Don’t worry if the options seem overwhelming, and the details appear indistinguishable. Keep reading; it is well worth the time it takes to find the best plan for your situation, because it could mean significantly less stress in your life.
In order to make loan repayment more manageable, the U.S. Department of Education has started offering more income based repayment options individualized for each borrower’s current financial situation. The federal government offers several different income-driven repayment plans for federal student loans. But what exactly is the IBR program for student loans? And what is pay as you earn? Let’s break it down.
Income-based repayment and other income-driven plans
- Income-Based Repayment (IBR): Payments are equal to 15 percent of discretionary income, with loan forgiveness after 25 years (not a new borrower after July 1, 2014), or 10 percent of discretionary income with loan forgiveness after 20 years (new borrower after July 1, 2014); never requires more than the 10-year Standard Repayment Plan monthly payment amount.
- Pay As You Earn (PAYE): Payments equal to 10 percent of your discretionary income with loan forgiveness after 20 years of payments; never more than the 10-year Standard Repayment Plan monthly payment amount.
- Revised Pay As You Earn Repayment (REPAYE): Like PAYE, REPAYE sets your monthly payments at 10 percent of discretionary income. REPAYE is open to more borrowers, but if you have graduate school debt, it will take 25 years of payments to qualify for loan forgiveness.
- Income-Contingent Repayment (ICR): Payments are the lesser of either what you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income or 20 percent of your discretionary income. Under ICR, federal student loans are forgiven after 25 years of payments.
To be eligible for the IBR and PAYE plans, you must demonstrate a “partial financial hardship” as determined by income, family size, and loan amount. Any borrower may utilize the REPAYE and ICR plans as an option. To help you decide what plan might be best for you, we have outlined the pros and cons of these Income-Driven Repayment Plans:
- Lower monthly payments: By definition, you monthly payments under the Income Based Repayment and Pay As You Earn plans must be lower than they would be under the 10-year Standard Repayment Plan. This should make your payments more manageable and can free up money to put towards other expenses.
- Loan forgiveness: If you have a remaining loan balance after the 20 or 25 years (depending on the program), the balance will be forgiven.
- Public Service Loan Forgiveness program: By repaying your loans through one of the Income-Driven Repayment Plans, you may be eligible for your loan balance to be forgiven after 10 years of timely payments through the Public Service Loan Forgiveness (PSLF) program. This, of course, only applies to certain career fields. An extra pro to this is that the forgiven balance is tax-free!
- Payments change with income: With all three Income-Driven Repayment Plans, you are not locked-in to fixed monthly rates. Your payments will change as your income changes, ensuring that your monthly payments are always affordable. Even if your income drops to zero, your payment will be adjusted to zero and still count as a timely payment towards your loan.
- Larger overall interest payments: Because you will be making smaller payments over a longer period of time through these income based repayment plans, the total amount of interest you will pay over the life of the loan will be higher compared to the 10-year Standard Repayment Plan. Though no one wants to pay more than they have too, it may be worth the trade-off of having affordable monthly payments.
- Longer loan term: All three of the Income-Driven Repayment Plans extend the term of the loan — to as long as 20 or 25 years, twice as long as with the 10-year Standard Repayment Plan. Depending on the size of your monthly payment, you may pay off your loan before you qualify for loan forgiveness — after 17 years, for example.
- Taxes on forgiven debt: Though these repayment plans may allow any remaining loan balance to be forgiven after 20 or 25 years, the forgiven balance may be taxable as income. The Public Service Loan Forgiveness Program is entirely tax-free.
- Required to provide income information: You are required to provide updated income and family size information to your loan servicer annually in order to continue to qualify for these repayment plans. This may not be a major con for everyone, but it can add to the headache of loan repayment. If you forget to provide this information, you will be dropped from your current plan and put on the 10-year Standard Repayment Plan.
- Not all loans qualify: These Income-Driven Repayment Plans are only available for federal student loans, and not all federal student loans qualify.
In general, these Income-Driven Repayment plans are best for borrowers whose monthly payment on their federal loans is more than or a sizable portion of their discretionary income. Remember that signing up for a repayment plan such as IBR does not mean you have to stick with it forever; you can always reevaluate in a few years if your financial situation changes.
Credible is a multi-lender marketplace that allows borrowers to get personalized rates and compare loans from vetted lenders, without affecting their credit scores.