One of the reasons that all college students are advised to borrow Federal loans is their excellent repayment plans. The best of these repayment plans is the Pay As You Earn plan. Borrowers on PAYE are expected to make monthly payments equal to 10% of their discretionary income. Those who do not pay off their loans after making 20 years worth of payments will have the remainder of their loans forgiven.
This plan is unquestionably the best student loan repayment plan available. Not only is it the best federal plan, but it is far superior to any private loan option. However, PAYE is not perfect and it could be tweaked to better serve the needs of borrowers.
How Discretionary Income Calculations Currently Work
Presently, discretionary income is defined as the money borrowers make in excess of 150% of the poverty level. So if the poverty level is at $20,000; all of the money you make over $30,000 is considered discretionary. PAYE participants are expected to pay 10% of their discretionary income towards student loans. In our example, a PAYE borrower would have to pay 10% of what they make above $30,000. If this borrower made $42,000 a year, they would have to pay $100 per month towards their student loans. (Note: this example uses round numbers to make the math easy, it most closely represents the poverty level for a family of three, but the exact figures will vary)
This common sense approach makes a big difference in households with children. Income that might be “discretionary” for a single individual, might barely be enough for a large family trying to get by. Because of this lifestyle difference, payments are calculated based, in part, upon family size. This approach is not only fair, but it helps provide more borrowers a manful chance on staying current on their federal student loans.
The Issue with Discretionary Income
Unfortunately, there are many other circumstances that dramatically alter a borrowers ability to pay. For example, if you are tasked with making huge private loan payments, or repaying medical bills, the amount of money that you can afford to pay towards federal loans might be dramatically less. Accounting for these student loans would put many more borrowers in a position for long term success.
Here are a few things that could be cooked into the discretionary income formula:
Undergraduate student loans are capped at relatively low levels. Many borrowers also take out federal loans to help cover the cost of education. When these borrowers graduate, they owe money to many different lenders. Borrowers on a federal Income Based Repayment plan may have bills that might otherwise seem reasonable, but when factoring in their private loan payments, they could be much more difficult.
Given that private loan payments are the opposite of discretionary, it hardly seems fair to include the money spent on these loans towards “discretionary” income.
Like private loans, medical bills can eat a huge chunk of your income every month. Even with insurance, an unexpected disease or injury can dramatically alter your finances. Spending money to address urgent health needs is by any definition a necessity.
Needs of Parents
Many people find themselves in situations in which they are caring for their parents. Making sure a parent’s basic needs are meet is something that many children feel obligated to do. Some states even mandate that children provide for their parents in certain circumstances.
Like caring for children, a factor currently accounted for, caring for parents should also be accounted for in the discretionary income formula.
How would this work?
In a manner similar to tax deductions, borrowers could adjust their discretionary income based upon certain life situations. Doing so would allow more people to stay current on their federal loans.
Obviously, lowering the payments of some would result in less money being used to pay back loans, but this shortfall could be made up for in a couple of ways. First, more people would stay current on their debt saving money on collection fees. Second, the percentage of discretionary income expected to be paid could be altered. If the 10% was tweaked to a slightly higher number such as 12% or 15%, the shortfall could be made up.
As it stands right now PAYE is a great program that is helping many borrowers. However, a couple minor changes could make it a better program to better serve the needs of more borrowers.