If you have a very HIGH debt to income ratio, meaning your student loan balance is more than your income (especially when it gets to the level of 2x income +), your repayment strategy should consider relying on income-based federal forgiveness programs. In short, what this looks like is you will be making the minimum income-based* payments towards your balance for the maximum repayment term* to maximize your forgiveness, while also saving for the tax consequence (private sector) at the end of that term.
*Income-based payments: 10%, 15% or 20% of discretionary income depending on your plan
*Maximum repayment term: 10, 20, or 25 years depending on your plan
So how or why does this make sense? Let's look at a case study:
2 Direct Consolidated federal loans, means eligible for all IDR plans
Had loans prior to 10/1/2007 & 7/1/2014, means ineligible for PAYE & New IBR
Interest @ 6.5%
Current Balance: $184,880
Current Plan: REPAYE - Maximum repayment term is 25 years since borrower had graduate Loans
Started in plan 5/10/2016 meaning 3 full years of qualifying payments, 22 years left
REPAYE interest subsidies: Since negative amortization will be a reality here, 1/2 unpaid interest would be WAIVED on ALL loans for the lifetime of the repayment plan AND ALL unpaid interest on subsidized loans is waived for the first 3 years.
Marital Status: Single, no dependents
Income trajectory: at least 2% pay-raise each year
State of Residence: Within 48 contiguous states ($12,490)
Works in Private-sector
Discretionary Income: AGI - (HHS Poverty Level x 1.5)
Discretionary Income: $65,000 - (12,490 x 1.5) = $42,265
REPAYE Monthly Payment: (Discretionary Income x 10%) / 12
REPAYE Monthly Payment: ($42,265 x 10%) / 12 = $385.54
Assuming no major changes occur for this borrower over the next 22 years (no marriage, children, major income changes, etc.), the time table above would transpire. Being income based, the monthly payments would slightly increase each year with the borrowers 2% annual income increase.
The projected amount to be forgiven after 22 years: $241,418.42 - WOAH!
The projected tax liability in the year 2040: $84,496.44 (Assuming 35% income tax bracket)
This tax liability would generate a need to save $320/mo* in addition to making the income-based payments each month.
*Assuming NO strategy for higher growth potential
Net Present Value of Repayment COST:
This repayment strategy generates an overall NPV cost to the borrower of $153,694.49 ($63,033.69 in tax savings + $90,660.80 in income-based payments) - which is LESS than today's original amount (seen in 1st chart) of debt... *insert mind blown emoji here*
NOW this is a VERY clean cut example of how leveraging the forgiveness plans can save you BIG - I absolutely would recommend speaking to a CSLP® to review if this strategy could be right for YOU because everyone's situation is different and life is not a straight line.
Meagan Landress, CSLP®
Certified Student Loan Professional™
Financial Coach Meagan