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What is an Income-Driven Repayment Plan?

Income-driven repayment plans aim to help college grads with student loan debt by lowering monthly payments to match their available income. But the payoff period is longer. 

By Megan Doyle | American Express Credit Intel Freelance Contributor

6 Min Read | August 13, 2020 in Money

 

At-A-Glance

Stuck with high federal student loan payments? You might be eligible for an income-driven repayment plan.

Income-driven repayment plans can help lower your monthly payments, but you’ll probably end up paying more interest over time.

There are several plans available, so consult your federal student loan servicer to see what’s right for you.

If you’re a recent college grad and living on your own, you’re probably familiar – maybe too familiar – with how much of your budget student loan repayments can take up. One way to lighten the load is through an income-driven repayment plan. If you’re eligible, these plans let you restructure your monthly payments as a percentage of your income, often reducing how much you owe every month. 

 

There are several income-driven repayment plans available, and eligibility requirements can be strict. If you think an income-driven repayment plan might be right for you, here’s what you need to know to get started.

 

Income-Driven Repayment Plans, Explained

An income-driven repayment plan lets you reduce your monthly federal student loan payment to a percentage – usually 10–20% – of your discretionary income. Any remaining loan balance is forgiven after you’ve made the equivalent of 20 to 25 years of qualifying payments, depending on the plan.This differs from Public Service Loan Forgiveness plans, which forgive your remaining balance after 10 years of qualifying payments. 

 

Income-driven repayment plans can only be used for federal loans. If you consolidated your federal loans into a private loan, you will not be eligible for an income-driven repayment plan. But you could be eligible if you consolidated your federal loans into a federal Direct Consolidation Loan.

 

How Do Income-Driven Repayment Plans Work?

By default, about six months after graduating or leaving school your student loans will be set to a standard 10-year repayment plan, and you’ll be asked to start paying every month. But if you don’t think you’ll be able to comfortably afford the fixed monthly payment, you might be able to apply for an income-driven repayment plan.  

 

There are three main steps to apply: 

 

Step 1: Figure out which repayment plan is best for you. There are four income-driven repayment plans: Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR). Each have different specifications, loan terms, and eligibility requirements. Eligibility is based on your income, loan balance, the date you took out your loans, and the type of federal student loans you have. Understanding each plan can be complicated, but your federal loan servicer should be able to help you choose the right plan, free of charge.2 The chart below can start you on the road to finding out whether you’re eligible for one or more of the plans.

 

Key Attributes of Income-Driven Student Loan Repayment Plans

Repayment Plan Monthly Payment Payment Terms Eligible Loans
Pay As You Earn (PAYE) Generally 10% of your discretionary income
  • 20 years if all loans were for undergraduate studies
  • Only Federal direct loans made to students
Revised Pay As You Earn (PAYE) Generally 10% of your discretionary income
  • 20 years if all loans were for graduate studies
  • 25 years if any loans were for graduate studies
  • Only Federal direct loans made to students
Income Based Repayment

Generally 10 or 15% of your discretionary income

  • 20 years if you started borrowing loans on or after July 1st, 2014
  • 25 years if you took out loans earlier
  • Federal direct loans made to students
  • Federal Stafford Loans made to students
  • Federal Family Education Loans (FFEL) made to students
Income-Contingent Repayment

No more than 25% of your discretionary income

  • 25 years
  • Federal direct loans made to students
  • Parent PLUS Loans that have been consolidated into a Federal Direct Consolidation Loan

Source: Federal Student Aid

 

Step 2: Fill out an application. When you find the right plan, you can apply online for free. You’ll need some personal information, like your verified Federal Student Aid (FSA) ID, address, contact information, adjusted gross income, and more.3

 

Step 3: Receive your monthly payment information. If approved, your monthly payments will be based on a percentage of your discretionary income. But be aware, in this case discretionary is based on a specific formula – it is not up for discussion. To understand other definitions of discretionary income, read “What is Discretionary Income?” For the purposes of income-driven repayment plans, discretionary income is defined as the difference between your adjusted gross income and 1.5 times the federal poverty benchmark income level for your family size and state.4 The calculation – and your monthly payment amount – might differ depending on your repayment plan and your specific financial circumstances. For example, under certain plans, your income includes your and your spouse’s income, if you’re married. Your spouse’s federal student loan debt, if any, might be considered, too.

 

Important: You Must Reapply Every Year – On Time

If you’re on an income-driven repayment plan, you’ll have to reapply every year. Why? To account for any potential changes to your income and family situation. If your income rises, for instance – and depending on the plan you’re on – it’s possible your monthly payment amount can exceed what you would have been paying under the standard 10-year repayment plan. If you forget to recertify your income, your monthly payments will revert back to the standard repayment plan.

 

Payment Forgiveness for Income-Driven Repayment Plans

After a set period of time – 20 or 25 years, depending on the plan and/or your status as undergraduate or graduate/professional student – any remaining loan balance will be forgiven. But you’ll owe income tax on whatever amount is forgiven. 

 

If you’re on an income-driven repayment plan and are also on a Public Service Loan Forgiveness (PSLF) plan, your remaining balance can be forgiven after only 10 years of qualifying payments. Take note: qualifications can be strict. Unlike standard IDR plan forgiveness, PSLF forgiveness is not taxed. To learn more, read “What is Student Loan Debt Forgiveness.”

 

Are Income-Driven Repayment Plans a Good Idea? The Pros and Cons

Ideally, financial experts suggest it’s best to pay off loans as quickly as possible to avoid paying more interest than you have to. But income-driven repayment plans extend payoff periods, making it likely more interest will accrue – meaning you’ll probably end up paying more in the long run.6 For example, if you have $35,000 in federal student loans with a 3.9% interest rate, you’d pay a total of $42,000 under the standard 10-year repayment plan. Under the REPAYE plan, you would pay a total of about $55,000 over 20 years.7

 

Still, that doesn’t mean income-driven repayment plans are a bad idea. Here are the pros and cons so you can decide if an income-driven repayment plan is right for you: 

 

Pros

  • Lower monthly payments.
  • Reduced payments won’t affect your credit score, as long as you’re paying consistently and on time.
  • Any remaining balance is forgiven after 20–25 years.
  • If you’re in the Public Service Loan Forgiveness Program, you might qualify for forgiveness after 10 years.8

 

Cons

  • Monthly payments change every year depending on your income and family situation. It could even rise above the standard 10-year repayment plan.
  • You have to reapply every year.
  • You’ll have to pay income tax on whatever remaining balance is forgiven.
  • A longer payment period means you’ll be in debt longer and will likely pay more in interest over time.

 

The Takeaway

If you’re a recent college graduate are facing a challenge making ends meet, an income-driven repayment plan can be an effective way to reduce the financial stress of student loan payments.

Megan Doyle

Megan Doyle is a business technology writer and researcher whose work focuses on financial services and cross-cultural diversity and inclusion. She’s paying her student loans back on the standard 10-year repayment plan.

 

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

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