An income-driven repayment plan can help to alleviate some of the financial stress of repaying your student loans. Although you will still have to make monthly student loan payments, this repayment option will take your income into account.
If you have a lower income with a relatively high student loan payment, then an income-driven repayment plan could offer the reprieve that your budget needs. However, it is not the right choice for everyone.
Let’s take a closer look at this student loan repayment option.
What types of income-driven repayment plans are available?
When you take out federal student loans through the Department of Education, the standard repayment schedule is ten years.
But that timeline might not be an affordable option depending on your loan balance and current income. If you have a high student loan balance, it can be difficult to make high monthly payments as you start your career.
Since many borrowers struggle to keep up with their student loan payments, the federal government has several income-driven repayment plans.
As the name suggests, the payment you’ll make is based on your income. With that, you can continue to make student loan payments at a more affordable percentage of your income.
Each of these income-driven repayment options is based on your discretionary income. You can calculate your discretionary income by finding the difference between your adjusted gross income and 150% of the annual poverty income in your state for a family of your size.
Since these repayment plans are based on your discretionary income, your monthly payment should become more manageable.
Currently, there are four income-driven repayment plan options. We will cover each below.
1. Income-Based Repayment
With the income-based repayment plan (IBR), you’ll make payments each month for 10% or 15% of your discretionary income. However, your payment will never exceed the 10-year standard repayment amount.
If you were issued your first federal student loan before July 1, 2014, then your payments will be limited to 15% of your discretionary income. After making payments for 25 years, you will be eligible for loan forgiveness.
If you were issued your first loan after July 1, 2014, then your payments will be limited to 10% of your discretionary income. After making payments for 20 years, you will receive loan forgiveness.
2. Pay As You Earn
Pay As You Earn (PAYE) will allow you to make payments equal to 10% of your discretionary income. But the payment will never exceed the standard repayment plan amount. If you make payments for 20 years, then you may qualify for forgiveness through this option.
If you took out a federal student loan before October 1, 2007, then you may qualify for this option. However, you’ll need to prove that you need repayment assistance.
3. Revised Pay As You Earn
Revised Pay As You Earn (REPAYE) was introduced three years after the PAYE program. Like the PAYE program, your payments will be equal to 10% of your discretionary income.
However, this program doesn’t note an upward limit on your monthly payment. That means that you might end up paying more on a monthly basis than the standard repayment plan at some point.
If you choose this option for your undergraduate student loans, then you will qualify for forgiveness after 20 years of payments. If you are using this option for graduate student loans, then you’ll need to make payments for 25 years before forgiveness is an option.
4. Income-Contingent Repayment
The final option for income-driven repayment plans is the income-contingent repayment plan. The monthly payment will be 20% of your discretionary income or what you would pay to repay the loan in a 12 year period. You’ll be allowed to pay the lesser of these two options.
After making payments for 25 years, you may qualify for student loan forgiveness.
Which income-driven repayment plan is best?
The appeal of an income-driven repayment plan is that you can potentially lower your monthly payments. Each of the repayment plans offers a way to reduce the strain on your budget. However, the plans are not created equally.
The income-based repayment plan could do the most to alleviate your budget in the short-term. But the choice will boil down to the loan balance you are dealing with and your annual income.
Take advantage of the free loan stimulator offered by the U.S. Department of Education. It can help you understand the options you have for your specific loans.
What to consider before applying for an income-driven repayment plan
Before you take the plunge with these repayment plans, take these factors into account.
You may pay more interest paid over time
A lower monthly payment might sound like a blessing; and it definitely can be when your budget is stretched to the max. However, there is a downside to making lower monthly payments.
Instead of knocking out your loan balance in the standard ten-year timeline, you’ll stretch out your payments for many more years. With that, you’ll also pay more interest over the course of the loan. No one wants to pay more interest on their loans, but it might be a necessity to enjoy a lower monthly payment.
There might be a lot of paperwork to update your status every year
The repayment plans offered are all based on your discretionary income which can change based on your family size and budding career.
With that, you’ll be required to file a hefty amount of paperwork each year. The paperwork will allow your loan servicer to accurately calculate your loan payment for the upcoming year.
You may have to pay taxes on the balance forgiven
Depending on your repayment plan, you might qualify for loan forgiveness at some point. When the balance of your loan is forgiven, you might be required to pay taxes on that balance.
Unfortunately, that could be a large hit to your savings. Make sure to consider the taxes before signing up for loan forgiveness.
Your current budget
Yes, there are some drawbacks to income-driven repayment plans. But if you are truly struggling to make ends meet with a large student loan payment, then you should consider these options.
Alleviating your current financial stress could be a necessity.
How to apply for an income-driven repayment plan
If you’ve decided that one of these plans is a good option for you, then here’s what you’ll need to apply.
1. Collect the documents you need
Before you start the process, take a minute to collect all of the documents you’ll need. Gather these items to make the process flow smoothly:
- Your Federal Student Aid ID. You should be able to find this by signing into your federal student loan account.
- Tax return information. There is an IRS Data Retrieval tool available within the application, but make sure that you have your Social Security Number ready to go.
2. Fill out an application
You can apply for an income-driven repayment plan through the FederalStudentAid website. The application is an online form that will ask you for a range of information. If you’ve already collected your documents, then this process should be a breeze.
Is income-driven repayment a good option for you?
As you evaluate your student loan repayment options, consider what your budget can reasonably support. If you cannot support your current payment, then IDR might be a good choice for your situation.
However, make sure that you fully understand the tax and interest consequences of how your student loans work. Otherwise, you might encounter an unpleasant surprise.
If you are working to balance your student loan obligations and long-term financial goals, then you might not want to move forward with IDR options. Instead, eliminating your student loan debt quickly could allow you to focus on other goals such as buying a home.
Don’t feel like you have to navigate this process without help! We have many resources readily available on Clever Girl Finance to help you on this journey. Check out our free courses that can help you understand how student loans really work.