Not Impressed with Student Loan Cancellation? This Payment Plan Might Help.

While $10,000-$20,000 in federal student loan cancellation is welcome news for many borrowers, those with larger balances—particularly approaching or exceeding six figures—may feel underwhelmed by the assistance. Fortunately, the Biden administration’s announcement on student loans included provisions that have the potential to significantly ease the burden on borrowers with large amounts of federal student loan debt.

A More Affordable Income-Driven Repayment Plan

We frequently see clients who want to repay their student loans, but their high balances and unsustainable payments make it feel impossible. This proposed repayment plan would cap payments at 5% of your discretionary income (rather than 10%-15%). It would also reduce the amount of income that is considered discretionary, a move that will help low-income borrowers the most.

Reduce Discretionary Income

While you might think of your “discretionary” income as money left over after you pay your bills, the Department of Education actually defines it as your gross income minus 150% of the federal poverty level ($20,385). So, if you make $50,000, your “discretionary” income is about $30,000. The proposed change would increase the amount of income considered non-discretionary to 225% of the federal poverty level ($30,577 for an individual). This means that the same borrower’s discretionary income would only be about $19,000.

Lower the Payment Cap From 10%-15% to 5%

Reducing the payment cap from 10% to 5% of a borrower’s gross income will significantly lower their payment. With a 10% payment cap, a borrower making $50,000 would have a monthly student loan payment of $250. Taking into consideration the changes to discretionary income, the same borrower would have a payment of about $80 under the proposed change. When you are trying to save or pay off credit card debt, that extra $170 per month can make a major difference in your budget.

One catch is that the 5% payment cap would only apply to undergraduate loans. Graduate school borrowers would still have to pay 10% of their discretionary income. Borrowers with loans from both undergrad and grad school would have a payment cap between 5%-10% calculated based on a weighted average of their loans.

An End To Growing Student Loan Balances

While there are many benefits to income-driven repayment plans, they have historically come with a major downside: if your income-based payment is too low to cover the interest on your loans, your student loan balance will continue to grow. Under this new IDR plan, that would no longer happen. As long as you make your minimum payments (which can be as low as $0 per month), the government will cover any unpaid interest on your loan so your balance won’t increase.

The benefits of this change will be both psychological and material. Making the minimum required payments on your student loans only to see your balance grow month over month is discouraging. Accruing interest also creates a bigger mountain for borrowers to climb if their financial situation changes and it makes more sense for them to switch to a traditional (non-IDR) repayment plan. 

Final Thoughts

The Biden administration’s proposed changes to student loans go way beyond a relatively modest amount of loan cancellation. Reducing income-driven student loan payments has the potential to have an even bigger impact on the day-to-day budgets of borrowers who need that flexibility.