How Does Discretionary Income Affect Student Loan Repayments?

It matters if you seek income-driven repayment

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Your discretionary income might not be something you think a lot about in your everyday life, but it’s highly important if you choose to pursue Income-Driven Repayment (IDR) for your student loans. That’s because the federal government sets your monthly student loan payments based on your discretionary income. 

The government doesn’t want you to have to repay your loan out of funds that are essential for you to survive, but they will set your repayments based on the income that would otherwise be used for what they deem to be discretionary spending.

If you’re thinking about an IDR plan, you can quickly determine what your monthly payments will look like by understanding how to calculate your discretionary income. 

What Does Discretionary Income Mean?

If you’re thinking of your budget in the broadest terms, you’ll probably notice that your spending breaks down into two separate categories: expenses that are non-negotiable, such as rent or food, and then expenses that aren’t essential, such as new clothes or entertainment. 

This second group of expenses is often referred to as discretionary spending. They are items you can do without if your budget gets tight. This could be anything from funds you use to pay for hobbies, gym memberships, or eating out. 

Your discretionary income is the money you have leftover from your essential expenses to pay for these non-essential items. 

While your rent and utilities are set expenses, discretionary income can fluctuate, depending on your lifestyle or current needs. If your budget is tighter than normal one month, that probably means you’ll have less discretionary income to use for your non-essential expenses. 

Discretionary Income and Student Loan Payments

Your discretionary income is important when you’re developing a student loan repayment plan.

For the purpose of IDR plans for student loans, the government determines your discretionary income by calculating the difference between your income after taxes, also known as your adjusted gross income (AGI), and 150% of (or 1.5 times) the federal poverty guideline applicable to your family size and state. 

Here’s how your discretionary income factors into different repayment plans:

  • Revised Pay As You Earn (REPAYE) Plans: Your monthly payment will be set at 10% of your discretionary income.
  • Pay As You Earn (PAYE) Plans: Your monthly payment is set at 10% of your discretionary income. 
  • Income-Based Repayment Plan (IBR): If you were a new borrower on or after July 1, 2014, your monthly payment is 10% of your discretionary income. If you borrowed before that date, your monthly payment is 15% of your discretionary income.

If you’re not earning a lot of money and you find you’ll owe the government less than $5 each month with those calculations, then your monthly required payment is $0.

Determining Your Discretionary Income

You can easily calculate the discretionary income that applies to your student loans like this:

 AGI - (applicable federal poverty guideline x 1.5) = discretionary income

For example, let’s say you’re single with no dependents and you live in California. Your AGI is $30,000 after taxes. The applicable federal poverty guideline there for 2019 is $12,490. Here’s what your discretionary income would be:

$30,000 - ($12,490 X 1.5) = $11,265 

The government deems 150% of the poverty guideline to be an essential income for your monthly expenses, which is why that is subtracted from the total you earn. So with this calculation, you can see that your discretionary income is $11,265.

Should You Enroll in an IDR Plan?

If you’re looking into discretionary income, student loans, and how you’ll repay them, an IDR plan could help you lower your monthly payments. This would allow you to keep up with your student loan repayment plan and not run out of money for your other financial commitments and occasional discretionary spending.

Remember that there are some cons to this strategy. If the government extends your repayment term to help you get lower monthly payments, you could end up paying interest for much longer, making your loan more expensive in the long run. 

Only you can decide what strategy is best for you, depending on what you think you can reasonably afford each month. If you’re struggling with a tight budget and are having trouble staying afloat financially, then an IDR plan could be a strategy that helps you gain control of your finances.