Student borrowers have another option before defaulting on loans

Many aren't aware of repayment program

September 19, 2011|Eileen Ambrose, The Baltimore Sun

The number of borrowers defaulting on federal student loans continues to rise in Maryland and elsewhere. But even during the long and painful economic recovery, many of these defaults likely are unnecessary.

The federal government has long offered leniency for borrowers in financial hardship. But two years ago it added an income-based repayment plan that caps monthly payments based on a borrower's income and family size.

If a borrower earns little or nothing, the monthly payment would be zero.

Yes, zero.

And after 25 years, any remaining balance is forgiven.

It's impossible to find such a generous break from any private lender.

"Given income-based repayment there really is no reason why anybody should default on their loans," says Mark Kantrowitz, publisher of FinAid.org, a website that provides student aid information.

Still, he adds, "a lot of students who could benefit from it, aren't aware of it. They default rather than calling their lender before they default to investigate their options."

Kantrowitz estimates that less than 2 percent of borrowers repaying loans are using the income-based repayment method, although as many as 10 percent would qualify.

Even the Department of Education, which released the latest default rates last week, noted that it plans to increase its outreach to make sure borrowers are aware of this repayment option.

Anything is better than defaulting.

Borrowers are in default on federal loans if they don't make a payment for almost a year. After that, the government has many tools, including garnishing wages and withholding tax refunds, to recoup taxpayers' money. And the government rarely lets up on its pursuit.

The Education Department reported last week that 8.8 percent of student loan borrowers — more than 320,000 — had defaulted within the first two years of repayment for the period ended in fall 2010. That's up from 7 percent for the two-year snapshot that ended in fall 2009.

In Maryland, 6.7 percent of borrowers defaulted in the first two years of repayment ending in 2010, up from 5.8 percent from the previous period.

You generally will qualify for income-based repayments if your debt is high in relation to your income.

Monthly payments won't exceed 15 percent of discretionary income, which is based on a formula tied to the poverty rate. If your income is skimpy enough, you might pay little or nothing.

For example, a Marylander graduating with $25,000 in student loans would pay about $287.70 a month under the standard 10-year repayment plan, according to the Education Department. But under the income-based plan, if that borrower made $20,000 a year, he or she would pay only $45 a month.

Your income will be reviewed annually. If your earnings rise, so will your payments.

Once you make 25 years of payments under the income-based plan, any balance left over is wiped out.

(You can eliminate the debt in 10 years if you work during that time in one of the many public service positions that qualify for forgiveness — provided the loan came through the government's direct lending program.)

One thing to be aware of: The faster you pay off loans the less you pay in interest over the life of the loan.

Some people don't like stretching out payments for 25 years. And if a borrower has a short-term setback, a deferment or forbearance that offers a temporary reprieve from payments could be a better alternative.

Michael Ryan, vice president with American Student Assistance, which counsels borrowers, says the income-based repayment plan is useful for people who now aren't in a position to pay student loans, "but also not very likely to be better off six months or a year from now."

To see if you qualify, contact your lender or loan servicer. Check out the Education Department's income-based repayment calculator at studentaid.ed.gov to see what your payments might be.

If you're already in default, you can still take advantage of income-based repayment.

The government offers an opportunity to rehabilitate defaulted loans. You will be given a new monthly payment based on your financial situation.

You must make at least 9 out of 10 payments to get back in good graces. If you can't afford this new payment, says Kantrowitz, of FinAid.org, negotiate for a lower sum.

Once loans are rehabilitated, you can apply for the income-based plan.

"Your monthly payment will be lower in most cases than the amount you were paying under wage garnishment," Kantrowitz says.

eileen.ambrose@baltsun.com

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