How Biden’s New Student Loan Plan Will Cut Payments For MBA Borrowers

The Biden administration made headlines when it announced cancellation of $10,000 in student loans for most Federal borrowers and $20,000 in forgiveness for Pell grant recipients. This announcement added to the pause on Federal loan payments and interest that began in March 2020.

However, while forgiveness and the continued Federal student loan freeze are a huge boon to existing student loan holders, current and prospective MBA may be wondering, “How will this help me?”

Good news: The Biden administration’s new student loan repayment plan will mean lower payments and higher interest subsidies for many new MBA graduates.

In January 2023, the Biden administration announced a new income drive repayment (IDR) called new REPAYE. This plan will cut monthly loan payments in half for millions of old and new borrowers and will make loan forgiveness easier to achieve.

OVERVIEW OF INCOME-DRIVEN REPAYMENT PLANS

IDR plans were introduced in 1994 to help borrowers manage crippling student loan payments. These plans limited student loan payments to a certain percentage of a borrower’s income and forgive the entire loan balance after 20 or 25 years of payment. To simplify and streamline the existing Income-Driven Repayment plans, the Biden administration has proposed changes to the existing REPAYE plan.

While the new plan has received less attention than loan forgiveness, it will potentially have a much bigger impact.

For many borrowers including MBA borrowers, this new plan called New REPAYE will mean:

• Lower student loan payments and more interest subsidies for those with Federal loans.
• An easier path to loan forgiveness

SUMMARY OF THE NEW INCOME-DRIVEN PAYMENT PLAN (IDR)

The updated Biden IDR is called New REPAYE or New Revised Pay-As-You-Earn. The changes to this plan are listed in order of how likely they are to impact new MBA graduates. The primary changes include:

• Covering a borrower’s unpaid monthly interest so that student loan balances will not increase even if a borrower makes no loan payments or a payment that does not cover all the interest;
• Raising the amount excluded from loan payments from 150% to 225% of the poverty line;
• Forgiving loan balances after 10 years of payments, instead of 20 years, for individuals with original loan balances of $12,000 or less;
• Capping payments at 5% of discretionary income for undergraduate loans. (Note: this will not impact those borrowing for just an MBA. The cap on payments for grad loans did not change from 10%. However, if you have both undergraduate and graduate loans, your cap could be closer to 5%. It is based on what percentage of your loan debt is from undergraduate).

MBA LOANS: HOW NEW GRADS WILL BENEFIT

To make this less abstract, here’s an example of how student loan payments could be changed for a new MBA graduate.

Imagine our MBA student, let’s call her Sarah, lands a job with a $150,000 salary once she graduates in May 2023. It has a September 2023 start date. She has $80,000 in Federal unsubsidized student loans borrowed for graduate school at 6.8%.

The below table shows what Sarah’s loan payments would look like under four scenarios: the new REPAYE plan, the old REPAYE plan, standard repayment after refinancing her loans at 5% through a private lender, and standard 10-year repayment at the original 6.8% interest rate.

Assumptions: We assume that Sarah certifies her income while in school and is single with no dependents. In addition, when Sarah was in school in 2022, she only earned $20,000 from her MBA summer internship. Once she starts her job in September 2023, she contributes 10% of her salary ($3,750) to a pre-tax 401K. In year 2, when she is earning her fully salary, she contributes $22,500 to a 401K.

NEW REPAYE

For Sarah, this plan would lead to the lowest payments in her first two years after graduation, and the largest interest subsidy. While she would want to switch to standard repayment after her first two years, this gives her time to save money while her loans stay at basically 0% interest.

First, under all the income-driven payment plans, payments are based on the last tax year that you reported to the IRS. This creates a lag between loan payments and income when you graduate. While Sarah will be earning a large six-figure income, Sarah’s student loan payments in 2023 and 2024 will be based on 2022 and 2023 income.

In our assumptions, in 2022, Sarah was a full-time student who earned $20,000 at an internship. Under the new REPAYE plan, no individual borrower who earns less than $30,600 will owe student loan payments. If you have a family of four, this income limit rises to $62,400. Since Sarah earned $20,000 in 2022, her loan payments will be $0 in 2023.

(Under the old REPAYE plan, Sarah’s payments would have risen to $99 / month. The new REPAYE plan decreases the amount of income that is deemed eligible for loan payments. While the old REPAYE plan excluded income under 150% of the poverty line, the new REPAYE plan excludes income under 250% of the poverty line. In addition, The poverty line is linked to the size of your family. In our example, Sarah is single with no kids. For her, the poverty line is considered $14,580 in 2023. For individuals with larger family sizes, the poverty line increases. The plan is designed that no one who earns less than $30,000 will have to pay anything towards their student loans.)

Second, pre-tax 401K contributions decrease taxable income. In 2023, Sarah started work in September earning only 25% of her $150,000 salary. In addition, she contributed 10% of this amount to retirement. Since pre-tax retirement contributions reduce taxable income, in 2024, her loan payments are still only $8 / month despite her high base salary.

Third, the new REPAYE plan keeps loan balances from growing even if payments do not cover the full interest. For Sarah, the annual interest on her $80,000 in loans would be $5,440 at 6.8%. If her loans were in forbearance on a standard repayment plan, her loan balance would grow by $5,440 while she makes $0 payments. With the new REPAYE plan, despite making no payments in year 1 and minimal payments in year 2, her loan balance does not increase. This put her interest rate for the first two years at just above 0%. The OLD REPAYE plan would only have subsidized 50% of the interest leading to an interest rate of 3.4% in year one and 4.2% in year two.

While payments on the new REPAYE plan jump in year 3, many MBAs should consider the new REPAYE for the first two years after graduation. (Most MBAs do not pursue loan forgiveness, but REPAYE also provides the opportunity to receive loan forgiveness after 25 years of payments. This would not make sense for Sarah who is earning a high salary and who would have higher payments under REPAYE than standard repayment. However, for MBAs who owe more than they are earning, forgiveness could be attractive.) The low interest rate is better than current private sector rates, and the monthly payments also give some breathing room while rebuilding savings and paying off any credit card debt accumulated in grad school.

OLD REPAYE

This plan also reduces Sarah’s payments in years 1 & 2. However, her loan balance would still grow. While the old REPAYE plan subsidized 50% of unpaid interest, the loan interest is still 3.4% in year 1 and jumps to 4.2% in year 2. In addition, in year 3, Sarah’s old REPAYE payment would be higher than standard repayment refinanced at 5% or below.

Historically, many MBAs took advantage of private sector refinancing terms instead of income-driven repayment plans. When private sector refinance rates were as low as 2%, sticking with the government plans and having balances grow made little sense for those with high, stable incomes.

STANDARD REPAYMENT REFINANCED AT 5%

Sarah, like many MBAs, could be an attractive candidate to refinance debt because she has a low debt to income ratio. She has $80,000 in loans, but a salary of $150,000.

If Sarah has good credit, depending on market conditions, she may be able to refinance her loans at less than 6.8% interest. For example, a 5% interest rate would translate to a monthly payment of $849 saving Sarah $8,654 in interest over the 10-year loan period. (Interest rates will vary based upon market conditions. As of February 2023, 5% refinance rate may be possible for borrowers with good and excellent credit scores.) Even if Sarah sticks with REPAYE in years 1 & 2, she should likely refinance in year 3 when payments under REPAYE or other IDR plans rise.

REPAYE has historically NOT been a good option for many MBAs because standard repayment at a low or moderate interest rate led to lower payments than an IDR plan.

STANDARD REPAYMENT, NO REFINANCING 

This is the option that requires the least work. Sarah does not have to sign up for an IDR plan or refinance her loans. She would have a $921 per month payment and would pay $110,477 over 10 years to become debt free. Since many MBAs with higher salaries can make extra payments this can still be a good option especially if interest rates keep rising and refinancing debt is less attractive.
Conclusion

The new Biden repayment plan will dramatically cut loan payments for most borrowers including prospective and current MBA graduates. This plan is good news for new and prospective MBA students looking at large student loan balances and uncertain job prospects.

As a result of these changes, the Penn Wharton Budget plan estimates that the number of graduates participating in IDR plans will more than double. Currently, 33% of borrowers are on IDR plans. This may jump to 70% or more of balances because of changes in the new plan. MBAs should consider if the new IDR plans are the best option for them.

Finally, while the new plan is good news for borrowers, it may also put more upward pressure on tuition. If individuals know the government will foot more of the bill, they may borrow more expecting loan forgiveness and subsidized repayment.

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Eryn Schultz is the founder of Her Personal Finance.  In 2015, she graduated from Harvard Business School and realized that she and her classmates were better equipped to manage a corporate balance sheet than their own finances.  Through her online classes, she has helped hundreds of students decide how to balance paying off student loans with saving for retirement, figure out how much cash to keep on hand, and finally feel confident investing outside of a 401K. Eryn has spoken to women’s groups at Amazon, Mass General Hospital, Harvard Business School, and Kellogg Business School, and you can see some of her work on Instagram and has been featured in publications including Forbes, NPR, Fortune, Real Simple, CNBC, and BuzzFeed. For more insights from Eryn, sign up for her email list here.

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