Would using PAYE like this make sense? Forum

[slawww]

Assuming I have a low salary relative to debt, under PAYE I'd end up paying like 6k or so yearly.

Since the interest rate is 6.8%, you will be paying interest only for 20 years. And, after paying $120k in interest, you will still have $100k in principal left on your loan. Assume another 10% for capitalized interest, to total $110k. (too lazy to do the exact math, but it doesn't matter for the example.) All of that debt forgiveness is taxable 20 years hence, so another 35%-50% goes to taxes (depending on your state of residence).

So you total payments are $120k+~$40k = $160k to the feds. Not a great deal to plan on, IMO.

On top of that, your debt payments will count against you when you try to get a mortgage.

True, but according to the article above, the tax of the forgiven loan is still to be determined.

I guess my plan wouldn't necessarily have me paying the least amount of money, but it would allow me to use the investment funds' profit to make the payments, while still maintaining that investments principle when it's over with. In my opinion, that would be better than just straight up dropping 70k (my anticipated loan amount)

Also, I was under the impression that as long as you're making payments on your loans, your credit, etc. should not be affected negatively.

[Rahviveh]

Assuming I have a low salary relative to debt, under PAYE I'd end up paying like 6k or so yearly.

Since the interest rate is 6.8%, you will be paying interest only for 20 years. And, after paying $120k in interest, you will still have $100k in principal left on your loan. Assume another 10% for capitalized interest, to total $110k. (too lazy to do the exact math, but it doesn't matter for the example.) All of that debt forgiveness is taxable 20 years hence, so another 35%-50% goes to taxes (depending on your state of residence).

So you total payments are $120k+~$40k = $160k to the feds. Not a great deal to plan on, IMO.

On top of that, your debt payments will count against you when you try to get a mortgage.

True, but according to the article above, the tax of the forgiven loan is still to be determined.

I guess my plan wouldn't necessarily have me paying the least amount of money, but it would allow me to use the investment funds' profit to make the payments, while still maintaining that investments principle when it's over with. In my opinion, that would be better than just straight up dropping 70k (my anticipated loan amount)

Also, I was under the impression that as long as you're making payments on your loans, your credit, etc. should not be affected negatively.

Your credit will not be affected (and could be helped) but it will still "count" against you when trying to obtain a mortgage since they will look at your monthly debt obligations. Of course, since PAYE only asks for ~8% of your gross income, you shouldn't have any issue as long as you borrow responsibly in other areas.

[Big Dog]

True, but according to the article above, the tax of the forgiven loan is still to be determined.

Incorrect. Loan forgiveness is taxable as of today. Whether it will be taxable in 20+ years is anyone's guess, but the law/regs are clear. From the federal government's own docs:

"You may have to pay taxes on any loan amount that is forgiven after 20 years."

http://studentaid.ed.gov/repay-loans/un ... s-you-earn

[20141023]

.

[09042014]

I’ve been going back and forth in my head between PAYE and a home equity loan through my parents, and it is turning out to be a very difficult decision to make.

As many have already mentioned, as long as you have “partial financial hardship” (which means that the standard 10-year repayment plan payments are more than 10% of your adjusted gross income minus 150% of the poverty guidelines), you will accrue “simple interest” and not “compound interest.” This basically means that your interest will not capitalize (become part of the principal balance), which in turn means that interest will not accrue on your interest, but rather on just your principal balance. Also, even if for some reason principal does capitalize, the amount that ever capitalizes over the life of the loan cannot exceed 10% of the original balance.

The scary thing is that if you are going to school at anything near sticker and taking out federal loans, it will take quite some time to pay your principal down with “brute force” even if you land big law because of the 6.8% / 7.9% interest rates, which will be adding around $20,000 to your balance each year. If you go the federal loans route, you almost have to hope that something will be done about the tax bomb because it will be extremely difficult to swim upstream against these kinds of interest rates if you land anything outside of biglaw.

Also, Papi and I have kind of been talking about this privately, but what I am worried about with PAYE is that the tax bomb will strike 20 years from now when most of us are in our mid-40s or 50s. If you are only making minimal payments (10% of your income minus the poverty guidelines), chances are that negative amortization (which means that accruing interest is greater than the payments you’re making towards the loan) will be occurring on your loans for the better part of 20 years. This could easily leave you with a $500,000+ balance at that time, which would require you to make a $200,000+ lump-sum payment that year in taxes. Although the government will only tax your forgiveness to the extent that it is less than or equal to the value of all of your assets, if you've stayed in the legal industry for that many years and have a decent pension plan, chances are that you could be taxed at the full price of the amount forgiven.

Having said that, I really think that everyone who uses PAYE will have to decide between one of two paths:
1) Start paying off your federal loans as soon as possible after graduation to keep them from growing
2) Stick with the minimum PAYE payments and prepare for the tax bomb while hoping that it will go away; don’t expect to pay off your loans with “brute force” after a couple years of minimal payments because the amount will reach a “critical mass” which will likely be very difficult to make a dent in because of the high interest rates

I am still not 100% comfortable with option #2, but it seems like the only viable thing to do if you’re set on using PAYE; if I were going with option #1, I would use a different type of loan (home equity, etc.) with lower interest rates that would actually give me a fighting chance to pay back my loans at a reasonable pace.

But since PayE limits capitalization of interest, your principle will never be more than whatever your loans were +10%. And the tax bomb doesn't include accrued interest. So we are talking about adding more like 250-280K of income during the tax bomb year. Which is more like 90k. Over twenty years you should be able to plan for that. 400 hundred a month into a savings account aught to do it.

[dr123]

If your parents have a law school fund of 100k, why dont you just use that for tuition? I dont get it.

[20141023]

.

[Elston Gunn]

But since PayE limits capitalization of interest, your principle will never be more than whatever your loans were +10%. And the tax bomb doesn't include accrued interest. So we are talking about adding more like 250-280K of income during the tax bomb year. Which is more like 90k. Over twenty years you should be able to plan for that. 400 hundred a month into a savings account aught to do it.

Are you sure about this? Even though it might not capitalize past 10% (and therefore that extra amount won't compound), I was under the impression that whatever you have left at the end of year 20 - whether it be interest or principal - is included in the "forgiven amount." Not that I'm saying that you're wrong, but this could be a huge game-changer, so I want to verify that it is correct.

I actually asked them about this because they didn't address it any materials. They told me it was on the total forgiven amount, not just the principal, which blows.

[20141023]

.

[IAFG]

This assumes PAYE is around by the time you graduate. The more you people keep yapping about how great a deal it is, the more likely they are going to restrict it. This program wasn't meant for shithead lawyers.

As much as the Obamas have talked about their law school debt, I think it was exactly meant for shithead lawyers.

[Big Dog]

The scary thing is that if you are going to school at anything near sticker and taking out federal loans, it will take quite some time to pay your principal down with “brute force” even if you land big law because of the 6.8% / 7.9% interest rates, which will be adding around $20,000 to your balance each year. If you go the federal loans route, you almost have to hope that something will be done about the tax bomb because it will be extremely difficult to swim upstream against these kinds of interest rates if you land anything outside of biglaw.

Even without including capitalized interest in the tax bomb, one still has to account for the fact that under PAYE you will be making 20 years of payments of interest only. Unless you earn a big raise, no principal will be paid down. So, borrow $250k+10% interest. In 20 years, you'll still owe $275k which will be forgiven (after you pay 40-50% of that in taxes, depending on your state.)

But, you will also have paid hundreds every month for 20 years. If say, your payment is $500/mo under PaYE, you will be paying $6000 per year x 20 years = $120k in interest to the feds (with no reduction in principal).

Total payments in this example = $120k+$140k in taxes = $260k. So, you have to ask yourself if the debt anchor is worth it?

[Rahviveh]

The scary thing is that if you are going to school at anything near sticker and taking out federal loans, it will take quite some time to pay your principal down with “brute force” even if you land big law because of the 6.8% / 7.9% interest rates, which will be adding around $20,000 to your balance each year. If you go the federal loans route, you almost have to hope that something will be done about the tax bomb because it will be extremely difficult to swim upstream against these kinds of interest rates if you land anything outside of biglaw.

Even without including capitalized interest in the tax bomb, one still has to account for the fact that under PAYE you will be making 20 years of payments of interest only. Unless you earn a big raise, no principal will be paid down. So, borrow $250k+10% interest. In 20 years, you'll still owe $275k which will be forgiven (after you pay 40-50% of that in taxes, depending on your state.)

But, you will also have paid hundreds every month for 20 years. If say, your payment is $500/mo under PaYE, you will be paying $6000 per year x 20 years = $120k in interest to the feds (with no reduction in principal).

Total payments in this example = $120k+$140k in taxes = $260k. So, you have to ask yourself if the debt anchor is worth it?

Im on my phone so i dont have any calculators handy, but the forgiven amount is going to be much larger than 275k and the tax bill could negate the benefits of the program. That also depends on your assets since you will only be taxed up to the extent of your assets.

The problem is that in your example, someone who makes a payment of 500/month would be making an income of around $75k a year. On that income its going to be very difficult to service sticker debt using a 10-year standard plan. That person really has no choice but to go on IBR.

[Big Dog]

The problem is that in your example, someone who makes a payment of 500/month would be making an income of around $75k a year. On that income its going to be very difficult to service sticker debt using a 10-year standard plan. That person really has no choice but to go on IBR.

That's exactly right, and why relying on these loans is not a smart idea.

Im on my phone so i dont have any calculators handy, but the forgiven amount is going to be much larger than 275k and the tax bill could negate the benefits of the program. That also depends on your assets since you will only be taxed up to the extent of your assets.

Anyone have a federal link which explains exactly how the forgiveness will work?

[20141023]

.

[trapster]

The problem is that in your example, someone who makes a payment of 500/month would be making an income of around $75k a year. On that income its going to be very difficult to service sticker debt using a 10-year standard plan. That person really has no choice but to go on IBR.

That's exactly right, and why relying on these loans is not a smart idea.

Im on my phone so i dont have any calculators handy, but the forgiven amount is going to be much larger than 275k and the tax bill could negate the benefits of the program. That also depends on your assets since you will only be taxed up to the extent of your assets.

Anyone have a federal link which explains exactly how the forgiveness will work?

Here's a numerical example based on my repayment estimator from studentloans.gov

My balance is $124, and assume a $60 salary. According to my repayment estimator, I'll pay $130 (all interest), and the projected loan forgiveness is $175.

(btw $124 at 7.3% for 20 years = $305)

[Rahviveh]

The problem is that in your example, someone who makes a payment of 500/month would be making an income of around $75k a year. On that income its going to be very difficult to service sticker debt using a 10-year standard plan. That person really has no choice but to go on IBR.

That's exactly right, and why relying on these loans is not a smart idea.

Im on my phone so i dont have any calculators handy, but the forgiven amount is going to be much larger than 275k and the tax bill could negate the benefits of the program. That also depends on your assets since you will only be taxed up to the extent of your assets.

Anyone have a federal link which explains exactly how the forgiveness will work?

You can try the calculator on finaid.org

http://www.finaid.org/calculators/ibr10.phtml

I did some rough math - 75k income with 3% raises, his final forgiven amount will be 554,000 if he borrowed sticker. For this person, PAYE is just not a viable option unless they address the tax element.

[Tiago Splitter]

The problem is that in your example, someone who makes a payment of 500/month would be making an income of around $75k a year. On that income its going to be very difficult to service sticker debt using a 10-year standard plan. That person really has no choice but to go on IBR.

That's exactly right, and why relying on these loans is not a smart idea.

Im on my phone so i dont have any calculators handy, but the forgiven amount is going to be much larger than 275k and the tax bill could negate the benefits of the program. That also depends on your assets since you will only be taxed up to the extent of your assets.

Anyone have a federal link which explains exactly how the forgiveness will work?

You can try the calculator on finaid.org

http://www.finaid.org/calculators/ibr10.phtml

I did some rough math - 75k income with 3% raises, his final forgiven amount will be 554,000 if he borrowed sticker. For this person, PAYE is just not a viable option unless they address the tax element.

Interest doesn't compound under IBR. Does it compound under PAYE?

[20141023]

.

[Big Dog]

You can try the calculator on finaid.org

http://www.finaid.org/calculators/ibr10.phtml

I specifically requested a federal source, for the simple reason is that these are federal programs. And you are borrowing from the feds. It is their rules, their docs and their legal contracts.

I have great respect for Joe Hurley, but until the federal government clearly lists out the rules for 20 years hence, the rest of us are just interpreting.

Here's a numerical example based on my repayment estimator from studentloans.gov

My balance is $124, and assume a $60 salary. According to my repayment estimator, I'll pay $130 (all interest), and the projected loan forgiveness is $175.

How does one get to the loan forgiveness estimate?

[Elston Gunn]

You can try the calculator on finaid.org

http://www.finaid.org/calculators/ibr10.phtml

I specifically requested a federal source, for the simple reason is that these are federal programs. And you are borrowing from the feds. It is their rules, their docs and their legal contracts.

I have great respect for Joe Hurley, but until the federal government clearly lists out the rules for 20 years hence, the rest of us are just interpreting.

Here's a numerical example based on my repayment estimator from studentloans.gov

My balance is $124, and assume a $60 salary. According to my repayment estimator, I'll pay $130 (all interest), and the projected loan forgiveness is $175.

How does one get to the loan forgiveness estimate?

Just email them, dude. They surprisingly got back to me pretty fast. I used the contact us link on the main fed PAYE page.

[20141023]

.

[Big Dog]

I can easily do the math on my trusty calculator.

But what I'd love to see is some federal publications -- not blogers' --clarifying (or correcting) the issue that you raise in your earlier post, regulus. How exactly, does the 10% cap work? If one borrows $250k, and makes only minimal (interest only payments) for 20 years, what is total principal and interest due? $250k+$25k (for simplicity)? Or, as you suggested earlier, the feds only forgive that $275k, and the tax bomb is on the whole thing (which includes compounded interest).

Again, a simple question which in my mind, the feds have a moral and legal duty to answer (and not pawn off to their vendors.)

This could easily leave you with a $500,000+ balance at that time, which would require you to make a $200,000+ lump-sum payment that year in taxes. Although the government will only tax your forgiveness to the extent that it is less than or equal to the value of all of your assets, if you've stayed in the legal industry for that many years and have a decent pension plan, chances are that you could be taxed at the full price of the amount forgiven.

[trapster]

You can try the calculator on finaid.org

http://www.finaid.org/calculators/ibr10.phtml

I specifically requested a federal source, for the simple reason is that these are federal programs. And you are borrowing from the feds. It is their rules, their docs and their legal contracts.

I have great respect for Joe Hurley, but until the federal government clearly lists out the rules for 20 years hence, the rest of us are just interpreting.

Here's a numerical example based on my repayment estimator from studentloans.gov

My balance is $124, and assume a $60 salary. According to my repayment estimator, I'll pay $130 (all interest), and the projected loan forgiveness is $175.

How does one get to the loan forgiveness estimate?

studentloans.gov

It's got a repayment estimator (bottom left after you log in) that lays out how much you'll pay under each plan as well as an estimate for loan forgiveness.

[Elston Gunn]

I can easily do the math on my trusty calculator.

But what I'd love to see is some federal publications -- not blogers' --clarifying (or correcting) the issue that you raise in your earlier post, regulus. How exactly, does the 10% cap work? If one borrows $250k, and makes only minimal (interest only payments) for 20 years, what is total principal and interest due? $250k+$25k (for simplicity)? Or, as you suggested earlier, the feds only forgive that $275k, and the tax bomb is on the whole thing (which includes compounded interest).

Again, a simple question which in my mind, the feds have a moral and legal duty to answer (and not pawn off to their vendors.)

This could easily leave you with a $500,000+ balance at that time, which would require you to make a $200,000+ lump-sum payment that year in taxes. Although the government will only tax your forgiveness to the extent that it is less than or equal to the value of all of your assets, if you've stayed in the legal industry for that many years and have a decent pension plan, chances are that you could be taxed at the full price of the amount forgiven.

90% sure you'll be paying taxes on the hypothetical $500K under current law.

[Big Dog]

90% sure

Therein lies my question. Where is the federal source which clearly states what/how the amount of the tax bomb is....