreme Court struck down President Joe Biden's plan to forgive up to $20,000 in debt, and after other COVID-era relief ends. The high court struck a decisive blow to one of Biden’s signature campaign promises when it declared his debt cancellation program was unconstitutional.
But while it will surely cause some financial shock to borrowers who have not been required to make loan payments during the COVID-19 pandemic, other changes are planned for this summer that can reduce monthly payments, stop interest accruals and forgive debts after 10 to 25 years even for high income borrowers.
And you probably haven’t heard of them.
The Saving on a Valuable Education plan, or SAVE, is an update to the Revised Pay As You Earn plan, or REPAYE. The new program takes full effect next year, but several of its features are scheduled to begin before borrowers need to resume their monthly debt payments.
What you need to know about the updated federal income-driven loan repayment program
What you need to know about the updated federal income-driven loan repayment program
Income-driven repayment plans set monthly payments as a percentage of the borrower's income, rather than the amount owed. This is supposed to make repayment easier on borrowers’ wallets.
In January, the U.S. Department of Education announced that it would modify REPAYE conditions to solve some of the program’s problems. The result is a more generous policy that improves repayment conditions for borrowers.
How does the current program work?
Under the current REPAYE plan, borrowers must pay 10% of their discretionary income each year. Discretionary income is defined as the part of a borrower's earnings that exceeds 125% of the poverty guideline. That threshold is $18,225 for a single person, but varies by family size and is updated periodically.
In many cases, the payments calculated with this method are lower than the interest that the borrower should pay each month. As it stands right now, any interest left unpaid by these monthly payments is added to the total debt. As a result, there are borrowers who comply with their repayment plans and yet are seeing their debts grow month by month.
This will end with the SAVE plan, which will replace REPAYE. This seemingly subtle change can be a significant benefit for high income borrowers.
What will change in the revised plan?
There are three main changes.
First, unpaid interest does not accrue and, therefore, borrowers’ total debt does not grow.
Second, discretionary income would be redefined as earnings above 225% of the poverty guideline. The threshold would increase to $32,805 for a single person. These changes would apply to both undergraduate and graduate student debt.
Finally, borrowers’ monthly payments would be calculated as 5% of their discretionary income for undergraduates. They would remain at 10% for graduate students.
Criteria for debt forgiveness would also change. Under the current REPAYE plan, if an undergraduate student makes payments over 20 years and does not complete loan repayment, the remainder of the debt is forgiven. The same applies to graduate students over a 25-year period.
This will continue to be the case, but there would be more generous criteria for lower debts.
If an undergraduate borrower has a loan of up to $12,000, makes payments over 10 years and hasn’t fully repaid his debt after that time, the remainder would be forgiven. For each additional $1,000 in debt, one year is added to the period of time a borrower must make payments before the remainder of the loan is forgiven. For example, if a borrower has a loan of $14,000, they must make payments for 12 years before the rest of the loan is forgiven.
The period of time a borrower must make payments before qualifying for forgiveness has a ceiling of 20 years for all undergraduate borrowers and 25 years for graduate borrowers. For example, a graduate student who hasn’t finished paying off a loan of $22,000 or more after 25 years of payments would have the rest of their debt forgiven.
Finally, the revised plan would allow married borrowers to file taxes separately so the monthly payment would not be calculated based on joint income.
Can you give me an example of how the plan would work?
Consider a dual income married couple without children, one spouse an attorney, earning $130,000 a year with $120,000 in student loans at 6% interest and the second spouse earning $120,000 a year without any student debt. Under the new SAVE repayment plan this couple could have a monthly payment as low as $563 a month vs. the Standard 10 Year Repayment with a monthly payment of $1,332.
Consider a single income married couple with two children, one spouse a doctor fresh out of residency, earning $230,000 a year with $200,000 in medical school loans, who is currently in the Public Service Loan Forgiveness Program using the Pay As You Earn (PAYE) repayment plan. Under the PAYE program, this doctor’s monthly payments would be $1,542 but under the new SAVE program the payment would fall to $1,354 a month, a savings of $188 every month with no change to the date when the loan will be forgiven.
Who can apply for this plan?
All REPAYE borrowers would automatically switch to these new terms. Those with another repayment plan, income-driven or not, may also apply, as long as they have a federal direct loan. That means a loan provided directly by the U.S. Department of Education. There are four types: Direct Subsidized Loans, Direct Unsubsidized Loans, Direct PLUS Loans and Direct Consolidation Loans. Every borrower with these types of loans can apply for the SAVE program.
Those with Parent PLUS Loans are not currently eligible to enroll in the SAVE plan. However, all hope is not lost, and some advanced student loan planning strategies may be possible which would allow them to enroll in the SAVE program.
A borrower interested in changing repayment plans should contact their loan servicer. There is no charge for the switch.
What other repayment alternatives exist and how do they compare to the new plan?
In addition to the REPAYE plan, there is the Pay As You Earn plan (PAYE), the Income-Based Repayment plan (IBR), and the Income-Contingent Repayment plan (ICR). The difference between each is related to who can apply, the monthly payment calculation and the loan forgiveness terms.
The SAVE Plan has more favorable terms than all previous programs. However, ICR is the only one that accepts Parent PLUS Loans, which are unsubsidized loans made to parents of dependent undergraduate students.
When would the new plan come into effect?
The SAVE plan comes into full effect on July 1, 2024, However, the Department of Education announced that it would implement three aspects of the SAVE plan this summer before student loans resume in October: the change of discretionary income definition from 125% to 225% of the poverty line; ending the accrual of unpaid interest; and allowing married borrowers to file separate tax returns for income calculation purposes.
Next July, the department will implement other parts of the plan, such as reducing undergraduate borrowers’ monthly payments to 5% of their discretionary income and forgiving outstanding debts for loans of up to $12,000 after 10 years.
Why might the new program be more beneficial for borrowers?
The new SAVE plan allows for benefits to high-income as well as low- to middle-income borrowers depending on their circumstances. High-income borrowers taking advantage of lower monthly student loan payments may instead be able to redeploy those savings which can help achieve their other financial goals. For low to middle-income borrowers, the SAVE repayment plan changes would allow them to make smaller monthly payments without accruing debt for unpaid interest. A number of these borrowers might reach the forgiveness deadline without fully repaying their loans.
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This content is developed from sources believed to be providing accurate information, and provided by Wrought Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.