"Pay As You Earn" Student Loan Plan May Backfire

In order to make student loan repayment more affordable, the Obama administration just announced a new plan to cap loan repayments at 10% of graduates’ discretionary income.   The question is, will this help graduates balance loan repayments with other financial obligations or is this just government intrusion?

It is true that student loan debt is rising, making it more difficult for graduates to afford their loans as they (hopefully) begin new careers post-graduation. Capping loans to 10% of their discretionary income is one way to make loan repayment more affordable, hopefully preventing loan default. 11% of loans are now 90 days delinquent, per the New York Fed. This also provides flexibility as graduates start off with lower paying jobs, allowing them to increase their payments as they work their way into higher paying jobs.

On the other hand, this new plan will result in significant government oversight and paperwork in order to make sure those graduates’ salaries are what they report they are. In addition, this plan will stretch out loan repayment for years, if not decades, which will significantly increase the total amount of interest that will be paid. It might even discourage graduates from earning more money, because they know that their student loan payments will increase. Finally, students may not be aware that if they work for one of the professions that are “forgiven” such as teaching or healthcare, this loan forgiveness actually results in a tax liability later on.

All in all, grads must keep their eyes wide open and know that they are signing up for when they make a decision about student loan repayments.