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  • Budget Proposal Caps Loan Forgiveness, Could Impact Public Service Lawyers

    A federal budget proposal includes a provision to cap public service loan forgiveness, impacting lawyers who work in public service jobs and carry significant law school debt. In this article, lawyer and student loan expert Heather Jarvis provides some insight.

    Joe Forward

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    Law school tuitionApril 2, 2014 – President Barack Obama’s proposed budget for fiscal year 2015 could impact the amount of loan forgiveness available to Wisconsin lawyers and other employees who work in public service jobs for 10 years or more.

    Currently, lawyers who have federal student loans can obtain complete Public Service Loan Forgiveness (PSLF) after making 120 monthly student loan payments while working for qualified “public service organizations,” which include federal, state, or local government entities and tax-exempt, 501(c)(3) nonprofit organizations.

    Lawyers working for private, nonprofit organizations that provide public services, including public interest law services, may also qualify for loan forgiveness.

    The purpose of the law,1 enacted in 2007 under former President George W. Bush, is to encourage long-term public service by forgiving student loan debts. The law also creates repayment options tied to income, lowering payments for lower earners.

    Prosecutors, public defenders, public interest, and other government and nonprofit sector lawyers can benefit from the law, which currently places no cap on the amount that may be forgiven. The law allows forgiveness for both principal and outstanding interest after 120 qualifying monthly payments, and the forgiven amount is not taxable under the Internal Revenue Code. (However, draft legislation called the "Tax Reform Act of 2014" proposes to eliminate this tax-free discharge of debt.)

    President Obama’s 2015 budget proposal caps the amount of debt that can be forgiven at $57,500. This amount represents the maximum amount of federal student loans that independent, undergraduate students may borrow for a four-year degree.

    However, the cap presents potential challenges for graduate and professional students, including law students, who generally borrow much more to pay the increasing costs of advanced degrees but take public service jobs with typically lower salaries.

    Will this Impact Existing Borrowers?

    Income-driven repayment plans help lower income borrowers who cannot afford to pay the full amount of interest that accrues on higher debt amounts each month.

    Under PSLF, unpaid interest and principal is forgiven after 10 years. But Obama’s proposed cap could leave many public service lawyers with significant balances.

    Even with a $57,500 reduction after 10 years, the principal and outstanding interest balance could be substantially greater than the original loan, even though the borrower was meeting their monthly payment obligation.

    As a result, PSLF borrowers would continue to repay their loans and incur interest until the balance is forgiven after 20 or 25 years (current law allows federal student loans to be forgiven after 20 or 25 years of repayment, regardless of whether the borrower is in public service or not). At that point, any forgiven amount is currently taxable.

    While any cap is concerning for those on a path towards PSLF, lawyer and student loan expert Heather Jarvis says she’s confident any change to current law won’t impact existing borrowers who obtained their student loans before any change is enacted.

    “I would be absolutely shocked, stunned, and amazed if Congress pulled the rug out from under those people who were already on this path,” Jarvis said in an interview. “I feel quite confident that won’t happen, and it’s certainly not what anyone is proposing.”

    “I guess if Congress really wanted to, it could do it,” Jarvis said. “But there are plenty of arguments in law and equity for why they should not. History also tells us that whenever there’s a reduction in these types of relief programs, the change is prospective.”

    Jarvis said President Obama’s proposal signals “that the administration is ready and willing to negotiate and potentially trade off benefits that are vital to those working in the public interest and public sector.” But any proposed change must go through the federal legislative process, she says, and that process could take several years.

    Federal Loans: How They Work

    Law students can borrow up to $61,500 ($20,500 per year) in federal “DIRECT” student loans at an interest rate of 6.8 percent. Law students begin accruing interest on the entire amount the moment it is disbursed, while the student is still in law school.

    Prior to July 2012, about 40 percent of the federal student loan amount each year was “subsidized,” meaning interest accrual began six months after graduation. However, the Budget Control Act of 2011 ended subsidized loans for graduate students.2

    Because $61,500 is generally not enough to cover tuition and law school expenses for three years,3 graduate “PLUS” loans are available at an interest rate of 7.9 and 8.5 percent. Qualifying students can finance the rest of law school with PLUS loans. Students who don’t qualify must seek alternative private loans to pay their way.

    Joe Forwardorg jforward wisbar Joe Forward, Saint Louis Univ. School of Law 2010, is a legal writer for the State Bar of Wisconsin, Madison. He can be reached by org jforward wisbar email or by phone at (608) 250-6161.

    A limited number of merit-based scholarships are available, but many law school students finance their educations through federal and private student loans, says Jarvis, a leading national expert on student loans who maintains a student loan website.

    Without scholarship money, independent financial means, or work during law school, a law school graduate can easily enter the legal profession owing well over $100,000. Indeed, law school debt is recognized as a major challenge facing new lawyers.

    Jarvis says law students must be cognizant of their expenses, borrow as little as possible during school, and work to pay in-school interest if they can. But the cost of law school education can still create a high debt situation for the stingiest of students.

    Principal loan amounts could be manageable without relatively high interest rates. But as noted, the interest rate on graduate-level federal loans is between 6.8 and 8.5 percent, which is tantamount to $100,000-plus debt on a low-interest rate credit card.

    Repayment Plans

    Law school graduates pursuing public service jobs must “consolidate” their federal student DIRECT and PLUS loans to qualify for PSLF. The law school graduate will pay interest on one or more consolidation loans. The interest rate on the consolidation loan is a weighted average of the DIRECT and PLUS loans, generally about 7.5 percent.

    Thus, law students who borrow $40,000 per year to pay yearly tuition will incur $9,000 of interest per year ($750 per month) on the $120,000 principal (see Table 1). Capitalization rules under certain plans could increase that principal amount.

    If a law student borrows $50,000 per year to cover tuition and other costs, including living expenses, the borrower will incur about $11,250 of interest per year ($938 per month) on the $150,000 principal (see Table 2), assuming no capitalization occurs.

    Before the recession, law school applicants were generally willing to borrow these amounts – as evidenced by a record number of individuals applying to law school through 2010 – hoping post-graduate employment would help them repay the debt.

    Post-recession, many lawyers are relying on student loan repayment plans that allow borrowers facing “partial financial hardships” to repay student loans based on a percentage of discretionary income, which significantly lowers the monthly student loan payment.

    Income-driven repayment options are available to all borrowers, not just borrowers working in public service jobs. These plans allow lower income borrowers to avoid default. Monthly repayment amounts increase as the borrower’s salary increases.

    Currently, individuals with consolidation loans can select “Pay As You Earn” (PAYE) or “Income Based” (IBR) repayment plans that calculate monthly repayment amounts at 10 percent and 15 percent of an individual’s discretionary income, respectively.4 

    Only students who received loan disbursements after Oct. 1, 2011 are eligible for the PAYE plan. Those who don't qualify for PAYE or IBR may qualify for the Income Contingent Repayment (ICR) plan with payments at 20 percent of discretionary income.

    If a borrower has a high debt burden and a modest to low income, the monthly repayment amount may not be enough to cover the monthly interest payment. As a result, the loan balance begins to balloon as the unpaid interest accrues monthly.

    Before income-driven repayment plans, Jarvis says, student loan borrowers had to pay no less than the monthly interest amount. New repayment plans recognize the higher costs of education and an increasing inability to repay monthly interest, at least in the first several years after graduation.

    Loan Forgiveness

    Those repaying loans under PAYE, IBR or ICR plans are currently eligible to receive the 10-year loan forgiveness for public service. But President Obama’s budget proposal severely restricts the PSLF program by capping that forgiveness amount at $57,500.

    Thus, public service lawyers could face significant student loan balances even if a $57,500 (amounting to $5,750 per year) forgiveness amount were applied. After 20 or 25 years, the remaining balance would be forgiven, but the forgiven amount is taxable.

    “It’s not that the borrower has been irresponsible. They’ve paid 10 or 15 percent of their discretionary income for 10 years as required and still could not get ahead,” Jarvis said. “The law is intended to provide relief for those in public service jobs with lower wages, and that includes lawyers and others who had to pay more for their advanced degrees.”

    Jarvis says enactment of any cap could derail efforts to attract public service workers in the future, including lawyers. And because individuals currently working in public service jobs perhaps relied on PSLF when they made important career and life decisions, any future legislative proposal for retroactive application would face resistance, she says.

    To minimize the risk of adverse legislative changes, including forgiveness caps or tax implications, Jarvis advises borrowers to pay as much as possible each month and understand the long-term impact of income-driven repayment plans in relation to any potential change.

    Table 1

    Estimated In-School Debt Accrual for Law Student Borrowing $40,000 per Year at Average 7.5% Annual Interest Rate

    Year Loan Interest Outstanding Interest Loan Balance
    School, Year 1 $40,000 $3,000 x 3 = $9,000 $3,000 $43,000
    School, Year 2 $40,000 $3,000 x 2 = $6,000 $9,000 $89,000
    School, Year 3 $40,000 $3,000 x 1 = $3,000 $18,000 $138,000
    Bal. at Grad. $120,000 $18,000 $18,000 $138,000

    Estimated Out-of-School Debt Accrual with $120,000 Principal Loan Amount at 7.5% Interest, Starting Salary $50,000 with Annual 3% Salary Increase and Corresponding Increase in IBR Repayment Amount

    Year Principal Yearly Interest Salary IBR Payment Per Month/Year Outstanding Interest Loan Balance
    Balance $120,000 -- -- -- $18,000 $138,000
    Year 1 $120,000 $9,000 $50,000 $416* / $4,992 $22,008 $142,008
    Year 2 $120,000 $9,000 $51,500 $425 / $5,100 $25,908 $145,908
    Year 3 $120,000 $9,000 $53,045 $440 / $5,280 $29,628 $149,628
    Year 4 $120,000 $9,000 $54,363 $460 / $5,520 $33,108 $153,108
    Year 5 $120,000 $9,000 $56,275 $490 / $5,880 $36,228 $156,228
    Year 6 $120,000 $9,000 $57,963 $525 / $6,300 $38,928 $158,928
    Year 7 $120,000 $9,000 $61,403 $560 / $6,720 $41,208 $161,208
    Year 8 $120,000 $9,000 $63,338 $590 / $7,080 $43,128 $163,128
    Year 9 $120,000 $9,000 $65,238 $620 / $7,440 $44,688 $164,688
    Year 10 $120,000 $9,000 $67,195 $650 / $7,800 $45,888 $165,888**

    * This is the monthly IBR calculation, based on a 2012 Department of Education chart, for a single person with starting salary of $50,000. That monthly repayment amount is lower for persons with a larger family size. Yearly increases are estimates, also based on the chart.

    **Proposed amount forgiven = $57,500 (currently not taxable), leaving a balance of $108,388.  Any balance remaining after 20 or 25 years in repayment, depending on the year the loan was disbursed, is forgiven. But the discharged amount is taxable.

    Table 2

    Estimated In-School Debt Accrual for Law Student Borrowing $50,000 per Year at Average 7.5% Annual Interest Rate

    Semester Loan Interest Outstanding Interest Loan Balance
    School, Year 1 $50,000 $3,750 x 3 = $11,250 $3,750 $53,750
    School, Year 2 $50,000 $3,750 x 2 = $7,500 $11,250 $111,250
    School, Year 3 $50,000 $3,750 x 1 = $3,750 $22,500 $172,500
    Bal. at Grad. $150,000 $22,500 $22,500 $172,500

    Estimated Out-of-School Debt Accrual with $150,000 Principal Loan Amount at 7.5% Interest, Starting Salary $50,000 with Annual 3% Salary Increase and Corresponding Increase in IBR Repayment Amount

    Year Principal Yearly Interest Salary IBR Payment Per Month/Year Outstanding Interest Loan Balance
    Balance $150,000 -- -- -- $22,500 $172,500
    Year 1 $150,000 $11,250 $50,000 $416* / $4,992 $28,758 $178,758
    Year 2 $150,000 $11,250 $51,500 $425 / $5,100 $34,908 $184,908
    Year 3 $150,000 $11,250 $53,045 $440 / $5,280 $40,878 $190,878
    Year 4 $150,000 $11,250 $54,363 $460 / $5,520 $46,608 $196,608
    Year 5 $150,000 $11,250 $56,275 $490 / $5,880 $51,978 $201,978
    Year 6 $150,000 $11,250 $57,963 $525 / $6,300 $56,928 $206,928
    Year 7 $150,000 $11,250 $61,403 $560 / $6,720 $61,458 $211,458
    Year 8 $150,000 $11,250 $63,338 $590 / $7,080 $65,628 $215,628
    Year 9 $150,000 $11,250 $65,238 $620 / $7,440 $69,438 $219,438
    Year 10 $150,000 $11,250 $67,195 $650 / $7,800 $72,888 $222,888**

    *This is the monthly IBR calculation, based on a 2012 Department of Education chart, for a single person with starting salary of $50,000. That monthly repayment amount is lower for persons with a larger family size. Yearly increases are estimated, also based on the chart.

    **Proposed amount forgiven = $57,500 (currently not taxable), leaving a balance of $165,388.  Any balance remaining after 20 or 25 years in repayment, depending on year the loan was disbursed, is forgiven. But the discharged amount is taxable.

    Endnotes

    1 College Cost Reduction and Access Act of 2007, Pub. L. No. 110-84 (2007).

    2 Katy Hopkins, Grad students lose federal loan subsidy, U.S. News and World Report (March 13, 2012).

    3 For example, Marquette Law School tuition is currently $41,040 per year. Resident tuition at Wisconsin Law School is $21,364; nonresident tuition is $40,062. These tuition rates, on par with other schools, do not include living expenses, books, and other costs associated with attending law school.

    4 For example, the Income Based Repayment option calculates monthly payments at 15 percent of the difference between AGI and 150% of the U.S. Department of Health and Human Services Poverty Guidelines for family size and state. If married, AGI is based on both incomes. Married persons who don’t want both incomes included must file their taxes as "married filing seperately." Filing separately will cause the borrower to lose certain tax deductions and credits, including the deduction for student loan interest paid. Another provision in Obama’s budget proposal would require both spousal incomes to be included, regardless of whether the couple files their taxes separately. This would increase the borrower’s monthly loan payment if the borrower's spouse has income.




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