More than 40 million Americans currently owe nearly $1.5 trillion total in student loan debt, and for many, the monthly payments on those loans create an insurmountable financial burden.
The payments are simply too high given what they earn. That’s where Income-Driven Repayment Plans come in.
What is an Income-Driven Repayment plan?
If you have federal student loan debt and you’re not in a position to refinance student loans, The U.S. Department of Education offers various repayment plans, including Income-Driven Repayment (IDR) Plans that set your monthly loan payments at an amount that factors in your income and family size.
To ensure what you pay each month is affordable for your particular financial situation, your monthly payment is set as a percentage of your discretionary income, typically between 10% and 20%, based on the plan.
IDR plans are an alternative to the Standard 10-year Repayment Plan, which is the default for federal student loans. The SRP requires you pay off your loan balance in ten years or less and sets your fixed monthly payments at a minimum of $50 per month.
The benefits of the Standard Repayment Plan are that you end up paying less than other repayment plans because of the relatively short repayment term, and you relieve yourself of your student loans in just ten years.
While IDR plans can offer you some relief in the form of lower monthly payments, keep in mind that you are not saving money on these plans.
In fact, you’ll end up paying more overall, since IDR plans lower your monthly payments by stretching out your repayment term, and interest will keep accruing during this time. Instead, the value of an IDR is that it allows you to pay what you can afford based on your circumstances.
How to calculate discretionary income
Before we get into the different types of IDR plans that are available, it’s helpful to review what “discretionary income” means. You’ll see that term used in reference to each different IDR plan because it serves as the foundation for determining your monthly payments.
Your discretionary income is generally the difference between your yearly income and 150% of the annual poverty guideline — a figure released by the federal government — for your household size. The idea is that this number shows how much money you have available after you pay for necessities.
Your IDR payment is based on the notion that you can pay some portion of that “extra” towards student loans without compromising your ability to pay for the basics you need to live.
Here’s an example: for a single-person household within the 48 U.S. contiguous states, the 2017 federal poverty guideline is $12,060. One-hundred fifty% of that is $18,090.
If you earn $25,000 a year, your discretionary yearly income is $25,000 minus $18,090, or $6,910. That works out to about $576 a month.
You can check out the poverty guidelines for every household size here, and compute your own discretionary income.
Income-Driven Repayment and loan forgiveness
You’ll also notice that all IDRs offer loan forgiveness at either twenty or twenty-five years, depending on the type of IDR. That means once you hit that deadline after making consistent qualifying monthly payments, you are not responsible for paying off whatever balance remains.
However, keep in mind that the forgiven balance may be taxable as income.
If you work full-time for a non-profit or for the government, you may be eligible for the Public Service Loan Forgiveness (PSLF) program, which forgives your remaining balance after as little as ten years of qualifying payments made under any IDR plan.
Although you can’t apply for PSLF until you make 10 years worth of qualifying monthly payments, you should start submitting the Employment Certification form annually or when you change jobs if you think you’ll pursue this option. So, when you hit that ten-year mark you won’t need to submit certification information from each of your relevant employers from the past ten years.
Any debt forgiven through PSFL is entirely tax-free.
Income-Driven Repayment plan options
The U.S. government offers four different types of IDR plans, each with its own requirements, eligibility rules, and benefits.
- Income-Based Repayment (IBR): The specifics for an IBR plan differ depending on whether or not you got your loan before July 1, 2014. If you did, you’re considered an “old borrower” and your monthly payment is generally 15% of your discretionary income and your loan is forgiven after 25 years of qualifying payments. If you’re a “new borrower” — if you acquired your loan on or after July 1, 2014 — the payment is generally 10% of discretionary income and loan forgiveness kicks in after twenty years
- Pay As You Earn (PAYE): With PAYE, you generally pay 10% 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 (REPAYE): Like PAYE, REPAYE, which first became available in December 2015, sets your monthly payments at 10% of discretionary income. It will take 25 years of payments to qualify for loan forgiveness if you have graduate school debt, and 20 years if you have undergraduate debt
- Income-Contingent Retirement Plan (ICR): Your payment amount is whichever is less: 20% of your discretionary income, or what you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income. Depending on your income, payments could end up higher than with the Standard Repayment Plan. Loan forgiveness kicks in at twenty-five years.
Use the following chart to compare the various IDR plans, and find the right one for you.
Is an Income-Driven Repayment plan right for you?
To help you decide what plan might be best for you, we have outlined the pros and cons of these Income-Driven Repayment Plans.
PROS
- Lower monthly payments: By definition, your 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
CONS
- 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.
Choosing the right Income-Driven Repayment plan (Standard, PAYE or REPAYE)
As you can see, there are a number of IDR plans available, each serving different needs. It’s important to ensure that you understand the details and eligibility requirements of each of these plans, and choose the right plan for you.
Partial financial hardship requirement: Both IBR and PAYE require that applicants show partial financial hardship to be eligible. That means the annual amount due on all of your eligible loans (and, if you are required to provide documentation of your spouse’s income, the annual amount due on your spouse’s eligible loans) exceeds what you would pay under IBR or PAYE.
REPAYE and ICR don’t have financial hardship requirements, and therefore no income limits.
- Loan origination dates: IBR and PAYE both have loan date requirements. To be eligible for PAYE, you can’t have a loan that you took out before October 1, 2007, and your Direct Loans must have disbursed after October 1, 2011. Your monthly payment on an IBR plan will differ based on your loans origination date — if your loans originated prior to July 1, 2014, your monthly payment will be15% of your discretionary income, whereas on loans from or after July 1, 2014, you’ll pay 10% of your discretionary income. REPAYE and ICR have no loan origination date restrictions
- Tax filing with spouse: If you file jointly, all IBR plans take into account both your income and debt, and that of your spouse, to calculate your monthly payment. If you file separately, only REPAYE takes both of you into consideration. The other plans disregard your spouse in that scenario
- Loan types: If you have only direct loans — which are the most common type of federal loan, with about 32 million borrowers currently — you can choose from all four IDR plans. If you have FFEL (Federal Family Education Loan) Program loans, IBR is your only option. If you consolidate your FFEL Program loans into a Direct Consolidation Loan, however, you’re eligible for REPAYE, PAYE, and ICR plans. You can check out what specific loans are eligible for each of the four IDR plans here
- Payment caps: Although all four plans use your income to calculate monthly payments, both PAYE and IBR cap your payments at what they would be under the 10-year Standard Repayment Plan. So even if your income goes up substantially while you’re making payments, you’ll never pay more than what you would pay on the Standard 10-year plan. REPAYE and ICR have no payment caps. This means that if your income increases over time, in some cases your payment may be higher than the amount you would have to pay under the 10-year Standard Repayment Plan
Generally, you’ll want to use whichever IDR you’re qualified for and will give you the lowest monthly payments.
While your own eligibility and circumstances are unique, many debtors find that REPAYE is the best bet of the IDR options, due to the fact that it is the least restrictive — all direct loans are eligible, and there are no limits based on income level or loan dates.
However, if you’re married, you’ll need to factor that into whether REPAYE is still your optimal choice given the fact your spouse’s income and debt play a role in your monthly payment calculation. PAYE may be more advantageous in that scenario.
You should also keep in mind that if you’re paying off graduate school debt, REPAYE stretches payments to 25 years.
There are many other considerations, of course, and you should review your specific situation with your loan servicer to ensure you get the IDR plan right for you.
To help you understand the nitty gritty details of REPAYE, we’ve put together a guide that will quickly get you up to speed. Our guide includes a breakdown of how REPAYE stacks up against Standard Repayment Plans if you’ve consolidated your loans (hint: it stacks up very well).
Applying for an Income-Driven Repayment plan
To apply for an IDR plan, you must submit an application called the Income-Driven Repayment Plan Request. You can do it online via StudentLoans.gov (you’ll need to use your Federal Student Aid ID to sign in) or on paper, which your loan servicer can supply.
The application will ask you to either select one of the four IDR options by name, or specify that you want your loan servicer to determine the IDRs you qualify for, and to put you on the one with the lowest monthly payments.
If you apply online, you can choose to have the IRS Data Retrieval Tool in the application transfer your income information directly from your federal income tax return. This ensures you submit accurate facts and your application is processed as quickly as possible. If you submit on paper, you’ll need to provide a copy of your most recent federal tax return.
If your income has changed since you filed your tax return, you can provide alternate acceptable income documentation — your loan servicer can help with that.
Re-certifying your Income-Driven Repayment plan
Every year, you must recertify your IDR plan, to verify you’re still eligible for it and to ensure your monthly payments reflect your current income. Be aware that your monthly payments are subject to change each time you recertify.
You’ll need to provide current proof of income, your spouse’s relevant information, and your current family size. Even if nothing has changed since the prior year, recertification is required to ensure your monthly payments are still calculated appropriately.
Failure to recertify on time can result in your monthly payment reverting to the amount you would pay under the Standard 10-year repayment plan, which may be significantly higher than your monthly payment on an IDR plan. This can result in an overdraft of your bank account if you set up automatic payments.
If your income drops or your household size increases before your annual recertification is due, you can submit a request to recalculate your monthly payment, either online or on paper through your service provider. You’re only required to submit recertification annually, but if your situation makes you eligible for lower payments, those changes can go into effect right away.