The Obama administration has made it easier for those
repaying their student loans to shift into the income-based payment plan. This
plan limits payments to a fixed percentage of a borrower's discretionary income
(currently 15%, dropping to 10% in 2014). Any remaining debt is forgiven after
25 years.
Income-based payment a good choice for recent graduates who
are getting settled into the labor market. In fact, I think it should be the
default option, rather than the 10-year payment plan that is currently the standard.
The current default makes little sense from an economic perspective - earnings are lowest and most uncertain when a graduate first enters the labor market, so why shove all the loan payments into those years? A college education pays off over a lifetime, so it makes economic sense to pay for that asset over a long horizon.
How different is the income-based repayment from the standard plan? For a graduate coming out of college with $22K in subsidized
Stafford loan debt, and earning $30,000 a year, the standard ten-year repayment
would be $217 at an interest rate of 3.4% (the current rate) or $253 (if the
rate goes up to 6.8% in July, as scheduled). With the income-based plan, the payment would be only $165, no matter what happens to the interest rate. The
borrower is free to pay more per month should she find some extra money lying
around and wants to knock the debt back more quickly.
