Is an Income-Driven Repayment Plan for Your Federal Student Loans a Good Idea?
With the cost of attending college inching higher and higher, it’s not entirely uncommon to find yourself with a debt burden your current income can’t accommodate.
Luckily, there is a solution.
If your federal student loan payments are higher than your income, or they would make it hard to pay the rest of your financial obligations, you could qualify for one of their income-driven repayment plans.
As with anything, there are pros and cons along with a list of requirements and stipulations you should be aware of.
Here’s what you need to know.
Types of Income-Driven Repayment Plans
There are three main types of income-driven repayment plans for federal student loans: Income-Based Repayment (IBR Plan), Pay As You Earn (PAYE Plan), and Income-Contingent Repayment (ICR Plan).
The IBR Plan requires that you pay 15% of your discretionary income, the amount that is left over after taxes and living essentials have been paid, if you aren’t considered a “new borrower.” If you are considered a new borrower, you are required to pay 10% of your discretionary income.
New borrowers are those who do not have an outstanding balance on a Direct Loan or Federal Education Loan (FFEL) as of July 1, 2014.
The repayment period for these plans are 20 years for new borrowers and 25 years for those not classified as new.
The PAYE Plan also requires payment of 10% of your discretionary income with a repayment period of 20 years.
However, the ICR Plan is slightly more complicated, requiring the lesser of 20% of your discretionary income or, according to StudentAid.edu, “what you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income.” The repayment period for these plans sits at 25 years.
For all plans, once the repayment period is reached, the remaining balance is forgiven. These repayment periods can include payments under certain other plans and periods of deferment due to economic hardship.
Knowing If You’re Eligible for an IBR Plan
In order to be eligible for both IBR and PAYE Plans, the required loan repayment amount should be less than the amount you would pay under the Standard Repayment Plan with a 10-year repayment period. The Standard Repayment Plan is the basic plan for Direct Loans and FFEL Loans.
However, if your annual student loan debt is higher than your annual discretionary income, or if your debt consumes a significant portion of your annual income, you will likely qualify.
Without an initial income requirement, eligibility for the ICR Plan only requires that you have eligible federal student loans. While this plan is open to more borrowers, it could come with a higher payment amount than IBE, PAYE and Standard Loan Repayment Plans, so make sure you run the numbers before settling on this plan.
Understanding the Pros and Cons of IBR
If paired with the right candidate, these repayment plans should lessen the financial burden of high student loan debt. Monthly payments should then be much easier to manage at current income levels alongside other financial obligations. In addition, payment amounts fluctuate with income, so financial hardship won’t push you into default. That alone should offer great peace of mind.
Another huge benefit to these plans is the forgiveness offered at the end of the repayment period.
On the other side of the coin, extending the repayment period from the standard 10-year to 20-25 years means the amount of interest you pay over the life of the loan increases drastically. The smaller the payments and the longer the period of repayment, the more money out of your pocket in the long run.
Another downside that many are unaware of is the tax requirements of forgiven debt. If you’ve reached the end of your repayment period and still have a balance on your loans, the remaining forgiven amount can be seen as additional income by the IRS. Therefore, you would be required to pay income tax on that amount. For those already struggling financially, this can be a large burden to bear.
Do Your Research
Finding the best option for your level of student loan debt, income and current financial obligations requires research. Make sure to look into each program and run the numbers to determine which would provide the most relief and the best chance to build a solid financial foundation moving forward.
The Federal Student Aid Repayment Estimator can help you run the numbers.
More Questions about Income-driven Repayment Plans?
About the Author
Kayla Albert is a writer and content strategist committed to helping others build a solid financial foundation in order to live their best life possible. You can read more of her writing at KaylaAlbert.com.