IBR Repayment, and Negative Amortization, and High Balances! oh my!

[Anonymous]

I'm new to the forum and looked for information on this topic, but was unsuccessful. I am a recent law school graduate with a high student debt balance (~180k) from some undergraduate and law school loans. Thankfully, I'm gainfully employed. In considering my repayment options, I am considering income-based repayment (IBR). The problem I am realizing is determining how much I should be prepaying on my load debt, if I should even be prepaying at all. Absent moral considerations of repaying all of the debt that I signed up to take on, if I am capable of doing it, IBR seems to provide an incentive of paying the minimum payment and having the balance cancelled after 25 years (I realize that this is taxable income during this year). As long as my salary doesn't reach a point where I will pay off the loan in 25 years paying the minimum payment, there is not much incentive to pay more than the minimum payment. If I foresee that happening, then it would make sense to at least pay the interest off as it is accruing in order to minimize the amount spent over the life of the loan.

With loans of this size, my initial minimum payment based off of my salary will not cover the accruing interest and the loan will be negatively amortizing until I reach a substantially larger salary. By this point, a substantial amount of interest will have accrued. My questions are how will all of this affect my credit score. 

1. Will having a large balance with low required monthly payments hurt my score? I know my debt to income ratio will not be affected because IBR is designed to keep the minimum payment manageable compared to income, but I have not found reliable information on what the looming balance will do to my score.

2. Should I decide it is cheaper over the life of the loan to let the beast grow making the minimum payments for 25 years, will the growth over the loan hurt my credit score? I am not sure how this would affect my score because my debt to income ratio would stay the same based on the way IBR works.

Overall, I do not have anything else negative on my credit report. Unfortunately, my student loans consist of approximately 10 accounts right now. I have one credit card with a $0 balance, and I have never missed any payments. 

Thanks for any advice.

[Anonymous]

If you work in public service your federal loans are forgiven after 120 payments(10 years).  I work in higher education, so I qualify for loan foregiveness.  Plus, one has to be enrolled in IBR or ICR.  When I submitted the application for IBR, I had no idea my payments would be $0.  And all my $0 payments counts toward the 120 payments.  I can automatically subtract 12 payments from the 120 payments.   IBR and public service is something to look into. 

[BoysMumx2]

One quick note:  when the balance is forgiven after 25 years of payments on the IBR, there are no tax consequences for the forgiven amount.  Those who have loans forgiven under the ICR have tax consequences but not IBR.  You can find out more information on StudentLoans.gov.

As for the impact on your credit score from the growing balance due to capitalized interest, that's a good question I'll leave to the FICO experts.  I'd be interested too, as I'm on the IBR.  Like the other poster, however, I work in higher ed so I'll be doing the Public Service program too. 

[Anonymous]

If only it were true... 

For PSLF, yes, there is no tax liability for the cancelled amount. This is not the current case for the 25-year cancellation for other IBR borrowers.

Loan Forgiveness

The maximum repayment period is 25 years. After 25 years, any remaining debt will be discharged (forgiven). Under current law, the amount of debt discharged is treated as taxable income, so you will have to pay income taxes 25 years from now on the amount discharged that year. But the savings can be significant for students who wish to pursue careers in public service. And because you will be paying the tax so long from now, the net present value of the tax you will have to pay is small.

A new public service loan forgiveness program will discharge the remaining debt after 10 years of full-time employment in public service. Unlike the 25-year forgiveness, the 10-year forgiveness is tax-free due to a 2008 IRS ruling. The borrower must have made 120 payments as part of the Direct Loan program in order to obtain this benefit. Only payments made on or after October 1, 2007 count toward the required 120 monthly payments. (Borrowers may consolidate into Direct Lending in order to qualify for this loan forgiveness program starting July 1, 2008.)

http://www.finaid.org/loans/ibr.phtml

[BoysMumx2]

Apologies - I searched and see that you are correct.  I could swear that I had read in my documentation for the IBR application that it was the same for the 25-year forgiveness as well, but I don't see that it is.

Based on that information, I'd definitely revise my opinion on the IBR for anyone not going into public service.  Depending upon the person's situation, graduated or extended repayment might work better.  At the very least, IBR offers an option that can help prevent default for borrowers with low starting salaries out of school. 

I will say that I'm surprised that StudentLoans.gov does not make it absolutely clear on the FAQ about IBR that there will be tax consequences for those with the forgiven balances.  In my book that is not far off from the sneaky tactics of credit cards in the not-so-distant past...

[Anonymous]

I still think it's a viable option for me. I am waiting to see if any FICO experts suggest that an IBR plan will present serious credit score risks. I learned through my research that the accruing interest will not capitalize until the borrower is no longer considered in partial financial hardship. With loans as hefty as mine, this would not occur unless I began earning a salary of approximately $200,000/year. Yikes!

Based on this capitalization rule, my plan is to make my minimum IBR payments and keep the additional funds that I would be required to pay under a more traditional loan as an emergency fund. I will make disbursements from this fund towards the accruing interest when I have a better idea of what my career prospects are. I would hate to make substantial prepayments to fight the the interest to then lose my job and fall into serious financial hardship without an emergency fund. I realize the IBR payments would likely adjust in the event of this type of contingency, but if there's no difference between paying the interest as it accrues or prepaying in an amount equal to the interest that accrued at say the end of the year, then I do not see a point in taking that risk.

This raises another question though. Would accrued, but uncapitalized, interest even show up on a FICO report? 

[BoysMumx2]

I can definitely answer the question on the non-capitalized interest and your report based on what I see on mine:  the non-capitalized interest does not show on my reports.

As for the tax consequences, I have to admit that I'd still choose to be on IBR even facing those consequences.  DH is still in school, working on his bach degree and having only my public service level income coming in means that it would be IBR or seeking deferments until he finally finishes up.  Once he is done with school and earning an income, we plan to aggressively pay down both our student loans as the interest on them will be higher than our mortgage.  Even with our best-case anticipated salaries when we hit that point, we'll still qualify for IBR (sad) and knowing that it's out there should an emergency (ie, job loss or medical) happen, makes me feel a bit better about that net.

It sounds like you have a good plan in place and so long as the increasing balance doesn't create a credit score sink-hole, it sounds like it could work well.

[Anonymous]

I've been working in higher education since 2003, so going the IBR route was my best choice.  The IBR and Loan Forgiveness application must be submitted every year. Taxes are not paid on forgiven loans under the IBR plan.

As for as FICO scoring concerns, I doubt there will be an impact.  If there are any decreases in scores it's because the AAoAs may have decreased.  FICO weighs revolving credit a lot more than installements.  People have mortgages higher than most student loans and still maintain  high FICO scores. 

[lazerz69]

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@Anonymous wrote:

The IBR and Loan Forgiveness application must be submitted every year.  

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Is this actually true.  Spoke with CSR at Direct Loan, who stated that nothing needs to be done during the 120 payment period.  I was told you did not have to submit an application at all.

[BoysMumx2]

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@lazerz69 wrote:

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@Anonymous wrote:

The IBR and Loan Forgiveness application must be submitted every year.  

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Is this actually true.  Spoke with CSR at Direct Loan, who stated that nothing needs to be done during the 120 payment period.  I was told you did not have to submit an application at all.

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You have to resubmit the qualification paperwork every year after you file your federal taxes.  They base your 12-month payment on your AGI.