Today there are more than 43 million people who have student loans, totaling in excess of 1.2 trillion dollars. As the debt loads have increased, so has the number of people searching for lower payments options. Between 2012 and 2016 the number of borrowers using an Income Driven Repayment (IDR) plan has increased to more than 6.3 million. And the goal of the administration is to another 2 million borrowers in IDR plans by next spring. While these plans can offer significant relief to borrowers, they may end up costing significantly more in the long run. The government does provide a warning: “Income-driven repayment plans usually lower your federal student loan payments. However, whenever you make lower payments or extend your repayment period, you will likely pay more in interest over time—sometimes significantly more.”
In order to assist borrowers with their loan repayment decision the department of education has created a repayment estimator available at www.studentloans.gov. Unfortunately, the assumptions made are misleading and could cost borrowers much more in the end.
Flawed Assumptions of the Repayment Estimator
Rate of income increases is assumed to be 5% – Always
The Department of Education basically assumes everyone is entitled to a 5% per year compounded income increase into perpetuity. Is this realistic? We don’t think so. Consider a resident doctor with a starting salary of $65,000 per year. As s/he progresses, their income will increase at a rate much greater than 5%. The repayment estimator will grossly underestimate their income and create a set of misguided assumptions that could lead to a situation where a borrower pays significantly more to pay off their loans because of the perceived value derived from the lower estimated payments when they chose their plan.
Another example is where teachers may receive increases below 5% a year and cap out at certain levels. Assuming a payment based on a 5% a year rate of increase in salary may discourage a teacher from selecting an IDR plan due to the incorrect assumed higher payments in future years. This decision could lead a teacher to select a repayment plan that could end up costing them more than the IDR plan.
A borrower never gets married
Part of the IDR plans repayment schedule is based on a borrower’s income AND their spouse’s income. Since IDR plans can extend to 25 years, many borrowers will be married within their repayment term (perhaps several times!) Failing to model accurate future income of a spouse can underrepresent future IDR payments. This can create erroneous beliefs about the potential value of loan forgiveness. This is especially true in the IDR plans that do not allow a borrower to file their taxes married separate and exclude their spouse’s incomes from their IDR calculations. Even in the IDR plans where a borrower can file their taxes married separate and have their payments determined by their income alone, the tax ramifications of filing separate may outweigh any relief from their reduced loan payments. Assuming a borrower never gets married is a gross misrepresentation of payments, and it could cause the borrower to pay significantly more than they should.
Borrower Family Size Never Changes
Payments in IDR plans are also determined by the family size of the borrower. While many borrowers are single when they enter into repayment, it is likely that they will marry and have children in the future. The increase in family size will reduce payments in IDR plans. Alternatively, borrowers who may have a child when selecting their repayment plans may not be able to claim them in their family size calculation for the entire repayment period and would have higher payments in the future. Not being able to account for anticipated changes in future family size can lead to either lower or higher estimated payments than a borrower would actually experience, and again mislead the borrower in determining the long-term value of their various repayment options.
Only Considers Loans Currently Eligible For IDR Plans
Currently, there are five different IDR plans that each have their own repayment terms and loan qualifications. In many instances, some or all of a borrower’s loan may only be eligible for certain IDR plans, while other loans may be eligible for other IDR plans. If a borrower completes a Direct Loans Consolidation, they would be able to repay all their loans under the different IDR plans than if their loans were not consolidated. While understanding IDR plan eligibility can be confusing, not providing borrowers with the ability to estimate their payment options if they completed a consolidation grossly misrepresents the repayment options that the borrower has. Many times a borrower select a less advantageous repayment plan than were available to them because the estimator only reflects the plans available without considering what plans would be eligible if the borrower completed a consolidation. In order to understand all the options available to the borrower should consider the repayment plans accessible after a consolidation as well as before.
Assumes a Borrower Has Just Entered Repayment
The repayment calculator assumes that the borrower is just now entering in repayment. In other words, if you’ve been repaying your loan for a year or two, or more, the calculator may provide inaccurate results for your situation.
If a borrower is just entering the repayment period, the AGI entered as the base-line for the 5% per year income increase is likely much lower than the borrower’s actual salary. This will create estimates that are much lower leading the borrower to select plans that may indeed end up causing the borrower to pay more interest than necessary.
The essence of all this is that over a potential 25 year repayment period the borrower’s actual life circumstances are likely going to deviate dramatically from what the estimator puts forward and ever their own expectations. Based on this, it’s impossible for a borrower to determine if their chosen repayment plan is the most efficient way to repay their debt.
The bottom line …
- IDR plans have the potential to provide significant relief to those burdened by student debt
- Decisions about student loan repayment INSIDE OF A FINANCIAL PLAN is not simple because of the many potential life changing decisions.
- The Certified Student Loan Advisor Board of Standards administers the Certified Student Loan Advisor (CSLA) designation, specifically for financial professionals to help borrowers with repayment planning.
- Software created by CSLA Tech LLC is used by CSLAs to allow modeling a wide range of financial assumptions that include actual life expectations.
- Anyone considering repaying their loans under an IDR plan should seek out qualified advice from financial professionals who know and understand how to incorporate student loan repayment into the personal and financial goals of the borrower.
- Borrowers would be wise to look for CSLA when seeking advice about loan repayment to make sure their repayment plan best suits their short and long term goals.