Help with student loans for many, but not all

New government program aimed at making debt more manageable is a boon for many struggling graduates, but there are a few catches.

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NEW YORK (CNNMoney.com) -- The government's new student loan reform plan gets good grades from graduates with low-paying jobs struggling under a lot of debt. But it's on probation from some borrowers, including married couples and those who will be subject to a new tax liability.

The Department of Education's income-based repayment program, which went into effect July 1, is designed to make to make repaying student loans more manageable and could even result in debts being forgiven for some borrowers.

Under the program, a borrower's monthly student loan payment is tailored to their income, debt load and family size. The aim is to make loan payments less of a strain on cash-strapped households.

An unfortunate dilemma: For married couples who file taxes jointly, the program compares the couple's combined income with the individual student loan debts of each spouse. In some cases, this means one or both spouses could be ineligible for the program, since their combined income looks high relative to their individual debts.

"Married borrowers who file jointly have an unfortunate dilemma," said Lauren Asher, president of the Institute for College Access & Success, a non-profit advocacy group that seeks to make higher education more affordable. "They could face payment caps twice as high as couples that files taxes separately or (someone who) is not married."

For example, a family of four in which both spouses earn $30,000 would not qualify for the program if they each had $25,000 in student loans. That's because their individual debts are smaller compared to their combined $60,000 income.

However, an individual with $25,000 in student loans and an adjusted gross income of $30,000 could see his or her monthly payments reduced by 40% under the program.

But if a couple files taxes separately, they could miss out on other benefits meant for married couples, Asher said.

The Department of Education said it has agreed to revisit the rules for married couples and could amend the program in July 2010.

Forgive and forget?: In some cases, the program makes it possible for borrowers to have their loans forgiven after 25 years, and graduates working in public services fields could see their debts canceled after 10 years.

The potential for loan forgiveness is one of the program's main attractions. But a borrower who meets the requirements for loan forgiveness after 25 years could get hit with a bill from the IRS.

Under current tax laws, the amount of student loan debt discharged after 25 years in program is considered taxable income. For those working in public service, however, forgiven student loan debt is not taxable.

"Most people will be able to pay off their debts within the 25-year window," Asher said. "But saddling those who can't with a tax liability is unfair."

A bill working its way through Congress would make forgiven student loan debt exempt from taxation.

An improvement: To be sure, many struggling graduates will benefit from the program.

"This is really good news for consumers," Asher said. "With a simple process, a borrower can get their loan payments under control, stay in good standing and know that if they fall on hard times it won't ruin them."

Of course, making a smaller monthly payment means the life of the loan is extended, which could result in higher interest. Also, the program does not cover loans made to parents and those not subsidized by the government.

Still, the program will result in savings of $458 a month for one borrower. The 41- year-old Seattle resident, who asked not to be named, said the monthly payment on her $120,000 debt will be reduced to $451 from $909 under the new plan.

"This repayment option is making my student loan seem manageable for the first time ever," the borrower said. "I was worried that I'd end up going into default over my student loans, now there's a light at the end of the tunnel."

What's more, the program could help encourage students to pursue traditionally low-paying careers in public service, such as nursing, education and the military.

"Under this new program, students no longer have to choose between serving their nation and communities and tackling a mountain of college debt," said Sen. Edward Kennedy, D-Mass., in a statement. "Our nation is better and stronger when the best and brightest young Americans choose careers in public service."

Michelle To, who will borrow $260,000 to pay her way through medical school, said the program helped convince her to become a primary care physician.

"Every doctor I've shadowed talks about being in debt for the rest of their lives," said the 24-year-old Los Angeles native. "I wasn't sure I wanted to make that step."

To, who starts medical school later this year, said she hopes to work for a non- profit organization after she graduates, and that she expects to earn about $170,000 a year. With her debt load, that means To would probably qualify for the program.

"If not for this program, I'm not sure what I would do," she said. "It's a huge weight off my shoulders." To top of page

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