Like many people in my generation, I was raised with the advice that securing a degree is the key to prosperity in America. For the better part of a century, that logic has held true; however, things have changed. No longer is a degree itself a guarantee of success. That’s not to say that an education isn’t valuable – quite the opposite. Education not only provides you with the skills that help build a successful career, it allows many people to develop the critical thinking skills necessary to grow in our information-dominated society. Critical thinking is the process by which we conceptualize and evaluate information through observation, experience, reflection, and reason. In all matters in life, critical thinking is important — and especially so in finance. This is especially true when it comes to making the right decisions with your student loan repayment. The Obama Administration recently unveiled a plan that just might help.
First, let’s take a look at why the Administration felt that a new program was needed. In 2010, the total amount of student loan applications topped $100 billion. When adjusting for inflation, students are borrowing more today than they did just 10 years ago. Why? Tuition. College education costs have risen steadily since the 1970’s, but much more so in the last few years. In 2010 alone, costs rose an average of at least 5%, and some states have experienced increases of 15% or more. The accumulation of student loan debt has, for the first time ever, surpassed credit card debt, as total indebtedness approaches $1 trillion dollars. This has earned the graduates of 2011 the distinction of being the most indebted in history, with an average debt load of roughly $27,000. This burden has made repayment extremely difficult for many grads trying to make their entry into the working world, where, already, more than 1 in 10 grads are at least three months behind in payments. Furthermore, the unemployment rate for college graduates aged 24 and younger has reached an all-time high of 9.4%.
Not only do these circumstances place an immense amount of stress on graduates, they also lead to the delay of life events promoting economic growth, such as the purchase of an automobile or home, and the pursuit of entrepreneurial endeavors. In an effort to help offset financial uncertainty, the Obama Administration has released an Executive Order to change the timetable for President’s Bush Income Based Repayment (or IBR) student loan repayment option. The existing law had set the cap at 15% of the borrower’s Adjusted Gross Income, extended the repayment period up to 25 years, and forgave any debt remaining after 25 years. The new version, starting in 2012, will lower monthly payments to 10% of AGI and forgive the debt after 20 years. Another portion of this initiative will allow borrowers with a Federal Family Education Loan Program and direct loan to consolidate these into one loan with up to a half percentage point lower interest rate.
The administration believes the changes could save some millions of borrowers a few hundred dollars a month – a much needed reprieve in the current economic cycle. However, if you’re interested in the program you have to consider the tradeoff. Although this program will help to make things comfortable for your financial situation, you will pay much more in interest over the 20-year term. For instance, I ran a projection on my own student loan debt under the program. Initially, I gave a sigh of relief, as my monthly obligation would be reduced by over $250 a month; however, I would pay back close to double what I borrowed – ouch! Would it make sense for me to use the program? That depends. If my monthly student loan payment exceeded what my Spending Plan allowed, I’d have little choice but to participate. However, if I can make my regular monthly payments while being able to meet my other obligations and build savings, I would not benefit from the reduced monthly payment
To be eligible for a new income-based plan, you must have taken out at least one loan no earlier than 2008 and have at least one federal loan made in 2012. Contact your loan service provider to apply for IBR. If you don’t know who your lender is, you can look it up on the National Student Loan Data System. Until next time, I’m Thomas Fox for Cambridge Credit Counseling.