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For student loan borrowers, it’s been a year full of news.
From multiple forbearance extensions to fraud settlements and the larges student loan forgiveness plan in U.S. history, many borrowers received a boost of momentum in 2022.
While there are still many questions about the evolving details of some of these announcements (including refunds), one issue that is coming into focus are the effects of changes to income-driven repayment plans.
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What Is an Income-Driven Repayment Plan?
Income-driven repayment plans (IDRs) are just that — payment plans for federal student loans that are intended to be affordable based on a borrower’s income and family size.
Under the four different IDR plans, the monthly payment amount is a percentage of your discretionary income, with the percentage varying under each plan.
Generally speaking, the percentage under two of income-based repayment plans runs around 10%, while the other two plans can range between 10% and 20%.
What Changes Are Coming to Income-Driven Repayment Plans?
The White House announced in August that the U.S. Department of Education was proposing new rules intended to make student loans more manageable for current and future borrowers.
Some of the proposed features include:
- Cutting monthly payments in half. The Department of Education proposed a new plan that “protects more low-income borrowers from making any payments and caps monthly payments for undergraduate loans at 5% of a borrower’s discretionary income — half of the rate that borrowers must pay now under most existing plans.” Because of this change, the DOE said the average annual student loan payment would be lowered by more than $1,000.
- Raise the “discretionary” income level. At certain income levels, borrowers are completely protected from repayment. The proposed changes would make borrowers earning under 225% of the federal poverty level — the annual equivalent of $15 minimum wage — free from having to make a monthly payment.
- Forgive balances earlier. Student loan balances would be forgiven after 10 years of payment, instead of 20. All borrowers with original loan balances of less than $12,000 would be eligible. The DOE estimated that this change would allow all community college borrowers to be debt-free within 10 years.
- Cover borrowers’ unpaid monthly interest. In current IDR plans, the monthly interest continues to accrue and grow the total balance.
These changes would protect the balance from monthly interest as long as the borrower continues making monthly payments.
The White House shared some examples to explain how these changes could affect specific individuals and families.
- A single construction worker making $38,000 annually would pay $31 a month on student debt, down from $147 for an annual savings of $1,392.
- A single public school teacher making $44,000 a year would pay $56 a month instead of $197, saving $1,692 in payments each year.
- A married nurse who has two children making $77,000 a year would pay $61 a month vs. $295 and save $2,808 on payments annually.
In all of these situations, the borrower’s balance would not grow if they continued to make monthly payments. After making the required amount of payments, their debt would be forgiven.
What Should I Do Next if I Have an Income-Driven Repayment Plan?
The White House is working quickly to make all of these student loan improvements, though a date hasn’t been released to approve or implement the proposed changes. You can sign up for DOE email updates to stay connected.
In the meantime, focus on making the most with those extra savings. For example, if you had been paying $147 a month and now you pay $30, you now have an extra $116 per month to make smart money moves with, such as:
Build an Emergency Fund
With $116 per month, you can build a $1,000 emergency fund in less than a year. Emergencies are going to happen — it’s just a matter of when. That fund, preferably stored in a high-yield savings account, can keep you from dipping into a high-interest credit card when you have an emergency car repair.
Contribute to an HSA
A health savings account (HSA) is an excellent way to pay for your medical expenses using your pre-tax income. While an HSA is typically used to pay for medical expenses, like co-pays, not covered in a typical high-deductible health plan, it can also be a long-term investment vehicle for retirement.
Fund Your Retirement
When it comes to retirement, compound interest is your friend. Every little dollar matters. That’s why $116 per month could begin building the foundation of your retirement plan – or give it a nice boost if you’re already underway.
Save for a Down Payment on a House
Again, every little bit helps when you’re trying to reach your financial goals. If buying a house is a goal for you, use that extra income to put toward your down payment. While not required, a 20% down payment would help you avoid private mortgage insurance (PMI).
Pay Off Other Debt
You could use the debt snowball method to put that extra $116 toward other debt. If you have high interest credit card debt, start there. Otherwise, consider private student loans or even your mortgage. Making the equivalent of one extra mortgage payment a year can save you tens of thousands in interest.
Fund Your Kids’ College
If you have kids, or plan on having them in the future, it’s not a bad idea to start thinking about college funds. Whether it’s a 529 plan or just a general investing plan, you have plenty of options. And the best part of saving for your kids’ college? They might not have to worry about as many student loans as you did.
Robert Bruce is a senior writer for The Penny Hoarder.
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