“Check out this NY Times example of a Pay as You Earn program (PAYE) student loan…It’s negatively amortizing: the balance owed increases over time, because the payment required by the government does not cover the interest owed!!! Isn’t this similar to the pre-crisis, much-derided Option-Arm mortgage loans offered by the private sector…
…and why in the world would government workers get their loans forgiven in 10 years (tax free) and private sector workers in 20 years (the forgiveness being a taxable event), when its only private sector workers who pay actual taxes (because government workers’ entire salary is paid by taxpayers)? Don’t we want a lot more private sector workers paying taxes and a lot less government employees (especially with our deficits)? Won’t this encourage the opposite?”, Mike Perry, former Chairman and CEO, IndyMac Bank
New York Times Example of a PAYE Student Loan, “Obama’s Move to Help Students Is Not as Forgiving as It Seems”, New York Times Article, June 24, 2014:
“But let’s look at the hypothetical case of a graphic designer: A single college graduate earning $46,900 a year through full-time work who will have an annual income increase of 5 percent. She has borrowed $100,000 and is charged 6.8 percent interest. According to the federal Repayment Estimator calculator, if the graphic designer meets her payments each month for 20 years (at 10 percent of her discretionary income plus interest, her payments would start at $245 in her first month of repayment and reach $717 by her last), the federal government will forgive nearly $130,000 of her remaining debt plus interest accrued over time. In total, she will pay $106,581.But there’s a catch. The relief of PAYE’s debt forgiveness can come with an onerous tax liability. It appears our graphic designer saves $129,419 thanks to the 20-year forgiveness stipulation, but because her chosen profession does not qualify for the Public Service Loan Forgiveness program, her “forgiven” debt could qualify as taxable income.”
DIGGING OUT OF DEBT
Obama’s Move to Help Students Is Not as Forgiving as It Seems
JUNE 23, 2014
If you’re a student loan-burdened recent college graduate putting the final touches on a note to President Obama, thanking him for his recent executive order on debt repayment, don’t get too excited.
Mr. Obama formally widened the pool of eligible participants in the Pay as You Earn program (PAYE) and said it could save recent graduates hundreds of dollars every month, helping an additional five million people manage their student debt. It fulfills a promise — made in a chipper, animated advertisement posted to Mr. Obama’s YouTube channel in 2011 — that graduates would not have to make student loan repayments greater than 10 percent of their income.
But if you look at the numbers closely, PAYE saves you money only if you borrowed big and earn little.
The revised program caps monthly loan payments at 10 percent of discretionary income, defined as income exceeding 150 percent of the federal poverty level for a single person. Well-paid graduates and those working minimum-wage jobs will dedicate equal proportions of their income to paying off debt.
Credit Tomi Um
But does the 10 percent cap make that much of a difference? It looks like PAYE saves money only for those low-income borrowers who have incurred an unusually large federal debt — so much debt that the federal government agrees to forgive whatever you haven’t paid off after 20 years. That certainly helps, but it isn’t going to help a majority of college graduates.
The federal government uses loan forgiveness as an incentive to encourage recent college graduates to pursue full-time government or nonprofit work. The Public Service Loan Forgiveness program will forgive the debt of students entering broadly-defined “public service” after only 10 years, mitigating the burden of debt for graduates pursuing fields not known for being lucrative.
Attention is often focused on extreme cases of students who borrowed hundreds of thousands of dollars. But only 3.7 percent of borrowers — including graduate students and parents who borrow to pay for their child’s education — actually take on debt in six figures.
But let’s look at the hypothetical case of a graphic designer: A single college graduate earning $46,900 a year through full-time work who will have an annual income increase of 5 percent. She has borrowed $100,000 and is charged 6.8 percent interest. According to the federal Repayment Estimator calculator, if the graphic designer meets her payments each month for 20 years (at 10 percent of her discretionary income plus interest, her payments would start at $245 in her first month of repayment and reach $717 by her last), the federal government will forgive nearly $130,000 of her remaining debt plus interest accrued over time. In total, she will pay $106,581.
But there’s a catch. The relief of PAYE’s debt forgiveness can come with an onerous tax liability. It appears our graphic designer saves $129,419 thanks to the 20-year forgiveness stipulation, but because her chosen profession does not qualify for the Public Service Loan Forgiveness program, her “forgiven” debt could qualify as taxable income. In short, the designer’s annual income taxes could nearly double in the final year.
Now consider an alternative payment route. If the graphic designer paid off her debt using the federal government’s 10-year Standard Repayment Plan, under which payments hold at a fixed amount each month for up to 10 years, she would pay a much greater sum each month, over a much shorter period of time. Repaying her debt within the 10-year limit demands monthly payments of $1,151. Including interest, and without the enormous benefits of a debt forgiveness stipulation, the graphic designer pays nearly $30,000 more than she would have using PAYE, according to the repayment calculator.
PAYE Saves Borrowers With Big DebtsGraduates with $100,000 of debt who pay back their student loans using the Standard Repayment Plan pay nearly $30,000 more than if they repaid using PAYE — largely because the government forgives any remaining unpaid debt 20 years after graduation.
The 6.8 percent interest rate used for this article reflects the rates on federal, direct subsidized loans in 2008, when the hypothetical graduate imagined here entered her sophomore year of college. This chart assumes a family size of one and a single tax filing status. Calculations include an annual 5 percent income and a 3.3 percent poverty line increase and are based on estimations by the federal Repayment Estimator calculator.
But PAYE doesn’t save much for our hypothetical borrower’s roommate, a Wall Street investment banker, whose larger income necessitates larger monthly payments. She is more likely to pay off her six-figure debt before she ever gets to the 20-year debt forgiveness. If she earns a salary of $85,300 (plus a hefty signing bonus), and repays her loans at 10 percent of her monthly income, under PAYE she will pay off her full $100,000 of debt, plus interest, in 14 years and 9 months.
This means that, while the graphic designer who borrowed $100,000 loses $30,000 with the standard plan (compared with PAYE), the newly minted banker saves $30,000 by paying down her debt using the standard plan’s flat rate: $1,151 every month for 10 years.
Where do those differences come from? Interest. Because her monthly payments are reduced under PAYE, the artist repays the loan over a longer stretch of time. The longer it takes to pay down debt, the longer she pays monthly interest.
But let’s look at a more common case. Say you carry the median federal student debt for a bachelor’s degree: $29,400. Now our graphic designer will actually save close to $3,000 over all by paying a flat rate from the time she graduates until she has whittled down the debt.
Uniform Payments Are Smarter if You Have Average DebtThe college graduate who borrowed the average of $29,400 in subsidized federal student loans will save about $3,000 while making uniform payments, compared with PAYE, which allows repayment in lower monthly amounts.
The median borrower who chooses PAYE pays less from the start, but gradually increases her monthly payments over nearly 12 years (beginning with $245 each month and eventually reaching $338), accruing over $3,000 additional dollars in total interest. Meanwhile, the borrower who consistently pays a monthly rate of $338 from the month she graduates until her debt is paid off 10 years down the line avoids paying nearly two extra years of interest.
The graphic designer is free to switch to a repayment plan that better suits her needs at any time. Of course, if she is far enough behind in her monthly payments, switching plans probably won’t be enough to keep her fromdefaulting on the federal loans.
PAYE’s real impact comes from the financial relief it provides during the first unsteady months after graduation, when job security and steady income are less stable. Whether recent graduates save more in the long haul depends on whether they have the financial flexibility and foresight to start paying larger monthly sums earlier.
Of course, there are any number of other factors to consider when choosing a repayment plan. For instance, the cost of living varies drastically from city to city. A recent college graduate moving to Buffalo might be better off paying his loans at a flat rate. His rent will carve out a significant, but not unmanageable, portion of his salary; his living expenses will be low enough that he can repay his debt more quickly, and at only $93 more each month than he would pay with PAYE.
But for the student setting out to conquer Manhattan, where the median monthly rent is $3,817 according to the most recent Manhattan Rental Market Report, delaying payment on larger chunks of debt until you’ve saved some money makes a lot of sense.
The charts show payment rates for employed, unmarried, childless people with undergraduate degrees. Needless to say, if you’re paying off debt over a 10- or 20-year period, at least one of those variables is likely to change. If you happen to marry and have a child in the 20 years after your college graduation, the burden of a flat monthly fee might feel weightier. But because PAYE repayment rates depend on discretionary income, which is calculated based on family size, your rate of repayment changes as your life does.
In this respect, PAYE does exactly what it was designed to do: act as a stopgap. Hypothetically, it accommodates the unpredictability of life, offering young borrowers limited flexibility to repay their debt at a rate that leaves enough left over to pay rent each month. Of course, the premise of a stopgap assumes a better, permanent and fast-approaching alternative solution.
For that, Mr. Obama turned to Congress, asking that it pass a bill that would allow current students to borrow at a cheaper rate or refinance their current loans down to match that lower monthly interest. On June 11, Senate Republicans filibustered the measure, arguing that the bill was midterm election political fodder that would have done little to lower education costs. “The Senate Democrats,” said the Senate minority leader, Mitch McConnell, “want an issue to campaign on to save their own hides this November.”