Demystifying Student Loan Reform; Income-Based Repayment (IBR) for Law Students

 

This is a post beneficial to many – not just JETs with J.D.s. But, since law students are the ones graduating in the largest numbers with work (or lack thereof) providing insufficient revenue to pay off their student debts, understanding the mechanics of what IBR is all about may not just be helpful, but necessary.

But first: because I’m an anal-retentive law school type, a DISCLAIMER: I’m not here to provide you legal or financial advice as to whether IBR is right for you (or whether you should go into law school and take on a massive amount of debt in the hopes that IBR will take care of all your financial worries). For that, please consult your conscience, or some kind of financial adviser.

Enough of that. Now onto the good stuff.

Why You Shouldn’t Expect a Student Loan Bail-out

There are plenty of folks out there hoping for some kind of student loan amnesty — a hope that, in some way, their student loan debt, acquired in a down-trodden economy with few job prospects, will evaporate by some magic act of the state. A quick look at the cost of such a bailout, however, is instructive. The average law grad carries around $100,000 in debt. There are currently 200 ABA-approved law schools in the United States. (This is a low-ball number as it does not count non-ABA approved schools. I’m looking at you California.) While each school admits different numbers of students each year, for my calculations I’ll assume 200 students per class. (I also consider this a low-ball since plenty schools clearly have more. See, for example, Northwestern, Ohio State, George Washington University, and the list goes on).

With those numbers, the low-ball cost to bail-out one graduating year’s worth of law school students is…
$100,000 x 200 schools x 200 students per school = $4,000,000,000.00. That’s billion with a “B” in case you’re bad at counting zeros. By comparison, that’s the low-ball estimate for the costs incurred by the BP Oil Spill.

Expand this number to include the entire “Lost Generation” of law students graduating between 2009-2011, and you are asking for a $12,000,000.00 bailout, c/o of the American taxpayer. This calculation doesn’t even entertain the risk that a law student loan amnesty would open the door to other unemployed students: undergraduates who graduate underwater; grad students. When you consider the financial implications of bailing them out, the numbers skyrocket.

I’m sure bailing out newly minted degree holders in the aftermath of the financial crisis carries with it a certain degree of moral superiority, at least compared to bailing out Wall Street bankers. But face it: it’s just not going to happen, and unemployed 20-somethings have a lot less political pull.

IBR may be the closest thing the student community will ever get to a bailout– so it’s worth your persual, especially if you are entertaining the thought of taking on law school debt.

Income-Based Repayment, and how it works

Eligibility

First: IBR only works for non-defaulted federal loans through the FFEL and Direct Loan programs (Stafford & Grad PLUS, for example), and only those loans are used to determine eligibility. So, if you’re in danger of defaulting on that $300,000 you took from Fat Tony that you gambled away in Vegas, sorry: no IBR for you.

Second: In order to be eligible for IBR, you have to be in a “partial financial hardship.” You have a partial financial hardship if the monthly amount you would be required to pay on your IBR-eligible loans under a Standard Repayment Plan with a 10-year repayment period is higher than the monthly amount you would be required to repay under IBR. That means you’re going to have to look at your individual situation to find out whether your current debt-load would be better under IBR than the Standard, and if you are eligible, determine if IBR is a better situation for you.

Reduced Payments

If your non-defaulted FFELS/Direct Federal Loans and your debtload meet the requisite criteria, IBR allows qualified borrowers to cap their monthly payment at an amount that is intended to be affordable based upon income and family size, and will be less than what you would have to pay under a 10-year Standard Repayment Plan. Whenever you hear President Obama talking about not having to pay more than 10% of your income in student loan payments, it’s reduced payments such as IBR that he’s talking about.

But reduced payments aren’t the only benefit. If you make consistent payments under an IBR plan for 25 years and meet certain other requirements, any remaining balance will be cancelled. If you work in public service and have reduced loan payments through IBR, your remaining balance after ten years in a public service job could be cancelled if you made loan payments for each month of those ten years. That’s right — loan forgiveness for consistent payers.

The Downside

You know there has to be one. But compared to the downsides of selling your liver for quick cash, the downside to IBR is not so bad. First: more of your payments are going to be going towards your interest, and not your principal amount. As a result, you’re going to put less of a dent into your principal. There’s also a mechanism in the loan repayment process whereby, if your payment doesn’t cover all the interest, unpaid interest capitalizes INTO the principal amount.

Second, because you’re paying more in interest and your principal is either remaining the same, or, possibly growing: your ultimate forgiven indebtedness after 10 or 25 years is going to be a larger number.

If it’s all disappearing, you’d think it wouldn’t matter, right? But, forgiveness of indebtedness counts as taxable income under the internal revenue code. So, if after 25 years, the government forgives your $100,000 law school debt in total – you now have $100,000 worth of taxable income.

Another drawback is that you’re going to have to submit paperwork to your debt servicer every year, indicating your income, so that they can recalculate your IBR payment for that given year.

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Resources

This post is just an overview of IBR, but I don’t want to provide you with just an overview. There are a great number of resources out there to help answer questions and flesh out IBR better for you than I can.

The Federal Student Aid Website has a quick explanation of IBR, and an IBR Calculator available for your use.

They Federal Student Aid site also has a document addressing the most common questions raised about IBR. There is a lot of great information there, including the mechanics of applying for IBR.

Here is a transcript running down the various other methods of student loan repayment, including IBR, that while quite lengthy, goes through things in great detail.

Finally, a fellow colleague of mine over at The Law School Tuition Bubble has also provided a couple of posts regarding IBR that are well worth reading.