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This Could Lower Your Monthly Student Loan Payment — but is It Worth It?
As if college wasn’t stressful enough, there’s also the crushing pressure that comes when your first student loan payment is due six months after graduation.
Depending on how much debt you have, that bill could range from a couple hundred dollars to more than $1,000 a month. And if you weren’t lucky enough to land a six-figure job right out of college, making those payments on top of all your other bills can be a struggle.
Income-based repayment plans can help. If you’ve got federal student loans, these plans may help relieve some of your stress by significantly lowering your monthly payment based on your income.
When he graduated with a degree in political science from Southern Illinois University-Carbondale, Derek Lawrence had $23,788 in student loan debt. He makes between $22,000 and $24,000 a year, which made paying $245 a month under the standard repayment plan a bit tough.
After he applied for an income-based repayment plan, his monthly payment dropped to $38, which created a little extra breathing room in his budget. Meanwhile, he’s focused on paying off a car loan with a higher interest rate than his student loans and building his savings for unexpected expenses.
“The beauty of (these plans) is that it doesn’t mean you can’t pay more,” Lawrence said. “If you are eligible for it, you can pay as much as you can while having the option to slack off one month if something happens. My payment dropped from $245 a month to $38, but I’m still paying well over double that amount and don’t plan on paying anywhere close to the minimum unless something drastic happens.”
Keep in mind: These plans may not be the best choice for everyone, but they’re certainly an option to consider if you know you won’t be able to make ends meet.
Income-Based Repayment Plans, Explained
In short, these plans cap your monthly payment at a percentage — typically between 10% and 20% — of your discretionary income. These plans are only available for federal student loans, so if you’ve got private loans, these plans can’t help you. If you’re in default, you’re also out of luck. After you make monthly payments for a set period of time, typically 20 to 25 years, any remaining debt is forgiven (more on that later — this perk comes at a cost).
Types of Plans
There are four types of income-based student loan repayment plans. They vary in terms of who qualifies, how much a borrower must pay each month, the length of the repayment period and the type of loans that are eligible. Certain types of federal loans may not qualify on their own, but may qualify if they’re consolidated.
Here’s a quick rundown on each. Stay with us, because this is about to get confusing. For more detailed information about each type of plan, be sure to visit the Federal Student Aid office’s website or consult with a financial planner.
“Each plan is a further improvement (mostly) of the plan before it,” according to Joshua Cohen, a lawyer based on the East Coast who specializes in student loans. “It is very confusing, even for those of us in the field.”
REPAYE Plan (stands for Revised Pay As You Earn)
- Monthly payment: 10% of discretionary income
- Repayment period: 20 years for undergraduate debt, 25 years for graduate debt
- Eligibility: Any borrower with eligible federal loans.
Income-Based Repayment Plan
- Monthly payment: 10% of discretionary income if you took out your first loan after July 1, 2014, and 15% if you took out your first loan before July 1, 2014.
- Repayment period: 20 years if you took out your first loan after July 1, 2014, and 25 years if you took out your first loan before July 1, 2014.
- Eligibility: Your monthly payment must be less than what you would pay under the standard repayment plan over a 10-year period.
PAYE Plan (stands for Pay As You Earn)
- Monthly payment: 10% of discretionary income
- Repayment period: 20 years
- Eligibility: Borrowers who took out their first loan after Sept. 30, 2007, and at least one loan on or after Oct. 1, 2011. Your monthly payment must be less than what you would pay under the standard repayment plan over a 10-year period.
Income-Contingent Repayment Plan
- Monthly payment: 20% of discretionary income or what you would pay on a 12-year standard repayment plan adjusted according to your income, whichever is less.
- Repayment period: 25 years
- Eligibility: Any borrower with eligible federal loans, including loans made to parents after they’re consolidated.
How Do I Know Which Plan Is Right For Me?
Good question. Since there are so many plans, loan types and eligibility dates, it’s best to get in touch with your loan servicer or the company that maintains your student loan. According to the Federal Student Aid office, your loan servicer can determine which plans you qualify for and which plan will provide you the lowest monthly payment amount.
If you’re confused about what types of federal loans you took out, you can visit the National Student Loan Data System, which serves as the U.S. Department of Education’s central database for student aid information.
Who Are These Plans Designed For?
Income-based repayment plans are designed for borrowers who have a high amount of debt compared to their income, according to the White House. Borrowers can apply through the U.S. Department of Education, which will factor in your discretionary income and the size of your family to determine your monthly payment amount. You may have no monthly payment at all.
The U.S. Department of Education calculates discretionary income using federal poverty guidelines. Depending on which plan you choose, your discretionary income is calculated by subtracting either 150% (IBR and PAYE) or 100% (ICR) of the poverty guideline for your household size from your income, depending on the program you qualify for and select.
Since your monthly payment is based on your income and family size, your payment will change over time. Bottom line: Every year, you must send in updated information about your situation, even if there’s been no change.
“For borrowers that experience an earnings bump, be prepared for a change in your income-based monthly payment,” said Greg Stallkamp, strategic adviser for GradFin.
If you forget to re-certify (remember, you’ll be doing this every year for 20 to 25 years — you may slip up), you’ll move to a standard repayment plan, which you may not be able to afford. This is one of the top reasons people default on their student loans, said Robert Farrington, founder of TheCollegeInvestor.com.
What If I’m Married?
It depends on which plan you pick, according to the Federal Student Aid office. Under the PAYE, IBR and ICR plans, if you file your tax return separately from your spouse, only your income and debt will be considered. Under the REPAYE plan, it doesn’t matter if you file separately or jointly. The payment will still be based on your combined income and loan debt.
Downsides to Income-Based Repayment Plans
Though they sound attractive upfront, these repayment plans may end up being more expensive than a standard repayment plan in the long run.
“Income-based repayment plans are really only suitable for borrowers with fairly specific circumstances,” said Katie Ross, education and development manager for American Consumer Credit Counseling. “It’s an attractive idea to recent grads to pay as little as possible because they’ve just started making money, and they want to enjoy it a little. It also sounds fair to pay based on what they’re earning. Unfortunately, this is a trap that makes the loan more expensive and increases the repayment timeline.”
There are two main downsides to income-based repayment plans.
- You’ll pay more interest. Under a standard repayment plan, you’d make fixed monthly payments for 10 years. But under an income-based repayment plan, you’re extending the payment period to 20 or 25 years, which means you’ll pay more in interest.
- You’ll pay taxes on any debt that is forgiven. This one is a huge bummer. The IRS views any amount of debt forgiven as income on top of your regular earnings, which means you could be looking at a hefty income tax bill the year your balance is forgiven. According to the Federal Student Aid office and the IRS, there are some exceptions to this rule, including the Public Service Loan Forgiveness Program, which is a plan for borrowers who work for the government, a nonprofit organization, or for a program like AmeriCorps or Peace Corps.
Depending on your situation, the pros of income-based repayment plans may still outweigh the cons. And there have been efforts over the years to remove the income tax burden on forgiven student loan debt. Who knows, maybe someday one of those efforts will be successful.
“The laws could change both for how income is calculated to qualify, and there may be tax advantages introduced later to waive the forgiveness of debt in this situation,” said Crystal Stranger, president of 1st Tax. “I wouldn't bet on it, but at the same time it would not surprise me. The bottom line is that for those who qualify, you may as well take advantage of the program while you can and get the most benefits possible, then hope and pray that Congress will be kind to you when the forgiveness payments finally come in.”
As you can see, there are a ton of factors to consider before deciding the best way to pay off your student loans. Just remember, if you sign up for an income-based repayment plan, you can always make extra payments or switch to a standard plan — nothing is set in stone. The important thing is to keep making payments in some shape or form so you stay out of default.
Your Turn: How are you paying off your student loans?
Sarah Kuta is an education reporter in Boulder, Colorado, with a penchant for weekend thrifting, furniture refurbishment and good deals. Find her on Twitter: @sarahkuta.