Student debt repayment options offer hope

(MoneyWatch) The statistics are alarming. Student borrowing, which has ballooned 300% in less than a decade, now stands at $1.1 trillion. Worse, roughly one in 10 borrowers has fallen into default.

Defaults not only burden cash-strapped borrowers with a plethora of penalty fees. They can ruin a young adult's credit rating, making it virtually impossible for him or her to buy a house or a car.

Fortunately defaults are easily avoidable for those with federal student loans, thanks to a host of new repayment options. In fact, federal student loans offer seven different repayment plans, including the old "standard" and "extended" repayment options that have students repaying their debts over periods ranging from 10 to 25 years.

For cash-strapped borrowers, however, the better options are the newer and less-understood programs, including income-based repayment and "pay-as-you-earn" repayment plans. These repayment options are not available to those with private student loans, however. (See related story: Private vs. Public student loans) Pay-as-you-earn and income-based repayment are only available to those who borrowed or consolidated into the federal direct loan program.

Both plans set your payments as a percentage of "discretionary" income, which is calculated as the income that exceeds 150 percent of the poverty-line income for your location and family size. If your income is low enough, this can cause your required monthly payments to be nothing -- and the government still gives you credit for being in repayment. That's important because it means you don't lose your ability to defer the loan, nor do you accumulate penalty fees for default.

Better yet, both repayment programs allow any balance remaining at the end of the loan term -- 20 to 25 years, depending on the program -- to be forgiven. That means the balance is wiped away without penalty or risk to your credit.

Time for Graduation
Pew Research Center

Who qualifies?

Who may be eligible for these repayment plans and how do they work? The "pay-as-you-earn" plan, which is the most borrower-friendly, is only available for those who were first-time borrowers in the federal student loan program after Oct. 2007 and who had a loan disbursed after Oct. 2011. You must also be able to show financial hardship. That generally means you can't afford to pay based on standard repayment formulas. Your repayment under the pay-as-you-earn plan also must be lower than it would be under standard repayment.

If you meet the other "pay-as-you-earn" requirements, but your loans were secured earlier, the income-based repayment plan is your best option.

How are payments calculated?

With pay-as-you-earn, your payment will equate to 10 percent of your discretionary income. With income-based repayment, your payments amount to 15 percent of discretionary income.

Discretionary income is defined as the adjusted gross income that exceeds 150 percent of the poverty line for your family size and state. You can find a calculator to estimate the IBR payment here. Click here to estimate your payment under pay-as-you-earn.

Are payments adjusted?

Yes. Both plans will adjust your payments annually based on your income.

What happens if my payments don't even cover the interest on the debt?

The unpaid interest will be added to the balance of the loan. If you continue to earn too little to pay off the debt (including accrued interest)  for an extended period, your balance may be forgiven. If, however, you earn more in the future, you are likely to owe more interest under this program than you would have if you'd enrolled in a loan repayment plan that would require larger monthly payments.

How long must I pay before the balance is forgiven?

With income-based repayment, the balance is forgiven after 25 years of payments; with pay-as-you-earn, it's forgiven after 20 years of payments.

There are some programs that can forgive your balance faster, however. If you qualify for public service forgiveness, the balance could be forgiven in 10 years. (Check out the details of public service forgiveness plans here.

There are additional loan forgiveness programs for teachers and some social workers and nurses, too. For more information, see other loan forgiveness and discharge options.

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