10.27.2011

Doing the math on Obama's new student debt rules

I came across this article in USAToday on one of the new options on student loan repayment that Obama is implementing through executive order.  While students will still have more traditional options, he is replacing an option that required graduates to pay 15% of discretionary income over 25 years, with a plan that requires 10% over 20 year.  In both cases, any remaining balance is forgiven.  Some question the wisdom of forgiving loans when the government is in debt up to it's eyebrows.  But as you can see below, far from costing the government money, most of the time we the people will actually be making money.



I'll use $10K so it's easy to multiply the numbers to get to ones actual debt level.

Borrowing $10K at 6.8%, (the current graduate school interest rate, not sure about undergrad) and making payments of $115.08 for 10 years will repay the loan at a cost in interest of $3809.64.  Total Cost: $13,809.64

Borrowing $10K at 6.8%, and making payments of $76.33 for 20 years
will repay the loan at a cost in interest of $8320.15.  Total Cost: $18320.15

If you make payments on a sliding scale over 20 years, paying even less up front and more on the back end, you will pay even more in interest.

Bottom line: While a scant few will have large debts retired, most will pay off their balances in full as their discretionary income rises, and at a significant profit to us/the government/tax payer; that is, now that government backed student loans are handled by the government. (You can still get private loans which this ruling does not impact.)

Those that do have a small amount forgiven will still have paid back more than they borrowed, (again, putting us in the black) just not an amount equal to what they should have paid under prevailing interest rates.

For instance, say you owe $50K at 6.8%. A standard, equal payment, 20 year plan would put your payments at $381.67. So now lets say 10% of your discretionary income puts your payments at around $300 instead of the $381. And for simplification lets say that never changed for 20 years. (In reality you might start with payments near $200 and move to $450 over 20 years, but lets assume the average was $300.) You would still pay back $72,000, (more if you start at $200/month, and move to $450), instead of  $91,600, the amount paid if you make payments of $381/month for 20 years.  In other words, even if you had almost $20,000 dollars forgiven, you would still have paid back over $20,000 more than you borrowed.

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