Young Professionals Income-Driven to Student Loan Insanity: How Financial Advisors Can Help

Doctors, lawyers, and other professionals nearly always finance their educations with student loans. Most young professionals owe hundreds of thousands of dollars before beginning their careers.

It’s enough to drive all these young professionals crazy. How do you begin getting out of that financial mess -- and what’s the best way to go about getting rid of those student loans?

Financial advisors can help Gen X and Gen Y clients successfully manage student loan debt, balance cash-flow, and save for the future using affordable income-driven repayment options. And it’s critical that, as an advisor, you know and believe this so you can communicate the immense value you provide to the professionals who need student loan help.

Here’s how, as a financial advisor, you can make a difference for your clients dealing with student loan debt by knowing the ins and outs of income-driven repayment plans so you can recommend the best options.

How Monthly Payments Are Calculated

Income-driven plans calculate payments as a percentage of “discretionary income.” Discretionary income is defined as the difference between a borrower’s Adjusted Gross Income (AGI) and 150 percent of the poverty guideline for the borrower’s family size.

Monthly payments on income-driven plans are set at 10 or 15 percent of discretionary income, depending on the plan.

For example, a single borrower with an Adjusted Gross Income of $60,000 pays $362 per month if payments are set at 10 percent of discretionary income, but the same borrower pays $527 per month if payments are 15 percent.

Income-Contingent Repayment (ICR) is the oldest of the income-driven plans and is rarely the best choice for today’s student loan borrowers because of how the numbers are crunched. Payments tend to be higher than under the other plans. Under ICR a single borrower with an Adjusted Gross Income of $60,000 and a student loan balance of $100,000 would pay $802 per month.

Now that you know how monthly plans are calculated, here’s how you can continue the process to determining the best income-based repayment plan:

Establish Eligibility Based on Borrowing Dates

Pay As You Earn (PAYE) and Income-Based Repayment for New Borrowers (New IBR) provide for 10 percent payments, but are limited to “eligible new borrowers.”

New IBR is limited to those who began borrowing very recently (having no outstanding student loans on July 1, 2014). PAYE is limited to those having no outstanding student loans on October 1, 2007.

Clients with older student loans are excluded from PAYE and New IBR, but the original Income-Based Repayment (IBR) is available without regard for when a graduate borrowed. Under IBR, payments are set at 15 percent of discretionary income.

REPAYE is the latest income-driven repayment plan, providing the first opportunity for borrowers with older student loans to make payments set at 10 percent of discretionary income.

Not sure when your client started borrowing? Check the National Student Loan Data System for disbursement dates.

Evaluate Debt-to-Income Ratio

Most income-driven repayment options require that a borrower demonstrate a “Partial Financial Hardship” to establish eligibility for income-driven repayment. A Partial Financial Hardship exists when a borrower’s debt-to-income ratio results in lower payments calculated under the income-driven plan than payments calculated under a standard repayment plan based on a 10-year repayment period.

Generally, a client meets this requirement if his or her loan balance is higher than annual income. The exception? REPAYE does not require that borrowers demonstrate a Partial Financial Hardship (PFH), and is available without regard for a borrower’s debt-to-income ratio.

Think About a Client’s Marital and Tax Filing Status

Under ICR, IBR, PAYE and New IBR, whether a spouse's income is taken into consideration when determining the borrower's payment depends on the tax filing decisions of the married couple. If a married couple chooses the “Married Filing Jointly” tax status, the joint AGI reported on the joint tax return will be used for calculating monthly student loan payments.

Under ICR, IBR, PAYE and New IBR, married couples may choose either to:

• file taxes jointly and have monthly payments based on joint AGI and combined student debt, or
• file taxes separately and have monthly payments based on individual AGI and individual student debt

Under REPAYE, married borrowers must pay based on combined income; no option to separate income is provided.

A total income-driven student loan payment amount for the couple will be calculated taking into account both spouses’ debt and both spouses’ income. A proportion of the total payment will be assigned to each spouse based on their share of the couple’s total student loan debt.

Bottom line for married folks? Don’t file taxes until evaluating the student loan impact, and don’t pick REPAYE if the plan is to make payments based on separate income.

Assess Whether a Payment Cap Matters

The maximum monthly payment amount the borrower is required to repay under IBR, PAYE, and New IBR is capped at the amount the borrower would have paid under the standard repayment plan based on a 10-year repayment period using the amount of the borrower's eligible loans outstanding at the time the borrower began repayment.

The lack of a monthly payment cap is intended to ensure that high-earning borrowers, including those with high student loan balances, will continue to make payments set at a percentage of income. If you project that a client will earn enough over time that the payment cap will come into play, bear in mind that there is no cap on monthly payments under REPAYE.

A payment cap is valuable for borrowers with the highest debt as compared to projected future income, especially if forgiveness is part of the plan.

Calculation and Capitalization of Interest

Neither IBR nor New IBR have any special limitation to unsubsidized interest capitalization or accrual. But PAYE limits capitalization of unpaid interest to 10 percent of the original principal balance.

Rather than limiting capitalization, REPAYE instead limits the amount of interest that can accrue during periods of negative amortization. If a borrower’s REPAYE payment does not cover 100 percent of interest, just 50 percent of unpaid interest will be charged to the borrower.

Evaluate Potential for Loan Forgiveness

Under PAYE and New IBR, if a borrower has not repaid his or her loan in full after 20 years of qualifying monthly payments, any outstanding balance on the loan will be forgiven. Under IBR, the forgiveness period is longer: 25 years rather than 20.

Clients in government and nonprofit careers may earn Public Service Loan Forgiveness of remaining balances more quickly, after making 120 qualifying payments (over at least 10 years).

REPAYE provides for loan forgiveness after 20 years if the client only borrowed for undergraduate study. But if the client borrowed for graduate or professional study, he will be required to continue making payments for 25 years before forgiveness of any remaining balance. Payments made under REPAYE, as under other income-driven plans, are eligible for Public Service Loan Forgiveness.

Continuing Education and More Information

Want more information about how to deal with this income-driven insanity? Here are sources for further professional development:

Update (April, 2017): The below courses have expired but you can use AskHeatherJarvis.com to find future trainings!

Custom Student Debt Management Plans: A How-To Course for Professional Advisors
A three-part web series eligible for 4.5 CE credits. Register here.

Student Loan Intensive: XYPN LIVE 2016 Pre-Conference, Sheraton San Diego Hotel & Marina
Sunday, September 18, 2016 8:45 AM - 4:30 PM Pacific. Register today.

Make sure to check out these free and self-study resources, too:

• Studentaid.ed.gov
• Askheatherjarvis.com

With the right education and knowledge, you can better prepare your clients to deal with their student loan debt by advising for the income-driven repayment plan that works for them.

About the Author

Heather Jarvis is an attorney and a nationally recognized expert specializing in student loan law. She has provided award-winning student loan education and consultation for universities, associations and professional advisors since 2005. Widely recognized as an expert source of information, Heather has trained thousands of students and professionals and is sought after for her sophisticated legal knowledge and accessible teaching style. She graduated cum laude from Duke University School of Law.