Navigating the future of student loan repayment

ARTICLE | October 04, 2023

In recent years, the narrative surrounding student loans has garnered plenty of attention. At the forefront was a widely discussed proposition from the Biden administration to forgive $10,000-$20,000 of student loan debt in a lump sum for nearly every borrower. This proposal, however, faced legal challenges and was eventually struck down by the Supreme Court. 

Now that the temporary suspension of student loan payments (a measure introduced during the pandemic) is concluding, a new approach has emerged: the SAVE plan. This isn’t a broad debt forgiveness program but rather a restructuring of certain student loan repayments. Those familiar with the REPAYE income-driven repayment plan might notice similarities, as the SAVE plan has now taken its place. Borrowers previously enrolled in the REPAYE plan will be automatically enrolled in the new SAVE plan, but others should closely examine its features to determine its relevance to their situations. 

Resumption of student loan payments

Since the onset of the pandemic in March 2020, there has been a suspension of student loan payments and interest accumulation. However, this intermission is nearing its end. As of September 1, 2023, interest recommenced on student loans, and monthly payments will resume in October. There are no subsequent extensions in the pipeline. 

To transition smoothly into this phase, borrowers should: 

• Ensure their contact details are up-to-date on studentaid.gov and with their respective loan servicer. 

• Familiarize themselves with their new payment details, which might already be updated on their loan servicer’s website. 

• Consider enrolling in autopay for a 0.25% interest rate reduction. 

Comparing income-driven repayment options

Federal student loans come with a range of repayment options, including income-driven repayment (IDR). In a nutshell, IDR plans modify your monthly loan repayments based on your family size and discretionary income. 

Discretionary income is the money you retain after meeting fundamental expenses such as housing, food, and other essentials. It’s determined by subtracting a percentage of the poverty guideline (set by the U.S. Dept. of Health and Human Services) from your adjusted gross income (AGI), considering your family size and state of residence. With some IDR plans, if your income falls below a certain threshold, your monthly obligation might even be set to $0, which prevents borrowers from defaulting due to an inability to pay. 

While these plans recalibrate your monthly payments, they often extend your repayment term beyond the typical repayment time frame. Also, if your monthly payment doesn’t cover the interest accrued, it could be added to your principal loan balance. For instance, if your monthly IDR payment is $50, but the minimum interest payment is $80 per month, your payment falls short by $30. With most types of loans, this interest shortfall adds to the principal loan balance, dramatically increasing the debt owed. 

However, the government offers some interest subsidies in certain situations. For instance, the government might cover the interest shortfall for a specific period (e.g., 3 years) to prevent the unpaid interest from being added to the principal loan balance. This subsidy period was designed to give borrowers a buffer, particularly if they’re facing financial difficulties early in the repayment process when they’re likely to have a lower AGI. After the interest subsidy period ends, if the borrower’s payment still doesn’t cover the accruing interest, the interest will start to capitalize (adding to the principal balance). 

IDR plan details

While there’s a newfound emphasis on the SAVE plan, several established IDR plans continue as an option. In this section, we’ll take a closer look at the core details of the existing PAYE, IBR, and ICR plans. These plans, with their unique specifications, remain valuable options to consider. We will cover the intricacies of the new SAVE plan in subsequent sections, but first, it’s useful to understand the foundational IDR plans for a comprehensive view of the repayment landscape. 

Pay As You Earn (PAYE)

• Eligible loans: all federal loans except those made to parents. Some loan types must be consolidated first. 

• Other eligibility requirements: your payment on this plan must be less than what you’d pay on the standard 10-year plan. 

• Monthly payment limitations: 10% of discretionary income. Your discretionary income is calculated as the difference between your AGI and 150% of the poverty guideline. 

• Interest subsidy: 3 years from the time the borrower begins the PAYE plan. 

• Repayment term: 20 years

Income-Based Repayment (IBR)

• Eligible loans: all federal loans except those made to parents. Perkins loans must be consolidated first. 

• Other eligibility requirements: your payment on this plan must be less than what you’d pay on the standard 10-year plan. 

• Monthly payment limitations: 15% of discretionary income if you borrowed before July 1, 2014 (this is reduced to 10% if you borrowed after this date). Your discretionary income is calculated as the difference between your AGI and 150% of the poverty guideline.  

• Interest subsidy: 3 years from the time the borrower begins the IBR plan. 

• Repayment term: 25 years if you borrowed before July 1, 2014 (20 years after this date). 

ICR

• Eligible loans: all federal loans, though some must be consolidated first. This is the only plan available for parent loans. 

• Other eligibility requirements: none.

• Monthly payment limitations: 20% of discretionary income or what you’d pay on a fixed 12-year plan, whichever is less. Your discretionary income is calculated as the difference between your AGI and 100% of the poverty guideline. 

• Interest subsidy: none. 

• Repayment term: 25 years

What is the SAVE Plan?

The U.S. Department of Education announced final regulations on its new income-driven repayment (IDR) plan, named the “Saving on a Valuable Education” or SAVE Plan. Designed to alleviate the repayment burdens on borrowers, here are some of its key features: 

• Expanded eligibility: the SAVE plan is available to any student borrower, regardless of income level. 

• Reduction in payments: the SAVE plan promises to halve the payments on undergraduate loans compared to current IDR plans. 

• Automatic transition for REPAYE users: borrowers currently enrolled in the Revised Pay as You Earn (REPAYE) plan will be seamlessly transitioned into the SAVE plan without any action on their end. 

• Greater protection of income: the plan shields more of a borrower’s income for essential needs.

• Interest accumulation: monthly interest that isn’t covered by the borrower’s payment will be absorbed by the government. This is to prevent loan growth due to unpaid interest. 

• Repayment for married borrowers: borrowers who are married filing separately will no longer need to account for their spouse’s income when it comes to repayment calculations. 

• Structured loan forgiveness: those with original principal balances of $12,000 or less will achieve forgiveness after 120 payments.

How does it work? 

Some features of the SAVE plan are available immediately, while others will not take effect until July 2024. 

Starting immediately, the discretionary income calculation and interest subsidies have changed. To determine monthly payments, the SAVE plan subtracts 225% of the poverty guideline from the borrower’s Adjusted Gross Income (AGI). This is a change from previous discretionary income calculations, which deducted 150% or 100% of the poverty guideline. For a two-person household in many states, the government will exclude more than $44,000 before determining monthly payments. This is a significant hike compared to $30,000 or less that could have been excluded with prior plans. Additionally, married borrowers filing separately will have their payments calculated on the individual borrower’s income instead of their combined income. 

The interest subsidy has also changed. If the borrower’s monthly payment doesn’t address the interest fees, the federal government steps in to cover these costs on both subsidized and unsubsidized loans. This means the loan balance remains constant, even if the monthly payment doesn’t fully cover the minimum interest. This is a departure from previous protocols where interest capitalization could increase the principal balance for borrowers. 

Starting in July 2024, SAVE borrowers will commit only 5% of their monthly discretionary income toward repayment of undergraduate student loans. This is a noteworthy 50% cut from the prior REPAYE plan. For graduate student loans, the payment remains at 10% of discretionary income. Those with mixed loan types (both undergraduate and graduate) will experience a weighted average payment based on their loans’ initial principal balances. 

Also, starting in July 2024, the SAVE plan introduces a tiered forgiveness framework. Borrowers with an original principal balance of $12,000 or less will see any remaining balance forgiven after 120 payments on the SAVE plan. This forgiveness period incrementally increases for every additional $1,000 borrowed. The longest forgiveness period caps at 20 or 25 years for larger balances. Note that this is not the same as Public Service Loan Forgiveness (PSLF), a forgiveness mechanism that has been around for years. There have been some minor changes to PSLF in 2023 that are not related to the SAVE plan. Also, loan forgiveness may be considered a taxable event, so it is worth consulting with an expert advisor if you are considering or approaching potential forgiveness. 

Who should consider the SAVE plan?

Determining whether the SAVE plan is right for you hinges on several factors. Here’s a rundown of circumstances where the SAVE plan could be particularly beneficial: 

• Existing IDR enrollees: if you’re already on an IDR plan, it’s worthwhile to give the SAVE plan a close look. Its redefined approach to discretionary income and lowered percentage payment requirements may present a better repayment structure. 

• Struggling with standard repayment plan: if the standard repayment plan is too onerous, the SAVE plan’s emphasis on discretionary income and interest subsidies could result in reduced monthly dues. 

• Facing financial hurdles with any form of payment: those considering forbearance or facing the possibility of default may find the SAVE plan to be a lifeline. Its flexible payment calculations can provide much-needed relief or reduce financial strain. 

• Type of loan matters: for borrowers with undergraduate loans, the SAVE plan shines even brighter. While it offers benefits for all, those with undergraduate loans stand to gain more favorable terms and potentially higher savings than those with graduate loans. 

It is important to keep in mind that any form of IDR, including the SAVE plan, can potentially extend the length of your repayment term. If your financial capacity allows for larger monthly payments, the standard repayment plan might be more cost-effective in the long run due to lower interest accrual. 

How to enroll

Before making a decision on a student loan repayment plan, you can use the loan simulator available on the Federal Student Aid website. This tool offers personalized loan simulations, showing potential repayment amounts under different plans, helping you make an informed choice based on your financial situation and future prospects. 

To enroll, head to the Federal Student Aid website. You will need your FSA ID, along with pertinent personal and financial information. For those who were on the REPAYE plan prior to the payment hiatus, the transition to the SAVE plan is automatic. If you were on a different plan and want to shift to the SAVE plan, an application is necessary. 

If you end up with an IDR plan, you are required to update your income and family size annually. Previously, borrowers had to manually enter this updated information every year. Now, borrowers can grant the Education Department permission to access their tax data. This allows for automatic yearly recertification and adjustments to the IDR plan. With this option, you can reduce the risk of being removed from an IDR plan for missing recertification deadlines. 

As the deadline for student loan payments swiftly approaches, borrowers face crucial decisions with limited time to deliberate. Given the financial implications of each repayment plan, it is advisable to speak with an expert advisor for personalized guidance on navigating the transition.