Graduates get option to repay student loans based on income

— -- What's worse than graduating from college with no job and no prospects of finding one anytime soon?

Graduating from college with no job, no prospects and thousands of dollars in student loans.

That's the grim outlook for thousands of graduates who are looking for work in a take-no-prisoners job market. The average undergraduate leaves college with more than $22,000 in debt. Many graduate and professional students leave with loan balances of $100,000 or more.

Most borrowers are required to start repaying the loans within six months after graduation. If you're unemployed or suffering other economic hardship, you can apply to have payments deferred for up to three years. But depending on the type of loan, interest may continue to accrue during that period, which means you'll have an even bigger balance when you resume payments.

Starting July 1, borrowers will have a new option: a repayment program that caps monthly payments based on income. It targets borrowers who would have a hard time paying basic living expenses if they had to make standard monthly payments on their loans, says Lauren Asher, acting president for the Project on Student Debt.

Under the income-based repayment program, such borrowers will never have to spend more than 15% of their discretionary income — an amount based on federal poverty guidelines — on student loan payments. Most who qualify for the program won't spend more than 10% of their income on student loans. Those whose income falls below 150% of the poverty level (see box) won't be required to make any payments, Asher says.

Here's an example of how it would work: Suppose you have $30,000 in student loans, and you estimate that your 2009 income will be $25,000. Assuming your loans have a fixed interest rate of 6.8%, your monthly payment under the income-based repayment program would be $110, vs. $345 under a standard 10-year repayment plan.

If your income rises in the future, your payments will, too.

For some borrowers, the reduced payments won't cover the interest on their loans. For those with subsidized Stafford loans — which are provided to students who demonstrate economic hardship — the government will pay the interest for the first three years of the program. For unsubsidized loans, the interest will be added to the balance, so you could come out of the program with a larger loan balance.