By: Edmund Lau, CFA
If you are new to Public Service Loan Forgiveness (“PSLF”) and need a basic primer, please be sure to read our first article. This is the second piece of a 3-part series that serves as a guide if you are considering PSLF. In this article, we will help you determine which Income Driven Repayment (“IDR”) program to select and walk through a realistic example of how much you could expect to pay and save under PSLF.
Selecting the Right IDR Program
Assuming that you are now familiar with the basics of Public Service Loan Forgiveness and are curious about how to qualify for an IDR program, the first step is to take inventory of your student loans to determine which IDR program your loans are eligible for. The types of loans that you have, the timing of when those loans were taken out, and whether you would save under an IDR program relative to your fixed traditional repayment plan, ultimately determines which IDR program you will be eligible for. Generally, all students will have one or more of the following types of federal loans:
- Direct Loans are loans made by the U.S. Dept. of Education.
- Federal Perkins Loans are loans made by schools.
- Federal Family Education Loans (FFEL) are Federal loans made by banks or other financial institutions, issued prior to July 1, 2010.
If you have loans that are ineligible for a specific IDR program, it may still be possible to qualify if you consolidate those loans into a Direct Consolidation Loan. Please refer to the table below for details. Also remember that private loans are not eligible for IDR or PSLF.
For most graduating students wishing to use Public Service Loan Forgiveness, it is usually most advantageous to enter into the PAYE or IBR for New Borrower plans as these two have the lowest income-based payment rates. However, the two programs do have eligibility requirements regarding the type of loans that qualify and when they were taken out; accordingly, not all borrowers will qualify. The type of IDR plan that will be most ideal for you and which can save you the most money will depend on the following factors: (i) the type of loans you have; (ii) when those loans were taken out; (iii) your marital/tax filing status; (iv) your state of residence; (v) your household family size; (vi) your AGI; and (vii) the amount of debt you have relative to your AGI.
To get an idea of how much your starting and ending payments will look like under an IDR plan, use the Federal Government’s Repayment Estimator or contact your loan servicer to help you identify which IDR plans you qualify for and which ones result in the lowest initial and aggregate payments. If you do use the Federal Repayment Estimator, keep in mind that the calculator is designed for traditional payments under each IDR plan and does not factor in the shorter repayment period and savings of PSLF.
Furthermore, the Federal calculator does not include ineligible loans under each IDR plan (e.g., if you know you have an ineligible loan but can consolidate it as a Direct Consolidation Loan, be sure to reflect that as a Direct Consolidation Loan in the calculator so that the results capture all of your loans). In summary, you should try to participate in an IDR plan with the least initial monthly payment, as that will usually generate the most savings for you under Public Service Loan Forgiveness.
How much Could I Potentially Save?
Let’s consider an example. Assume that you recently completed graduate school with $75,000 in Direct Grad Plus loans at 6.8% and still have $50,000 of Direct Unsubsidized loans at 5.8% from undergrad. You just landed a job with a non-profit and estimate that your adjusted gross income will be $75,000 (your AGI can be found on line 37 of your 1040 tax return).
In this example, I assume that you are single, have a household size of 1, and are a resident in the Continental United States. To perform these calculations, I also rely on the Federal Government’s assumptions, including income and inflation growth.
Assuming that your loans qualify for Pay as You Earn (“PAYE”), you would make total payments of approximately $74,500 over the next 10 years (assuming you remain employed at a non-profit and make 120 payments). Under these assumptions, you could save up to $95,000 relative to the $169,500 that it would have cost to pay back the student loans under the standard 10-year loan repayment schedule.
What if your AGI is significantly more or less than $75,000? The table below provides a snapshot of the potential savings with different combinations of AGI and student loan debt under a PAYE repayment plan and forgiveness under PSLF.
As a rule of thumb, you can see that Public Service Loan Forgiveness is beneficial if your aggregate federal student loan balance is generally greater than or equal to your AGI. Obviously, the more student loan debt that you have or the lower your AGI is, all else equal, the more you can expect to save by participating in PSLF. In the last and final article of this series, we will explore what you can do while you are in PSLF to maximize your savings.
I’m in, What do I do now?
If you believe Public Service Loan Forgiveness is right for you, you can get started by applying for an IDR plan through the Federal Government’s Student Loan Servicing website. Be ready to send them the necessary paperwork, including your last year’s tax return. If your income has recently changed and looks drastically different than your tax return, they may also ask for other forms of income verification (W-2 or pay stub). If you just recently graduated and are still in your grace period, be sure to start looking into this as soon as possible. The sooner you are prepared, the sooner you can start the clock towards the path of loan forgiveness under PSLF once you start working.
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