Federal student loan borrowers facing financial hardship severe enough to not be able to make their loan payments have some options available to them. Borrowers who default on payments can either “rehabilitate” their loan or “consolidate” into a new loan. After rehabilitation or consolidation, a borrower can get into an income based or income contingent repayment program. Rehabilitation requires borrowers to make nine monthly payments over a ten-month period. Payments must not be more than what is reasonable and affordable for the borrower. However, collection fees up to 16% of the unpaid principal and interest are capitalized into the loan balance upon completion of the rehabilitation. Rehabilitation is only available one time to borrower who default on their loan payments. After rehabilitation, a borrower can select an income based (IBR) or income contingent (ICR) repayment plan.
Borrowers in default can also consolidate their loans into the direct loan program and then select an income based or income contingent repayment plan. They will also face an additional collection fee of up to 18.5% of the balance. The IBR program allows borrowers with a financial hardship to reduce their monthly loan payments. The payment cannot exceed 15% of the borrower’s household income above 150% of the applicable poverty level, divided by 12. The payment is recalculated every year and if a borrower successfully pays for 25 years the remaining balance is forgiven. However, the debt forgiven is treated as taxable income.
The ICR program also allows borrowers to reduce their monthly payments. The ICR payment cannot exceed 20% of a borrower’s household income above 100% of the poverty level divided by 12. The payments are recalculated annually and again result in high collection fees and forgiveness of debt after 25 years. The ICR is the only program available to Parent PLUS borrowers.
The “Pay As You Earn” (PAYE) plan is available to borrowers with loans disbursed in or after 2012. Eligible borrowers pay 10% of their discretionary income and can have the loan balance forgiven after 20 years. The “Revised Pay As You Earn” (REPAYE) program is available to direct loan borrowers and allows borrowers to pay 10% of their discretionary income. Borrowers with undergraduate loans are eligible for loan forgiveness after 20 years of repayment but borrowers with graduate loans are eligible for forgiveness after 25 years of payments. The “Income Sensitive Repayment Plan” (ISRP) is only available to borrowers with guaranteed federal student loans and the payments can fluctuate based on a borrower’s annual income.
Deferments and forbearances are available to borrowers facing financial hardship or those who are in school full-time. These options do nothing however to create long-term solutions for defaults. Interest continues to accrue on unsubsidized loans and will be capitalized into the principal when the deferment or forbearance period ends if it hasn’t been paid otherwise. Since payments are not being paid during the deferment or forbearance periods, borrowers are not making an progress towards having the loan balances forgiven. The ease of granting a deferment or forbearance makes it a favorite solution offered by loan servicers however. In a 2013 conference call with investors, a Navient official said it was less expensive to put borrowers into a forbearance than to help them get into an income based repayment plan that wold eventually result in a forgiveness of the loan.
Borrowers will need to be assertive at seeking the best loan repayment option rather than only relying on the advice of their servicer.