Graduates Can Find Help Scaling Mountain of Debt

If you've got a diploma hanging on your wall, chances are it didn't come cheap. Of the 3 million or so college seniors who donned a cap and gown this year, about two-thirds of them went into debt -- an average of $22,500 -- for the privilege of that diploma. The debt of graduate and professional students is often tens of thousands more.

As graduates struggle to find jobs during the worst economic crisis of their lifetime, an adviser to the secretary of education has said he expects that the default rate on student loans, which cannot be easily renegotiated or discharged in bankruptcy, will rise.

But relief is here for some. A provision of the College Cost Reduction and Access Act of 2007 that took effect Wednesday reduces the monthly payments of hundreds of thousands of borrowers who qualify for the new Income-Based Repayment plan (IBR). Borrowers who work in certain public service jobs could also have their loan balances erased after they make qualifying payments for 10 years. (Supposedly this costs the government nothing, because it will now change the way it subsidizes student-loan lenders.)

So will your student loan be bailed out?

In a word: maybe.

At the very least, IBR will lower the monthly payments of people who accumulated significant federal student loan debt but do not have the income to make the payments on the standard 10-year repayment plan. This relief may reach as many as 1 million people, according to the Project on Student Debt. And despite lower payments, they will not be paying their loans off indefinitely -- any remaining balance will be forgiven after 25 years of payments.

Basing loan payments on income is not a new concept. For years, graduates with federal student loans had options to reduce or eliminate their payments, depending on how much money they made. But IBR is intended to be more generous than that.

IBR caps monthly payments at 15 percent of earnings above 150 percent of the poverty line, or $10,830 for a one-person household. Online calculators can help you compare what your income-based payments, income-contingent payments and income-sensitive payments would be.

In some situations an IBR payment would be zero if a borrower earns below 150 percent of the poverty line for his or her family size. If your payment is zero, or is so low it does not cover the interest accruing on your loan, for the first three years in IBR the government will continue paying the interest on subsidized Stafford loans, which are government-backed loans given to financially needy students that do not accrue interest while the borrower is in school. After that period, and for all of the other kinds of unsubsidized federal loans, unpaid interest will accrue but will not compound. In other words, you won't be charged interest on top of interest.

Borrowers who think they could benefit from IBR should contact their lenders and ask for an application that will authorize the release of their adjusted-gross-income figures from the Internal Revenue Service each year.

The news is even more promising for people working in public service jobs -- all levels of government work, teachers in public schools and universities, employees of public hospitals, and anyone working for a 501(c)(3) nonprofit would all qualify. Anyone working in a qualifying job who borrowed from the Direct Loan Program is eligible for loan forgiveness after 10 years, down from 25.

To qualify for forgiveness, borrowers who work in a public-interest position must either have an existing Direct Loan or consolidate a federal loan with a private lender into the Direct Loan Program and make 120 payments after Oct. 1, 2007. The payments do not have to be consecutive, can be made while at different eligible positions, and must be made on the income-based or standard repayment plans.

At this point, the burden is on borrowers to document where they were working during their repayment period. The Education Department is planning to develop a more definitive system to confirm eligibility, but right now borrowers should keep pay stubs and tax documents that verify their work history.

IBR and public-loan forgiveness won't be the best options for every borrower. Some borrowers, if able to make higher monthly payments, would be best served by sticking with a traditional payment plan to avoid accruing years of additional interest. Graduates who financed their education with private loans are ineligible entirely.

But for MBA grads who borrowed $150,000 planning to be investment bankers and ended up in government service, IBR will result in payments they can afford on their civil service salaries.