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How student loans will change this year

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The end of summer marks the beginning of a brand-new school year, and with it come changes to the financial aid system. This year, the government will raise interest rates on student loans, along with easing eligibility restrictions on the Pay As You Earn student loan repayment plan and lightening the debt burden for loan borrowers enrolled in the federal Income-Based Repayment Plan. Here's how the changes might affect you.

Changes in repayment plans

Pay As You Earn

In June, President Obama announced a new executive order that will expand the federal Pay As You Earn student loan repayment plan, one of two income-based repayment plans that are seeing changes this year. Under the current plan, federal loan borrowers with a high debt-to-income ratio are eligible to have their monthly loan payments capped at 10 percent of their discretionary income and forgiven after 20 years of payments, or after 10 years of payments if the borrower works in a public service job. "Discretionary income," in this case, is defined as any income over 150 percent of the current poverty line, which would be anything over $17,505 annually for a single-person household in 2014.

One of major criticisms of the current plan is that it comes with strict eligibility requirements. To qualify, borrowers must "be a new borrower as of October 1, 2007, and must have received a disbursement of a Direct Loan on or after October 1, 2011," according to the Department of Education. The new Pay As You Earn provisions, which won't be available until December of 2015, expand the program to all borrowers — though no announcements have been made as to how the government will finance the expansion.

"There are students who are struggling with their repayment out there, and I think the Pay As You Earn expansion as well as some of our other income-based repayment programs are really great tools that the federal government offers to make sure that students have manageable payments," says Megan McClean, director of Policy and Federal Relations for the National Association of Student Financial Aid Administrators (NASFAA).

Income-Based Repayment Plan

Changes are also coming to a different student loan repayment plan. The Health Care and Education Reconciliation Act, a 2010 reform of the Affordable Care Act, contained several provisions aimed at changing federal financial aid, one of which will go into effect for the upcoming school year. The current Income-Based Repayment Plan caps monthly payments at 15 percent of discretionary income and offers loan forgiveness after 25 years of payments, or 10 years of payments for public servants. Thanks to the Health Care Act changes, new borrowers enrolling after July 1 will have loan payments capped at 10 percent of discretionary income and remaining debt forgiven after 20 years.

Currently, about 190,000 borrowers are enrolled in Pay As You Earn and an additional 1.4 million are enrolled in the Income-Based Repayment Plan, reports The Chronicle of Higher Education.

Student loan interest rate hikes

Rates are also going up on federal Direct and PLUS loans. The rates on new subsidized and unsubsidized Direct Loans for both undergraduate and graduate students will go up by 0.8 percent — from the current 3.86 percent and 5.41 percent rates on undergrad and grad loans, respectively, to 4.66 percent and 6.21 percent for the 2014-15 school year.

"Assuming a 10-year repayment plan, for every $10,000 in debt … the impact [of the interest rate hike] is between $4 and $5 additional debt per month," says Mark Kantrowitz, senior vice president and publisher of Edvisors.com. That amounts to about $2,000 in additional debt over the life of a typical student loan, assuming that interest rates hold steady.

The hike will affect parents as well. Rates on new federal Direct PLUS loans for undergrad parents and graduate students will rise from 6.41 percent to 7.21 percent.

The rate hike for this year isn't a financial catastrophe for students, but it could be "a harbinger of things to come," Kantrowitz says. Instead of setting a fixed rate each year as Congress has done in the past, starting in 2013, the federal government tied student loan interest rates to the rates on 10-year Treasury notes. The move took advantage of the exceptionally low interest rate environment the economy is currently in, but it leaves families burdened with rising interest rates as the economy bounces back. Congress has instituted a cap on student loan interest rates — 8.25 percent on federal Direct Stafford loans for undergrads, 9.5 percent on Direct Stafford loans for graduate students and 10.5 percent on graduate and parent PLUS loans — which Kantrowitz estimates will be hit in the next four to five years if the markets continue to improve.

Megan McClean says that as overall interest rates rise, families should also be prepared for incremental hikes in their student loans.

"The interest rates will change every July, and they're hard to predict because they're based on the market," she says, adding that NASFAA supports tying student loan interest rates to market rates. "That's something that students should be aware of."

In addition to changes on the federal level, students can also be affected by financial aid decisions made by their state or college.

"About half of all colleges practice front-loading of grants, where you get a better mix of grants your freshman year than in subsequent years," Kantrowitz says. "You should expect and in fact ask the school if they practice front-loading of grants, so you can anticipate and plan for it …"

Your aid package may also fluctuate from one year to the next if you have a change in your family's financial circumstance. In that case, Megan McClean recommends explaining your situation to your financial aid office and filing a professional judgment to have your aid package reviewed.

Sources:

"Obama's Loan-Debt Relief Might Not Reach the Neediest Borrowers," Kelly Field, The Chronicle of Higher Education, June 10, 2014,
http://chronicle.com/article/Obamas-Loan-Debt-Relief-Might/147001/

Mark Kantrowitz, Senior Vice President and Publisher of Edvisors.com, Interviewed by the author, July 3, 2014

Megan McClean, Director of Policy and Federal Relations for the National Association of Student Financial Aid Administrators, Interviewed by the author, July 3, 2014,

Loans: Interest Rates and Fees, Federal Student Aid, U.S. Department of Education,
https://studentaid.ed.gov/types/loans/interest-rates

Public Service Loan Forgiveness, Federal Student Aid, U.S. Department of Education,
https://studentaid.ed.gov/repay-loans/forgiveness-cancellation/charts/public-service

Repayment Plans: Income-Driven Plans, Federal Student Aid, U.S. Department of Education,
https://studentaid.ed.gov/repay-loans/understand/plans/income-driven

"Student Loans Overview: Fiscal Year 2014 Budget Proposal," U.S. Department of Education, pages 4-5,
http://www2.ed.gov/about/overview/budget/budget14/justifications/s-loansoverview.pdf

2014 Poverty Guidelines, Office of the Assistant Secretary for Planning and Evaluation, U.S. Department of Health and Human Services,
http://aspe.hhs.gov/poverty/14poverty.cfm

"Federal Student Loans: Borrow Interest Rates Cannot Be Set in Advance to Precisely and Consistently Balance Federal Revenues and Costs," U.S. Government Accountability Office Report to Congressional Committees, January 2014, page 5,
http://www.gao.gov/assets/670/660548.pdf

"FACTSHEET: Making Student Loans More Affordable," The White House,
http://www.whitehouse.gov/the-press-office/2014/06/09/factsheet-making-student-loans-more-affordable