An income driven repayment plan can help to alleviate some of the financial stress of repaying the remaining balance of 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.
Income driven repayment plan - what is it?
Maybe you're a new borrower, and you're considering various student loan repayment plan options. You've heard of income driven repayment plans. But what are they?
It's a way to pay back your student loans in an affordable manner, based on your income and other factors like how many people are in your family. Your plan is determined by your specific situation.
Your federal student loan payments can be easier to handle this way because your monthly payment amounts could be lower. Federal student loan borrowers may choose this option if it works for their budget. Generally, a private lender won't offer this choice.
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 large 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(AGI) 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 plan), 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 plan) 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.
The types of loans that qualify for this are direct loans, both subsidized and unsubsidized, some Direct PLUS loans, and some direct consolidation loans. There are also some others, including some FFEL loans. Unfortunately, parent plus loans do not qualify.
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, Revised Pay As You Earn 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.
Direct subsidized and unsubsidized loans, some direct PLUS, and direct consolidation loans are eligible. Also, some Stafford loans, some FFEL PLUS, some consolidation loans, and some Perkins loans are also eligible. Parent plus loans aren't eligible for Revised Pay As You Earn.
4. Income-Contingent Repayment
The final option for income-driven repayment plans is the income-contingent repayment plan (ICR 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 financial 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 simulator 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, consider these factors.
You may pay more interest 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 10-year standard repayment plan 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. But doing an income driven repayment plan will not get you a lower interest rate.
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.
Tax implications
Depending on your repayment plan, you might qualify for loan forgiveness at some point.
When the balance of your loan is forgiven, you might have been required to pay taxes on that balance at your income tax rate, but student loan forgiveness was recently reported to be tax free. However, there are still exceptions and complications, so look into your individual loan situation to see if you qualify.
And remember that things could always change, so it's important to be prepared.
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.
Income based repayment student loan calculator options
The more you know about repayment options and your finances, the better off you are. You'll likely want to use an income based repayment calculator for student loans. Here are our favorites.
Mapping your future calculator
Mapping your future offers an income based repayment student loan calculator that has all the basics like the amount you'll pay and a budgeting tool to help. It's simple and easy to use.
Lendedu
The Lendedu calculator offers an income based repayment student loan option that asks a few questions like income and loan balance and includes a chart to illustrate the answers. The chart shows what you currently pay versus what you'd pay with IBR. Highly recommended.
Saving for college
The Saving for College calculator for student loans has a simple format with easy questions and clear places to enter all info. Easy to use and will help you with the financial side of college, plus has a FAQs section.
Student loan planner
Student loan planner has a great income based repayment calculator for student loans that offers you a chance to create your own loan plan. It's a good way to get an accurate financial picture, and it offers a chart with multiple IBR loan options like REPAYE and refinanced.
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 Federal Student Aid 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 (IDR) a good option for you?
There are some benefits and downsides to income driven repayments. How do you know if you should try this or not?
When income driven repayment plans make sense
As you evaluate your student loan repayment options, consider what your budget can reasonably support. For low-income borrowers who can't support their current payment, IDR plans might be a good choice for their situation.
Be sure to try out an income based repayment calculator for student loans to get an accurate perspective.
Make sure that you fully understand the tax and interest consequences of how your student loans work. Otherwise, you might encounter an unpleasant surprise.
When you shouldn't do an income driven repayment plan
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.
Alternatives to income driven repayment plans
Income driven repayment plans are not an ideal solution for every budget. Here are some other ideas.
Side hustles and second jobs
If you've already taken out student loans but you've decided income-driven repayment isn't for you, consider a side hustle or second job to pay extra on your loans. While this may be challenging, it will get you out of debt faster than most other things.
Cut back on your budget
If you've noticed that your student loan payments are high, but your spending is a bit out of control, it's time to change your habits. Consider following a necessity-based budget, only buying what you need, and then putting the rest of your income towards student loan payoff.
Pay for college without student loans
As radical and time-consuming as this may seem, if you've not yet taken out student loans, or you aren't finished with school and can afford to do this, try paying for college slowly, without student loans.
Work while in school and pay your tuition out of pocket or with grants and scholarships. It may take longer, but not taking on debt in the first place is the fastest and easiest way to avoid student loans and income driven repayment plans.
Public service loan forgiveness
Public service loan forgiveness (PSLF) allows you to be forgiven of your student loans after 10 years of payments when you work in public service. If this applies to you, you may be able to get your student loans forgiven. To find out if you qualify, check out this article from Saving for College.
Economic hardship deferment
Economic hardship deferment isn't a solution so much as a pause while you manage your finances and get to a place where you can pay off your loans. It allows the borrower to defer payment for a time based on certain requirements.
Quite a few loans qualify, but some will accrue interest (unpaid interest) and can result in capitalization, so this may not be the best option for you. Forbearance is a similar option to consider, but also costly.
Income driven repayment plans can be helpful but they aren't for everyone
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 make the right decision. Check out our free courses that can help you understand how student loans really work.