Episode Transcript
[00:00:00] As details about changes to income driven repayment plans come out in the news. It's easy to understand if a lot of these developments sound like you're learning something in a different language. In this episode, we talk about some of the key terms associated with income driven repayment plans. So that as you get closer to making important decisions for your loans, you have a better idea of how each of these items affect your payment. Let's get started.
Hello, this is Brenton Harrison of escape, student loan debt, and your host for the escape student loan debt podcast. In the last episode, we talked about some of the key elements that are associated with income driven, repayment plans, things like nondiscretionary income, the calculation of discretionary income itself.
And we teased that there are some major decisions on the horizon that many federal student loan borrowers will have to make before July of this year.
Those decisions are centered on the fact that the Biden administration has announced some groundbreaking changes to one of its income driven repayment plans. And in some [00:01:00] cases, borrowers who choose to take advantage of this newly changed income driven repayment plan will forever for go the opportunity to go back to one of the original popular plans that's in existence today.
And as we build towards giving you more data about that decision-making process, I thought it would be important to give you a part two, as we talk about some of the key terms that are associated with income driven repayment plans in the first place. Now I will tell you, I can only give you a summary in an episode, this brief. This is not for me to try to push you to the course unnecessarily. The fact of the matter is these are all detailed things when we get into these key terms. So I'm going to give you a brief explanation of it, but trust me, each of them requires its own video, its own segment in a course.
And if you want to know the details, as it pertains to each plan and each term, you really need to consider purchasing the escape student loan debt course. If you want to know more information about when it's going to be released, you can join our email [00:02:00] list at escapestudentloandebt.com. But this episode is more about giving you a brief introduction so that when we referenced these terms in future episodes, you are not in the dark.
Let's start with the difference between eligible loans and eligible borrowers. When you have any income driven repayment plans, there are some plans that are only available for people with eligible loans. In many cases, that means direct loans only, but there are certain repayment plans that allow you to have direct loans.
And they also allow you to have Stafford loans. None of the income driven repayment plans allow you to use Perkins loans, which we talked about in the first and second episodes of this podcast. But when we say eligible loans, that's what we mean.
Conversely eligible borrowers are those who have borrowed their loans before or after a certain date and time. For example, there are certain loan repayment programs under the IDR umbrella who do not allow borrowers to participate unless they're considered new borrowers after [00:03:00] October, 2014.
As an example, maybe you took out a loan for your undergraduate studies in 2005. After you finished school, you worked for a number of years and you repay that loan off in full. And maybe in August of 2015, you decided to go back and get your MBA. If you took out a loan to do that, you had repaid your original loans in full before the 2014 date. So you are still considered a new borrower in this scenario who may be eligible to participate in a payment plan whose cutoff is for new borrowers after October, 2014.
Next we have two terms that we covered in the previous episode. We have your percentage of discretionary income. And then we also have the calculation of nondiscretionary income. As a reminder, regardless of the payment plan you choose under this umbrella, the calculation for discretionary income is your adjusted gross income minus your nondiscretionary income.
We covered that nondiscretionary income is a term [00:04:00] that stands for the multiplication of a certain percentage of the federal poverty level. Different payment plans require you to multiply federal poverty level by different percentage.
But even within the same plan, there is a way that they calculate nondiscretionary income now that will be radically different post July of 2023. And you need to know those details.
These are some of the key terms building off of that previous episode that I would say are hallmark, concrete, foundational elements of income driven repayment plan. And after the break, we'll tell you some more specific terminology that's getting deeper in the weeds, but will still be relevant as you build toward making the decision for the right payment plan for you.
Before the break, we talked about some of the newsworthy headline grabbing terms that you will hear thrown around when it comes to income driven repayment plans. Now it's time to talk about some of the more specific details of these plans and glossary type terms that you won't see in an article, [00:05:00] because it is getting too deep into the weeds, but they are important components that factor into choosing a plan.
First we have the married filing separately allowance.
Going back to the discretionary income formula, we take your adjusted gross income, and we subtract a certain percentage of the federal poverty level based on the number of people in your household. If I have two people in my household, the federal poverty level is going to be lower than if I have a household of three.
The higher my federal poverty level, the lower my discretionary income and the lower my student loan payment. Another part of that formula that can decrease your student loan payment is finding a way to lower your adjusted gross income. And there are two ways that married couples have benefited in the past from this scenario in certain cases. One of those is by filing their taxes separately from their spouse.
A reason that they would do this is because when you file your taxes separately from your spouse, you are essentially wiping their income off of the calculation. So this is the first part of [00:06:00] why this strategy was so beneficial.
It's lowering the adjusted gross income, thus lowering your discretionary income. But there was also a second way that you could benefit from this scenario. Because even though I had erased income from the calculation. I still got to include a person in my household. I'm able to subtract a certain percentage of the federal poverty level for a family from my adjusted gross income only.
Not all IDR plans allow this in many cases, it's not the right thing to do, but this is an option that certain people have used and the way that they use it or choose not to use, it will also change as a result of the recently announced updates.
Next interest subsidies. When we initially talked about income driven repayment plans, we mentioned that an element of these plans is that by paying a percentage of your discretionary income, there is not necessarily a guarantee that payment would cover the interest growing on your loans. As an example, let's say that you owe [00:07:00] $100,000 in student loans at 5% interest. That means that $5,000 of interest is growing on your loans. If you're not paying over $400 a month towards them, you're not even paying enough for your loans to stand still. You would instead be watching that balance increase year over year.
To counteract this damage, certain income driven repayment plans offer something called an interest subsidy.
And what it means is the government will cover a percentage, in some cases, all of that interest for you. So in our scenario, if we have a hundred thousand dollars and it's growing at a rate of 5% interest in that first year, $5,000 would grow in interest on that loan. If we are only paying $2,500 towards our loan, then there's still an extra $2,500 of interest that's uncovered by that payment. An interest subsidy would see the government pay some or all of that remaining $2,500 in interest.
It's designed to blunt the impact on your loan [00:08:00] imbalance that could result from you not paying enough to cover that interest. And certain IDR plans have subsidies that are much more forgiving and robust than others.
Next. And this is a perfect companion to a conversation about interest subsidies, is what's called a capitalization cap. Going back to our example of a hundred thousand dollars of student loans are growing at a rate of 5% interest, you need to understand that the way federal student loan payments work, it's not as simple as $5,000 increasing your loan balance to $105,000. It seems that simple and technically in that scenario at the end of the year, you would owe $105,000 in total, but where they place that $5,000 in interest is crucially important.
With most loans, if $5,000 of interest accrues on a hundred thousand dollar debt, it grows on top of the a hundred thousand dollars. Meaning that the next year, when they calculate 5% interest growing on that loan, it would be growing [00:09:00] on $105,000. With federal student loans, if $5,000 of interest accrues on a hundred thousand dollars debt, they put that $5,000 in a separate category. And when you get your loan statements, you would have one category that says loan principal, and you would have another that says loan interest. This is very beneficial because in the next year, when they're calculating 5% interest, they calculate it on the hundred thousand dollars of principal even though you technically owe $105,000 in total.
This wrinkle also helps blunt the impact of the amount of interest growing on your loans. But there are certain steps you could take that could lead to that balance on the interest category, being capitalized onto your loan principal, which essentially means they're taking it out of that second category and they're adding it onto that loan balance. This means that instead of you seeing 5% accruing on the initial hundred thousand dollars, It would be like a more [00:10:00] conventional loan and see 5% interest accrued on the whole balance that you actually owe.
We don't have enough time in this episode to talk about all of the ways that you could see interest capitalized on your loans. But what you do need to know is that certain income driven repayment plans have no limit on the amount of interest that could capitalize on your loan principal. Whereas others limit you to a certain percentage of your original loan principle when it comes to how much interest can capitalize.
And then lastly, the standard repayment cap, we also talked about this in the previous episode. There are certain income driven repayment plans who calculate your payment every year, and they compare that payment to what you would owe under a 10 year standard repayment plan. In other words, paying off your loans in full in a 10 year period.
If they find that you would actually save money by instead of using an IDR, choosing to do the standard plan, they will kick you out of that IDR plan. And automatically place you into [00:11:00] the 10-year standard plan. Conversely, there are other IDR plans who have no such cap. And even if you would pay your loans off in two years, as compared to 10, by being on IDR, they will not alert you to that fact. They will not calculate it.
It would be up to you to figure out if it's still the right plan or if there's a better option available.
Hopefully by now you understand what I mean? When I say some of these things you need to buy the course. We can only talk about them in so much detail in a 10 to 15 minute episode. But even beyond that, I'm hoping that you're benefiting from us stair-stepping you up in terms of your knowledge base. Because in the next episode, we will finally start using some of the specific names for these IDR plans and go through each of these glossary terms so you can know their impact on your available options.
