Community College Students: New Forgiveness Rules Can Mean Free Education

Unsure how you feel about pursuing higher education given the costs? Considering the price tags of some four-year schools, community college can be an attractive and more affordable choice for some students.

But what if community college was free?

Student loan forgiveness might soon be within reach through minimal to no payments. It sounds crazy, but this might become reality for graduates of community colleges with federal student loans under new income-driven repayment (IDR) plan language, specifically for the Revised Pay As You Earn (REPAYE) plan.

Proposed changes for the new REPAYE plan

The Biden-Harris administration announced plans to modify the existing REPAYE plan, which is already one of the more attractive IDR plans. For undergraduate loans, the required payment would be based on 5% of your discretionary income, instead of 10%. Additionally, the deduction to your adjusted gross income based on the poverty guidelines of your family size (which dictate the discretionary income calculation) would increase to 225% from 150%.

Forgiveness in REPAYE is already available over a 20-year period for undergraduate borrowers, or a 25-year period for graduate borrowers. The new REPAYE plan proposes a shortened time frame based on the original principal balance. 

If you have $12,000 or less in loans, loan forgiveness would be reached after 10 years. For every $1,000 above that, an additional year of monthly payments would be required up to $22,000, and respectively 20-years. This makes any balance over $22,000 forgivable over the 20- or 25-year period whether you’re an undergraduate or graduate borrower.

Two more notable changes to new REPAYE that could make community college free are the increase from 50% to 100% of an unpaid interest subsidy, meaning your balance can’t increase. Second, rather than ignoring tax-filing status and always requiring spousal information — if you’re filing taxes separately — you can exclude spousal information from the required payment calculation.

These proposed changes for new REPAYE may be available as early as July 2023.

How new REPAYE will lead many to free community college

With a lower monthly payment, a faster forgiveness timeline, a balance that can’t increase with interest, and the ability to exclude spousal income, new REPAYE is arguably the most exciting thing to happen to federal student loans for community college graduates.

Let’s explore how this all adds up.

New REPAYE example #1: Single

Let’s say you graduate with $15,000 of Direct Stafford Loans, are single, and start earning $36,000 a year with 3% annual pay increases. You also make annual pre-tax retirement (IRA or 401k) contributions of 10%.

Your required monthly payment in new REPAYE would be $0 each year based on your income and family size. Your balance would not grow due to the unpaid interest capitalization and you would reach forgiveness after 13 years of making the required $0 monthly payment.

Generally, forgiveness through IDR plans like REPAYE is taxable. If you were hypothetically taxed on an additional $15,000 at a 22% federal income tax rate and a 3% state tax rate, then you’d owe approximately $3,760 in taxes. 

A savings rate of approximately $18 monthly starting after graduation would be enough to satisfy this tax obligation if the account earned a hypothetical 3% rate of return.

While neither are certain, I probably overestimated the taxes there by not using our marginal tax system, too – so, you’re looking at solving your $15,000 of student loan debt with $13 a month for 13 years. All of which would satisfy some additional taxes owed in year 14. Not so bad.

New REPAYE example #2: Married with a child

Now let’s consider graduating community college with $20,000 in federal student loans and above-average pay. A dental hygienist is married with one kid and starts out earning $70,000 annually. They contribute 20% of pre-tax income to their 401(k) plan, and their spouse doesn’t earn income.

Due to their higher family size of 3, and spouse who doesn’t have taxable income, the hygienist’s required monthly payment in new REPAYE is $0. Here’s how the math works:

$70,000 (salary) – $20,000 (pre-tax 401(k) contribution) = $50,000 assumed AGI

$50,000 AGI – 3 (2023 HHS Poverty Guideline family size) x 225% ($24,860 x 2.25) = discretionary income of $0. 

Their required payment length before forgiveness would be 18 years.

Married, and filing taxes jointly, they’re in a lower tax bracket. Using 12% federal income tax and 0% income tax for a state, like TX, they would owe an assumed $2,400 in tax.

A savings rate of $9 monthly would be necessary to satisfy the $2,400 owed in 19 years if it grows at a hypothetical 3% rate of return.

What if loan forgiveness tax liability for IDR plans goes away?

In both examples, the required payments are $0 for the length of term, but taxes might be owed on the forgiven balance. 

Forgiven student loans through IDR plans is currently untaxed federally through the end of 2025 due to the American Rescue Plan Act. If legislation like this is extended, or forgiveness through IDR plans is no longer taxed (like for Public Service Loan Forgiveness), then paying back federal loans after community college could be entirely free. Of course, this depends on your loan balance, income and family size.

Calculate your potential payments using our new online calculator for the new REPAYE plan. 

If you’re thinking about community college as an option for you, check out our guide on getting student loans for community college. For ongoing updates about IDR and REPAYE changes, subscribe to our newsletter.