• The Disappearing College Loan

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    A new federal program should make it easier for some recent college graduates to keep their student-loan payments manageable.

    The new option, known as the “Pay as You Earn Repayment Plan,” lets eligible borrowers sharply lower their monthly loan payments and qualify for loan forgiveness quicker than they might otherwise.

    The University of California, Los Angeles

    “It’s a very good safety net for students who borrow too much,” says Mark Kantrowitz, publisher of the financial-aid site FinAid.org. “If your debt exceeds your annual income, you will probably benefit.”

    The new program comes at a time when rising student-loan balances—amid a still shaky job market—have weighed heavily on many families.

    The amount of student-loan debt outstanding has swelled to nearly $1 trillion. Payments on 11% of student-loan balances were 90 or more days behind at the end of September, according to the Federal Reserve Bank of New York, the most recent data available.

    Typically, federal student loans must be repaid within 10 years. At current interest rates, that can work out to a monthly payment of roughly $300 for a borrower with $26,000 in debt.

    Pay as You Earn, by contrast, limits student-loan payments to 10% of “discretionary income” as defined by government formulas. Borrowers who make regular payments could have the remaining unpaid amounts forgiven after 20 years.

    In some cases, borrowers with low incomes could be required to make a zero-dollar payment and would still be considered current on their loan. Monthly payments can increase or decrease each year based on the borrower’s income and family size.

    The new program is more generous than the Obama administration’s Income-Based Repayment Plan, or IBR, launched in 2009. IBR caps loan payments at 15% of discretionary income, and borrowers can have unpaid amounts forgiven after 25 years.

    Under both programs, borrowers with public-service jobs may qualify for loan forgiveness after just 10 years.

    Pay as You Earn, which took effect on Dec. 21, “is designed to help offset the effects of the recession for student borrowers most likely to take a hit in this tough job market,” says Lauren Asher, president of the Institute for College Access and Success, which has pushed for the creation of income-based repayment plans. The government estimates that roughly 1.6 million of the 37 million borrowers with federal student loans could qualify for the new option.

    Pay as You Earn is available only to borrowers with federal direct student loans, but other borrowers can consolidate existing federal student loans into a direct loan to take advantage of the program, provided they meet other requirements.

    To be eligible for the program, borrowers must have taken out their first federal student loan after Sept. 30, 2007, and received at least one federal student loan after Sept. 30, 2011. Borrowers also must meet eligibility cutoffs based on the size of their debt, their discretionary income and family size.

    The U.S. Department of Education’s Pay As You Earn calculator, available at studentaid.gov, can help you determine if you qualify. Borrowers can apply for the program online or by contacting the loan servicer that collects their payments on behalf of the federal government.

    The new program isn’t for everyone. Since the loan is repaid over a longer time period, some borrowers could wind up paying more interest than they might have otherwise.

    To remain in the program, borrowers also must provide their loan servicer with updated information about their income and family size each year.

    Under current federal rules, many borrowers could face a tax bill on the amount of debt that is forgiven. Debt forgiven under the public-service loan-forgiveness program is currently tax-free.

    Besides adding a new repayment option, the government has taken some steps to make it easier to qualify for a repayment plan by, for instance, allowing borrowers to input and update their tax information online.

    Still, the process can be cumbersome, says Nancy Coolidge, a policy analyst at the 10-campus University of California system. She advises borrowers to follow up with their loan servicer if they don’t get confirmation they have been enrolled in the program, and to pay their federal student loans electronically.

    With IBR and Pay as You Earn, Ms. Coolidge says, “there is no reason for any borrower to be in delinquency or default on a federal student loan.”

    Write to Ruth Simon at ruth.simon@wsj.com

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