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Income Contingent Repayment

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The Income Contingent Repayment (ICR) plan is designed to make repaying education loans easier for students who intend to pursue jobs with lower salaries, such as careers in public service. It does this by pegging the monthly payments to the borrower's income, family size, and total amount borrowed. The monthly payment amount is adjusted annually, based on changes in annual income and family size.

Income-contingent repayment is currently available only from the U.S. Department of Education, not from banks or other private institutions making government-guaranteed loans through the Federal Family Education Loan (FFEL) Program. (FFEL lenders offer Income Sensitive Repayment as an alternative.) But if you have one or more FFEL loans, the Department of Education will allow you to consolidate your loan or loans into a federal direct consolidation loan (1-800-557-7392 or TDD 1-800-557-7395) so that you can elect income-contingent repayment. Students at some schools get their loans directly from the US Department of Education through the Direct Loan program. If you already have a Federal direct loan, you may elect income-contingent repayment without having to consolidate.

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(There are some restrictions on the ability to consolidate into Direct Lending if you have only FFEL loans. However, if you haven't been able to obtain a FFEL consolidation loan, or if you haven't been able to obtain income sensitive repayment terms acceptable to you, or you have defaulted on your FFEL loans, you should be able to obtain a DL consolidation loan. If the direct consolidation loan people say that you must have defaulted on your FFEL loans to consolidate into direct loans, remind them that this restriction was repealed by sections 7015(c) and 7015(d) of Public Law 109-234, the Emergency Supplemental Appropriations Act for Defense, the Global War on Terror, and Hurricane Recovery, June 15, 2006. If they still give you trouble, ask the FSA Ombudsman for help.)

The maximum repayment period is 25 years. After 25 years, any remaining debt will be discharged (forgiven). Under current law, the amount of debt discharged is treated as taxable income, so you will have to pay income taxes 25 years from now on the amount discharged that year. But the savings can be significant for students who wish to pursue careers in public service. And because you will be paying the tax so long from now, the net present value of the tax you will have to pay is small.

In addition to discharging the remaining balance at the end of 25 years, the ICR program also indirectly subsidizes the interest by including an interest capitalization cap. If your payments don't cover the interest, unpaid interest is capitalized (added to the principal) once a year. However, this capitalization is capped at 10% of the original loan amount. Any additional unpaid interest continues to accumulate but is not compounded. This means that if you decide to prepay the loan or switch to a different plan, the unpaid interest will be included in the loan balance. But as long as you remain in the ICR program, any excess interest above the 10% threshold will not be capitalized.

The interest rate is fixed for the lifetime of the loan, and is not variable. It is based on a weighted average of the interest rates of the loans included in the program, rounded up to the nearest 1/8th of a percentage point. It may be advisable for students who wish to use this plan to switch to it just before their loans enter repayment, since the interest rate will then be the in-school rate, which is 3/5th of a percentage point lower.

Many students do not participate in the ICR program because they are intimidated by the thought of a 25-year repayment term. However, it is worth careful consideration, especially by students who might be considering using an extended or graduated repayment plan. The total amount repaid over the lifetime of the loan is only slightly more expensive than that of the 25-year extended repayment plan, but can be significantly cheaper on a constant dollar basis.

A new public service loan forgiveness program will discharge the remaining debt after 10 years of full-time employment in public service. The borrower must have made 120 payments as part of the Direct Loan program in order to obtain this benefit. Only payments made on or after October 1, 2007 count toward the required 120 monthly payments. (Borrowers may consolidate into Direct Lending in order to qualify for this loan forgiveness program starting July 1, 2008.)

Calculating the cost of a loan in the ICR program can be somewhat complex, in part due to the need to make assumptions about future income and inflation increases. FinAid provides a powerful Income Contingent Repayment Calculator that lets you compare the ICR program with standard and extended repayment. You can compare the costs under a variety of scenarios, including the possibility of starting off with a lower income and later switching to job with a higher salary.

FinAid's ICR calculator also computes the net present value of the total payments, telling you how much they would cost in constant dollars. The idea is that a dollar ten years from now will have less buying power than a dollar today, due to inflation. Net present value tells you how much that dollar would be worth today, under certain assumptions. Comparing different loans using constant dollars can provide a more realistic analysis of the difference in real cost.

When comparing the ICR program with the standard and extended repayment programs, it is important to recognize that the loan term has a significant impact on loan cost. Although net present value figures allow you to compare costs on a constant dollar basis, comparing the cost of a 10 year loan with a 25 year loan is like comparing apples and oranges. A 10 year loan will likely have a lower overall cost than a 25 year loan, primarily because of the shorter loan term. For example, consider a student with a $75,500 loan and an AGI of $27,000. Under the ICR program, the net present value is $85,779.76. Under the standard repayment program, the net present value is $84,738.39. So the standard repayment program is slightly less expensive than the ICR program. However, it would be a mistake to conclude from this that the extended repayment program with a 25 year loan term is better than the ICR program, because the relative costs change as the loan term increases. The 25-year extended repayment program turns out to have a net present value of $95,525.98, much more expensive than the ICR program.

The Federal government's income contingent repayment formula compares two payment ceilings, picking the lower ceiling as your monthly payment. The first ceiling is 20% of your monthly discretionary income. Discretionary income is defined to be the adjusted gross income minus the federal poverty line that corresponds to your family size and the state in which you reside. The second ceiling is the amount of the 12-year standard repayment plan monthly payment, multiplied by an income percentage factor (IPF). The IPF corresponds to your income and marital status, and starts at about 50% for incomes near the poverty line. There is also a $5 minimum monthly payment. (Technically, if your monthly payment is $0 it is not rounded up to $5, but a monthly payment of $0.01 would be rounded up to $5.)

Only student loans may be included in the income contingent repayment plan. Parent loans, such as the Parent PLUS loan, are not eligible. Only loans that are guaranteed by the Federal government may be included. (Grad PLUS loans are not eligible for income-contingent repayment until July 1, 2009. However, consolidation loans that include Grad PLUS loans are eligible for income-contingent repayment, provided that the borrower did not enter repayment before July 1, 2006.)

One flaw with the government's ICR formula is the treatment of married borrowers. It combines the income of both spouses, effectively introducing a marriage penalty compared with the repayment for two borrowers who are not married. However, this effect is most evident when comparing monthly payments, and may be minimal in terms of net present value of repayment over the life of the loan.

An important feature of the government's ICR program is that although you must initially sign up for 25-year income-contingent repayment, you are not locked into this payment plan. If your circumstances change or if you just decide that you want to pay off your loan more rapidly, you may do so.

 

 
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