Vol. 85, No. 4, April 2012
High educational debt is one of the most difficult challenges facing new lawyers. In this tight job market, many new lawyers (and other people with post-high school degrees) may find themselves unable to make their loan payments according to the standard repayment schedule. It is important to address repayment issues early – before the loan goes into default. Default can have dire consequences, and knowing the options for repayment before difficulties arise can help avert those consequences. State Bar of Wisconsin President James Brennan has formed a task force to examine law school debt and other challenges facing new lawyers.1
This article discusses payment options, ways to avoid defaulting on student loans, the consequences of defaulting, and how to get out of default.
Repayment Options for Federal Loans
The standard repayment option calculates payments based on a 10-year repayment term. There is no penalty for paying off the loan early.
For individuals who believe their income will increase over time, the graduated repayment plan may be ideal. This plan requires smaller initial payments, with increases every two years. Payments still must be completed over a 10-year period.
The extended repayment plan, for borrowers with at least $30,000 in student loan debt, stretches out payments over a longer period. This plan allows either graduated or fixed payments and gives the borrower 25 years to repay the loan balance.
The income-contingent repayment (ICR) plan allows the borrower to make payments based on monthly income. This usually results in a much lower payment than the standard amount. The repayment period is 25 years, with the remaining balance being discharged if it is still unpaid.2 The amount forgiven is considered taxable income by the Internal Revenue Service.
For individuals undergoing a partial financial hardship, income-based repayment (IBR) is available. A partial financial hardship exists when the standard 10-year-repayment plan amount is more than 15 percent of the difference between the borrower's adjusted gross income and 150 percent of the federal poverty guidelines.3 IBR is a "pay as you earn" model.4 Calculators are available to determine whether a hardship exists and to determine an individual's IBR payment amount.5 The monthly payment for individuals with high loan balances and income below 150 percent of the federal poverty guidelines will be zero. If the borrower's payment under IBR does not cover the interest on the subsidized portion of the loan, the government will pay the interest during the first three years of payments.6
Regulatory changes that took effect July 1, 2010, provide that the income and loan balance of both a married borrower and his or her spouse will be considered if the couple files income tax returns jointly. Only the individual borrower's income will be considered if married borrowers file income tax returns separately.7 Borrowers should consult with a tax professional to determine the tax consequences of filing together or separately. The government will forgive the remaining balance after 25 years of payments under IBR,8 but forgiveness of the loan under IBR is considered taxable income.
For individuals in certain low-paying public interest occupations, the College Cost Reduction and Access Act of 2007 (CCRAA) also created the Public Service Loan Forgiveness (PSLF) program. This program provides for forgiveness after 10 years of the balance of a borrower's eligible federal loans. To obtain loan forgiveness, the borrower must make 120 payments through the Direct Loan program while engaged in qualifying full-time employment. Occupations that qualify include work for public interest law organizations, I.R.C. § 501(c)(3) nonprofit organizations, and governmental entities.9 To achieve the greatest benefit from the program, borrowers should elect IBR and consolidate their loans using the Direct Loan consolidation program.
When a Borrower Cannot Afford to Pay: Deferment and Forbearance
Even with a multitude of repayment options, many borrowers still have difficulty making student loan payments. A 2005 study of participants in the now-defunct Federal Family Education Loan (FFEL) program found that 56 percent of loan recipients had difficulty repaying their loans, with 15 percent eventually defaulting on those obligations.10
When contacting a student loan servicer about payment difficulties, the first options that may be presented by the servicer are deferment and forbearance. Each option has advantages and disadvantages.
A deferment is a temporary suspension of payments. Deferments are granted while the borrower is still in school or is unemployed or otherwise experiencing an economic hardship.11 The type of loan dictates the benefits or negative consequences of deferment. For instance, the government pays the interest portion of the borrower's subsidized loans during deferment.12 For unsubsidized loans, interest continues to accrue during deferment.13 Note that deferment is not available for loans in default. Default on FFEL or Direct Loans occurs after payments are 270 days behind.14 There also are limits on the length of time a borrower's loans can be deferred. For the Direct Loan program, economic hardship and unemployment deferments may not exceed three years.15
Forbearance is a reduction or suspension of payments available in certain instances of financial hardship. Unlike deferment, interest continues to accrue during the forbearance period. Forbearance can be granted during default, although the lender may refer to it using different terminology. Forbearance requirements vary and can be either mandatory or discretionary. Many servicers will encourage a borrower to use forbearance even if more useful options are available.16 Borrowers should explore all their options before contacting their servicer to ensure that they are requesting the option that is most favorable to their situation.
For borrowers who are unemployed or whose income has been reduced for some other reason, IBR can function like a deferment or forbearance because it is tied to the borrower's income. A borrower whose income decreases should immediately contact his or her servicer and ask to have his or her IBR amount adjusted. The servicer will request documentation of the income change before an adjustment can be made. If the borrower's income drops below 150 percent of the federal poverty guidelines, the borrower's IBR payment will be zero, without having to request deferment or forbearance on the loan.
Defaulting on a federally backed student loan has harsh consequences.17 The government has many tools at its disposal to collect defaulted student loans. They include:
- Garnishment of wages without judgment;
- Seizure of tax refunds (including earned income tax credits);
- Seizure of portions of benefits such as Social Security;
- Denial to the borrower of eligibility for new educational grants;
- Denial of federal housing loans through the Department of Housing and Urban Development's Federal Housing Administration or the Veterans Administration; and
- Dramatic increases in balances as a result of high collection fees and costs.
Getting Out of Default: Consolidation and Rehabilitation
Borrowers who have already defaulted on a student loan can use one of two different methods to get out of default: rehabilitation or consolidation. Note that each of these can only be used one time. To consolidate out of default, borrowers have to either make three "reasonable and affordable" monthly payments or agree to elect either IBR or ICR.18 The advantage of consolidation is that it allows the borrower to get out of default quickly. However, substantial fees and costs may be added to the balance on the loan, making it more expensive in the long run.19
Rehabilitation is another tool borrowers can use to cure a student loan default. To rehabilitate a loan, the borrower must make "reasonable and affordable monthly payments" on time nine times over a 10-month period.20 The reasonable and affordable payment amount must be negotiated between the borrower and the loan holder and should be part of a formal written rehabilitation agreement. It is based on the borrower's total financial circumstances.21 Borrowers should also request an end to collection efforts during the rehabilitation period. Once the loan is rehabilitated and out of default, borrowers may elect to use IBR or any other repayment plan available to other borrowers.
Public Service Loan Forgiveness Updates
In the October 2008 Wisconsin Lawyer, an article entitled "Financial Help Puts Public Interest Careers in Reach" discussed how the CCRAA could help lessen the burden of law school debt that discourages many lawyers from pursuing traditionally low-paying public interest careers. Since that article appeared, the Department of Education has made some changes to the PSLF program, including the following:
- The amounts forgiven under PSLF are no longer taxable as income.22
- The government issued a "dear borrower" letter regarding PSLF requirements. It is available at www.publicservice.ed.gov/publicservice. Anyone who believes that they will qualify for loan forgiveness under that program should carefully read the letter and follow its recommendations.
- The government has produced an employment certification form for individuals who believe they will eventually be eligible for PSLF. The form provides applicants with the ability to certify their qualifying employment and to track their progress toward obtaining loan forgiveness. The form is available at http://tinyurl.com/7278q7p.
Karen M. Bauer, U.W. 2009, is an attorney with the Legal Aid Society of Milwaukee. She represents low-income individuals in foreclosure and consumer law cases. She formerly practiced with Wisconsin Judicare in Wausau. She is a member of the State Bar of Wisconsin Young Lawyers Division Board and the Public Interest Law Section Board and has written and provided continuing legal education instruction on student loan repayment options.
All borrowers should know their repayment options, long before repayment of a student loan becomes problematic. Repayment options such as IBR or graduated repayment can help reduce payments before they become too large to handle. To find out more about these options, the following resources may be helpful:
- www.ibrinfo.org: this site has a good IBR calculator
- www.equaljusticeworks.org: the "go to" site for public interest lawyers who believe they will eventually qualify for loan forgiveness
- www.studentloanborrowerassistance.org: a project of the National Consumer Law Center, this site has "insider" information about many of the repayment methods mentioned in this article.
- www.studentaid.ed.gov: created by the Department of Education, this website has good general information on student loans and repayment options.
1 See James M. Brennan, Assisting New Lawyers, 85 Wis. Law. 3 (Feb. 2012).
2 See http://www.direct.ed.gov/RepayCalc/dlindex2.html (last updated March 3, 2011).
3 34 C.F.R. § 685.221(a)(4).
4 See http://studentaid.ed.gov/PORTALSWebApp/students/english/IBRPlan.jsp (last updated Dec. 7, 2011).
5 See IBR Info, IBR Calculator, http://www.ibrinfo.org/calculator.php.
6 34 C.F.R. §§ 682.215(b)(4), 685.221(b)(3).
7 34 C.F.R. § 685.221(a)(4)(i).
8 34 C.F.R. § 685.221(f)(1).
9 34 C.F.R. § 685.219(b). Consult the regulations carefully to find out if a specific occupation qualifies.
10 Alisa F. Cunningham and Gregory S. Kienzl, Delinquency: The Untold Story of Student Loan Borrowing 5 (Report of Institute for Higher Education Policy) (Mar. 2011), available at http://www.ihep.org/assets/files/publications/a-f/Delinquency-The_Untold_Story_FINAL_March_2011.pdf.
11 A summary of loan deferment conditions is available at http://studentaid.ed.gov/students/attachments/siteresources/DefermentConditionsChart.pdf.
12 34 C.F.R. § 682.210(a)(3)(i)(A).
13 34 C.F.R. § 682.210(a)(3)(i)(B).
14 34 C.F.R. §§ 682.200, 685.102(b).
15 34 C.F.R. § 685.204(c).
16 See generally National Consumer Law Center, Student Loan Law 58 (4th ed. 2010).
17 See U.S. Department of Education Ombudsman's Office, Defaulted Loans, http://www.ombudsman.ed.gov/loandefault.html (last updated June 18, 2009).
18 34 C.F.R. § 685.220(d)(1)(ii)(C), (D).
19 See generally National Consumer Law Center, Should I Consolidate or Rehabilitate My Student Loan? available at http://www.studentloanborrowerassistance.org/blogs/wp-content/www.studentloanborrowerassistance.org/uploads/File/information-sheet.pdf (last visited March 4, 2012).
20 See 34 C.F.R. § 685.211(f)
21 20 U.S.C. § 1078-6(a)(1)(B).
22 See I.R.S. Info. Ltr. 2009-0126 (June 26, 2009), available at http://www.irs.gov/pub/irs-wd/09-0126.pdf. (Amounts forgiven after 25 years of IBR payments are taxable as income.)