Tuesday , 27 June 2017

IBR + PAYE: Frequently Asked Questions

IBR + PAYE FAQTo supplement the Student Loan Repayment: IBR and PAYE article, which describes the general basics of the two repayment plans, this is a list of frequently asked questions that graduates often ask about the plans:

  • If I do not qualify for PAYE, can I still qualify for IBR?

Answer: Yes. PAYE is simply a slightly tweaked version of IBR that has more restrictive prerequisites. Assuming you have a partial financial hardship, it is easier to qualify for IBR as PAYE has an additional “new borrower” condition and a shorter list of eligible loans.

  • Will my interest capitalize if I do not pay enough each month to cover that month’s accrued interest?

Answer: Capitalization is the process by which the interest on the original amount of the loan is added to the principal. The principal amount is the amount from which interest accrues. Therefore, if interest is capitalized you are paying interest on interest and the original loan amount, not just the latter. Under both plans, if your payment does not cover the amount of interest that has accrued that month, as long as you maintain a partial financial hardship the interest does not capitalize. A partial financial hardship (a high debt to income ratio) is a prerequisite for qualification under either plan, so this essentially means that the interest that has accrued but not been paid as a result of making insufficient monthly payments to cover the growing interest will be in a “frozen” state so long as your original financial situation has not drastically changed. Of course, at some point all this frozen interest must be repaid or forgiven, but the plans provide a benefit to the borrower because this frozen interest does not increase the principal amount automatically to produce a snowballing effect of growth to the extent interest is not entirely paid each month. PAYE is extra generous in this regard because unlike IBR it additionally caps the total amount of frozen interest that may capitalize when there is no longer a partial financial hardship to only 10% of the original principal balance. That means if someone has 100K in eligible student loans under PAYE, and the frozen interest accumulates to 12K before the borrower gets out from under a partial financial hardship, that extra 2K would not capitalize. Whether this additional PAYE benefit would benefit you depends on your total loan amount, the extent to which you are unable to meet each month’s interest growth, and the duration of time over which all this occurs. However, it is a noteworthy benefit to some borrowers. As a bonus, the government makes interest payments on any direct subsidized loans you may have for the first three years under either plan.

  • What is an alternative documentation of income?

Answer: Under both plans, each year you must submit documentation that shows your adjusted gross income and family size so the next year’s monthly payments can be adjusted accordingly (even if no change exists, which means the same monthly payment will be recalculated). An alternative documentation of income form is a form that you must send to your loan servicer if your income changes drastically during the course of the year. This way the recalculation can take place earlier than annually required due to the income change. This form is optional. If you are not interested in increasing your loan payments, there is no duty to report. The only time it would be mandatory once you’re qualified is if you didn’t file a tax return, at which point it would act as a substitute.

  • Can I qualify if I am unemployed?

Answer: Neither plan has an employment requirement. In fact, your payments count towards each plan’s forgiveness time period (IBR: 25 years, PAYE: 20 years) even if your payments are $0. This happens when your income is at or below 150% of the poverty level for your family size. A payment of 0$, however, may show on your credit report as a deferral, which may have a negative impact on your credit score and may make it harder to qualify for credit. Speaking of deferrals, keep in mind that many of these loan servicers are themselves confused about all the intricacies of these repayment options. Regardless of any potential credit impact, if your loan servicer tries treating a $0 payment as a deferral for purposes of your loan payments, don’t let them. If they do not budge, contact the Dept. of Education. A 0$ payment counts as a payment under either plan if it is the payment for which you qualify.

  • Can I ever purchase a home if I am on IBR or PAYE?

Answer: Assuming you have the financial flexibility to place a solid down payment on a piece of real estate, IBR/PAYE actually helps you obtain a mortgage. Many people mistakenly assume that it is the principal amount of the student loan that matters for purposes of obtaining a mortgage, but that is incorrect. What matters is your debt to income ratio: your monthly gross income in relation to your monthly expenses. Because these repayment plans lower your monthly student loan payments to a mere 10/15% of your discretionary monthly income, they lower your monthly expense total, thereby increasing this debt to income ratio in your favor. However, for your own protection, it would probably be best to calculate this ratio using your after-tax take home rather than your gross income. Even though this is not required, your take home monthly income is obviously much more indicative of your ability to make any mortgage payments after subtracting your monthly expenses than a gross income figure that does not account for taxes.

  • If I make more money and no longer have a partial financial hardship, do I come off IBR or PAYE?

Answer: No, you stay on either plan no matter what your income becomes unless you leave voluntarily. This means that even if your income rises to the point you are able to make the standard 10-year repayment plan monthly payments, they will still count towards your plan’s loan forgiveness time period. This is why it does not hurt to get on IBR or PAYE just in case, but keep in mind that if your income qualifies for the standard 10-year repayment plan there will no longer be a partial financial hardship, which means the interest will capitalize (be added to your principal).

  • When applying, should I use last year’s tax returns even if my current income is greater?

Answer: Use whichever income amount is more advantageous to your particular circumstances. You can either use last year’s tax returns and pay less for the first year by waiting until the annual documentation is required for the following year, or if you want to pay more immediately you can submit last year’s tax returns with the alternative documentation of income addendum containing this year’s income.

  • Does either plan affect my ability to borrow money (ex. mortgage)?

Answer: It should not, unless the lender decides to tighten credit conditions by factoring in your overall debt amount. Otherwise, what matters is the cushion between your monthly income and liabilities. IBR or PAYE can actually help you in this regard because the lower monthly student loan payments lower your overall monthly liability amount, altering the income to liability ratio in your favor.

  • Is my spouse’s salary included for calculating adjusted gross income?

Answer: Your spouse’s income is included only if you file jointly. In this case, both his or her debt amount and income will be counted and if both of you are under either plan your specific monthly payment will be proportional to your debt amount (and vice versa). If you file separately, your spouse’s income will not be counted for calculating your monthly payments. Filing separately usually increases your taxes but it may be worth it if it will save you more on your monthly payments than you lose with the tax hit.

  • How can I predict my monthly payments on IBR or PAYE before I apply?

Answer: Finaid has the necessary calculators for both IBR and PAYE.

There are two things you need to remember when setting up either of these repayment plans. First, your loan servicer’s interests are adverse to your interests because the loan servicer wants to be paid as much money as possible as quickly as possible. Setting up IBR or PAYE, which limits monthly loan payment amounts, is not in their interests. Therefore, they have every incentive to put obstacles in your path either at sign up or later on to try and get you to pay more money each month. For example, they may give you grief if your unemployment status produces a monthly payment of $0. Do not fall for this and call them out on it if it happens. Some loan servicers are nicer than others, but the point is they are not your friends. Also, it would be wise to avoid setting up monthly auto-pay online. You do not want to suffer an overdraw and the subsequent charges, but more importantly you do not want to forget your annual document re-certification and find out your monthly payments are monstrous due to the shift back to the 10-year standard repayment plan (especially if the newly high payment unexpectedly overdraws).

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