After you graduate college and start repaying student loans, you may realize that the monthly payments are too high. With federal student loans, you may be able to lower your monthly payment. Known as income-driven repayment plans, these strategies can it easier to pay.
The federal government offers four income-driven plans:
- Income-Based Repayment (IBR)
- Revised Pay As You Earn (REPAYE)
- Pay As You Earn (PAYE)
- Income-Contingent Repayment
Most people informally refer to those options as income-based repayment, even if you don’t select the Income-Based Repayment Plan.
Pros and Cons of Income-Based Repayment Plans
Compared to What?
Income-driven plans only make sense in comparison to the Standard Repayment Plan. Under the standard program, you make fixed monthly payments that cover your interest costs and loan balance over 10 years. However, those payments might not be affordable.
Income-driven repayment plans can result in loan forgiveness. But it’s critical to understand exactly how that works.
- Public Service Loan Forgiveness (PSLF): Employees of qualifying not-for-profit and government employers might be eligible for PSLF after 120 “qualifying” payments.
- Loan forgiveness: If you don’t qualify for PSLF (because you work for a private employer, for example), you could still receive loan forgiveness after 20 or 25 years of repayment under an income-driven repayment plan.
Will You Pay Taxes?
Unless you receive PSLF, your forgiven loans may be treated as taxable income, resulting in a significant tax bill in the year your loans are forgiven. It’s critical to discuss this with a CPA, and it may be wise to prepare for that tax bill by saving money every month while you repay your loans.
Longer Repayment Period
While Standard Repayment Plans allow you to pay off your loans in 10 years, income-based plans have a lower monthly payment. As a result, it takes longer to pay off debt. Your cash flow improves today, but an extended repayment period can make it harder to save for other goals, make dramatic life changes, and qualify for other loans (like home and auto loans).
Higher Interest Expense
The longer you take to repay, the more interest you pay. With income-based programs, the total amount you pay for education may be significantly higher, after accounting for interest costs.
Income-driven repayment plans require that you “recertify” your income and family size each year with your loan servicer. If you fail to do so, your monthly payment could increase, and you might lose the option to make payments based on your income. Also, any unpaid interest may be capitalized (or added to your loan balance). If that happens, your loan balance increases, and you pay interest charges on the total amount. Put another way, you start paying additional interest on the interest charges.
Which Income-Driven Plan Is Best?
The right plan for you depends on your situation and your goals. You don’t necessarily have to choose a plan on your own—you can ask your loan servicer to select the best option—but it’s helpful to understand the key features of these plans.
Revised Pay As You Earn (REPAYE)
REPAYE may be one of the first choices to investigate if you qualify.
- Let the federal government pay 50% of your interest costs on subsidized loans
- Forgiveness period extends from 20 to 25 years if paying off graduate student loans
- Spouse’s income can make this less attractive
- Rising income can cause you to pay more than the standard 10-year amount
Pay As You Earn (PAYE)
- Forgiveness after 20 years, even if you’re paying off graduate student loans
- Payment is the lesser of the income-driven amount or the standard 10-year payment, which caps payments if your income increases
- Limited to “new borrowers” on or after October 1, 2007, with loans received on or after October 1, 2011
- Broad eligibility requirements, making it an option for those who don’t qualify for PAYE or REPAYE
- Payment cap at the lesser of your income-driven amount or the standard 10-year payment
- Forgiveness after 20 to 25 years
- FFEL Loans allowed, as long as they do not involve loans made to parents
- The only option for those with Parent PLUS loans (after consolidating)
- Forgiveness after 25 years
- Less-generous calculations lead to relatively higher payments (compared to other programs)
Income-Driven Repayment Details
If your favorite option doesn’t seem feasible, it might be possible to change your circumstances for more options.
Tax Filing Status
If you’re married, one strategy is to file taxes as “married filing separate.” That approach has significant tax consequences, so discuss the specifics with a tax adviser.
You might gain more options by consolidating loans. For example, borrowers with Parent PLUS loans might not think they qualify for income-driven repayment. But consolidating into a Direct Loan may make the Income-Contingent plan available.
Income-driven plans are available to borrowers with federal student loans only. If you have private loans, these programs are not available, but your lender might have other options.
Each plan calculates your payment based on “discretionary income.” To determine that amount, start with poverty guidelines in your area, and then calculate based on the income-driven plan you choose.
- For Income-Based Repayment, Pay as You Earn, and Revised Pay As You Earn, discretionary income is the difference between your income and 150% of the poverty guideline for your family.
- For Income-Contingent Repayment, your discretionary income is the difference between your income and 100% of the poverty guideline for your family.
If your discretionary income is zero or negative, you may have a monthly payment of zero.
How to Apply
To start using an income-driven repayment plan, contact your loan servicer and determine which option is best for you. Once you’re ready to move forward, apply directly through the Department of Education.