'Pay As You Earn': What students need to know

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  • Students with both FFEL and Direct loans can get a lower rate for consolidating.
  • Those who meet certain income criteria can make lower payments.
  • Borrowers making payments for 20 straight years may enjoy debt forgiveness.

For families struggling to pay for college, 2012 won't be pretty. This year, interest rates on some federal loans will increase, tuition will go up, and it will become harder to qualify for a full Pell Grant. But there is also some good news. This year, President Barack Obama's special consolidation initiatives will begin, potentially reducing interest rates for students with a Federal Family Education Loan, or FFEL, and Direct federal loans. The "Pay As You Earn" proposal, which would make federal loans cheaper for low-income borrowers, is also expected to go into effect in 2012, pending final negotiations. Here's how the programs work.

Loan consolidation incentives

Currently all federal student loans are administered through the Department of Education's Direct lending program. But prior to July 1, 2010, some federal loans were also available through private lenders enrolled in the FFEL program. Starting in January, students who have federal loans through both the Direct and FFEL programs may be eligible for up to a 0.5 percent interest rate reduction if they consolidate their loans, reports the White House. Loans in default aren't eligible unless the borrower makes repayment arrangements with the lender.

Joseph Orsolini, a CFP and president of College Aid Planners, a college planning firm in Glen Ellyn, Ill., says the interest reduction will help students, but not very much. "You're really looking at a benefit that's going to save people less than probably $60 a year in interest," he says.

The true benefit to consolidating may be more organizational than financial. Students with both FFEL and Direct loans currently must make at least two separate payments each month to their respective lenders. Those who consolidate can make a single payment to one lender each month.

The White House reports there are approximately 6 million borrowers who may be eligible for the consolidation interest rate reduction. In early 2012, the Department of Education will reach out to qualified borrowers. Borrowers will have between January and June 30, 2012, to take advantage of special consolidation incentives.

Better income-based repayment options

Under current regulations, students with federal Stafford, Grad PLUS or consolidation loans can opt for an income-based repayment plan, which caps monthly loan payments at 15 percent of the borrower's discretionary income, reports the Department of Education. "Discretionary income" is defined as any income above 150 percent of the current U.S. poverty line for your family size and state. That means loan payments for single borrowers with no dependents enrolled in income-based repayment can currently be capped at 15 percent of all earnings above $16,335 per year. If borrowers earn less than that amount, they won't have to make a monthly payment at all. If borrowers make payments for 25 consecutive years, all remaining debt will be forgiven.

The proposed "Pay As You Earn" plan will reduce loan repayment caps from 15 percent of discretionary income to 10 percent and will lower the loan forgiveness threshold from 25 years to 20 years. Though the income-based repayment adjustments were already slated to go in effect July 1, 2014, Obama's new provision would make them available to some borrowers in 2012. Rules on eligibility and the exact date the changes will go into effect have not been announced, reports the Department of Education.

"Less of your income has to be committed to student loan repayment under the changes," says Joe Hurley, founder of the college planning site "('Pay As You Earn') will help some of the lowest income graduates that really haven't been able to pay much off over the years."

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Will it help?

The White House estimates the new provisions can lower payments for more than 1.6 million borrowers, but critics argue far fewer students will actually benefit.

"Unless you have really low income, you'll end up paying the loan off before you'd ever have anything forgiven," says Orsolini. "If you have borrowed the maximum $27,000 (federal loan allowance) and if you make $24,500 (per year), you'll pay your loan off in less than 20 years."

Publicity -- or lack thereof -- may be another barrier. Millions of borrowers can lower their monthly payments through the current income-based repayment plan, but only a few have enrolled, says Lauren Asher, president of the Institute for College Access and Success, an Oakland, Calif.-based nonprofit that focuses on financial aid policy.

"People still don't know about income-based repayment," she says. "We estimate that about 500,000 borrowers are enrolled now, which, frankly, is far lower than what we would expect in this climate."

The initiatives offer some consolation in contrast to more drastic 2012 financial aid changes. Next July, the interest rate on subsidized Stafford loans for undergrads will double from 3.4 percent to 6.8 percent, the government will stop subsidizing Stafford loans for graduate students, and the family income threshold to qualify for a full Pell Grant will decrease from $30,000 a year to $23,000. The government will also shorten the number of semesters students can qualify for a Pell from 18 to 12, making it tougher for nontraditional students, and will eliminate federal financial aid for students without high school or GED diplomas who entered higher education through the Ability to Benefit program. The American opportunity tax credit, the largest education tax credit currently available, is also scheduled to expire at the end of 2012, while college tuition continues to increase an average of 8 percent this year, according to

"If you're currently in college, there's not a lot you can do. You're just going to have to buck up and pay (the cost increases)", says Orsolini. "If you have kids going off to college, you've certainly got to take a look at all these factors and plan them into your college decisions."



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