Income-driven repayment plans for federal student loans set your monthly payment amount based on your income and family size. These plans can make payments more affordable by reducing payments on federal loans.
The major income-driven repayment plans offered by the Department of Education include:
- Revised Pay As You Earn (REPAYE)
- Pay As You Earn (PAYE)
- Income-Based Repayment (IBR)
- Income-Contingent Repayment (ICR)
This guide explains everything you need to know about income-driven repayment plans including how they work, eligibility requirements, pros and cons, and the application process.
What Are Income-Driven Repayment Plans?
Income-driven repayment plans are federal student loan repayment plans that calculate your monthly payment based on your discretionary income and family size using a percentage of your income.
As your income changes each year, your required monthly payment is recalculated and adjusted, so payments stay affordable based on your earnings.
Some key features of income-driven repayment plans:
- Monthly payments based on 10-20% of discretionary income
- Payment is recalculated annually based on updated income
- Any remaining balance is forgiven after 20-25 years
- Eligible loans: Direct Loans, FFELP, Consolidation Loans
- Must recertify income annually
These plans are designed to help federal student loan borrowers struggling to make standard fixed payments by providing an affordable option with the potential for forgiveness.
Pros and Cons of Income-Driven Repayment
Before enrolling, weigh the advantages and potential drawbacks:
| PROS | CONS |
|---|---|
| Lower monthly payments – Payments are based on income, so can be reduced significantly | More interest paid – Lower monthly payments increase the total interest paid over the life of the loan |
| Payment Flexibility – Payment adjusts each year based on changes in income and family size | Tax implications – Loan balances forgiven after 20-25 years may be taxed as income |
| Interest subsidy – The government pays unpaid interest on subsidized loans for the first 3 years on certain plans | Annual recertification – You must update your income and family size each year to recalculate payment |
| Path to forgiveness – The remaining balance can be forgiven after 20-25 years of payments | Slower progress – Lower payments mean the principal gets paid down slower |
| Covers many loans – Most federal loans are eligible including older FFELP loans | Ineligible loans – Defaulted loans must be rehabilitated first. Parent PLUS loans have limited options |
| Spousal income – Plans available that do or don’t include the spouse’s income | Marriage impacts payment – Getting married or divorced changes household size and payment amount |
Consider how these pros and cons will affect your financial situation. Income-driven plans provide flexibility but also have potential limitations.
Who Qualifies for Income-Driven Repayment?
In order to be eligible for an income-driven repayment plan, borrowers must have qualified federal student loans. Private loans do not qualify.
You must also pass a standard credit check, though criteria are more flexible than private lenders. Defaulted federal loans are not eligible but can become eligible if rehabilitated.
Available income-driven plans include:
- Revised Pay As You Earn (REPAYE) – Available to all borrowers with eligible federal loans regardless of when taken. Must use household income.
- Pay As You Earn (PAYE) – Available for loans taken out after October 1, 2007. Can use individual income.
- Income-Based Repayment (IBR) – Available for all federal loans. Can use individual income.
- Income-Contingent Repayment (ICR) – Available for all federal loans. Must use household income.
Consult the eligibility criteria for each plan to confirm you qualify based on your loans, income, and marital status.
Having federal student loans in good standing is key. Private loans must first be consolidated or refinanced into an eligible federal loan.
How Do Income-Driven Repayment Plans Work?
Income-driven plans work by calculating your payment each year based on your adjustable gross income (AGI), family size, and other factors:
Payment = AGI x Repayment % – Poverty Guideline Allowance
Your AGI comes from your most recent federal income tax return. Family size includes your spouse if you filed jointly.
The repayment percentage is 10-20% depending on the plan. The poverty guideline allowance helps reduce payments for low-income borrowers. It varies by family size and state.
As your income changes year to year, your required monthly payment is recalculated using the same formula. Your payment can go up or down each year depending on income fluctuations.
If your calculated monthly payment does not cover accruing interest charges, the government will pay a portion of the unpaid subsidized loan interest for up to 3 consecutive years at a time to avoid negative amortization under certain plans.
Any loan balance remaining after making 20-25 years of payments is forgiven tax-free.
How to Apply for Income-Driven Repayment
Follow these steps to get started on an income-driven repayment plan:
- Determine which income-driven plan you qualify for based on loan types and other eligibility criteria.
- Fill out the online application with income, family size, and loan data.
- Provide documentation to verify income and eligibility such as recent tax returns if requested.
- Receive official approval and confirmation of your newly calculated monthly payment amount.
- Make your first monthly payment under the new income-driven repayment plan!
Your servicer will then have you recertify income, marital status, and family size each year before recalculating your new monthly payment for the next 12 months based on any changes.
Be sure to recertify on time annually to avoid any lapse in payment adjustment that could make your monthly bill unaffordable. Get notifications set up through your loan servicer.
Comparing the Income-Driven Repayment Plans
The major federal income-driven repayment plans have some key differences:
| Plan | Payment Percentage | Time Until Forgiveness | Uses Household Income | Federal Subsidy? |
|---|---|---|---|---|
| REPAYE | 10% | 20 years | Yes | Yes |
| PAYE | 10% | 20 years | No | Yes |
| IBR | 10-15% | 20 years | No | No |
| ICR | 20% | 25 years | Yes | No |
REPAYE provides the most payment flexibility and federal benefits but uses household income. PAYE may provide lower payments for single borrowers. IBR offers a graduate rate and no subsidy. ICR has a longer road to forgiveness.
Choose the plan that best fits your financial situation and loan details. You can switch between income-driven programs annually if needed.
Will My Income-Driven Repayment Plan Be Forgiven?
Yes, any remaining federal student loan balance is forgiven after making the required monthly payments over a 20-25-year period under income-driven repayment.
The payment periods until forgiveness are:
- REPAYE: 20 years
- PAYE: 20 years
- IBR: 20 years
- ICR: 25 years
Once you make the needed 240-300 payments as required by your specific plan, you can apply to have the Department of Education discharge and forgive your outstanding federal student loan balance.
This provides a light at the end of the tunnel after making reduced income-based payments for 20-25 years. Just be sure to continue recertifying income annually and making monthly payments to complete the full repayment term and qualify for loan forgiveness.
What Are the Drawbacks of Income-Driven Repayment?
While income-driven repayment plans make monthly payments more affordable, there are some potential disadvantages to consider:
- You may pay more total interest over the life of the loan due to lower monthly payments.
- Any loan balances forgiven after 20-25 years under current tax laws would be taxed as income.
- You must recertify income and family size annually for your servicer to recalculate your payment each year.
- Lower payments mean your loan principal gets paid down slower compared to standard repayment.
- Changes in marital status can affect your repayment term length and monthly payment.
- Parent PLUS loans have limited income-driven repayment options available.
- Any unpaid interest capitalizes if you later switch out of income-driven repayment.
Make sure you understand the pros and cons. For many borrowers struggling with payments, the benefits outweigh the drawbacks. But consider your own financial situation.
Are Income-Driven Plans Right for You?
Ask yourself these key questions:
- Will an income-driven plan provide enough monthly savings based on my income and loans?
- Can I handle needing to recertify income, tax status, and family size each year?
- Am I comfortable with the possibility of long-term forgiveness that may be taxed?
- Do I accept potentially paying more total interest over the loan term?
Running the numbers to see the monthly savings compared to standard repayment is essential. Also, think about your long-term financial goals.
For borrowers facing economic hardships or only able to afford small payments, income-driven repayment can be a great option. But weigh the pros and cons carefully based on your circumstances.
If you want to lower your federal student loan payments, enrolling in an income-driven repayment plan is definitely worth exploring. Evaluate if the benefits will outweigh the potential limitations based on your specific situation.
Don’t forget to check our post on the Fresh Start Program… you’ll find it interesting.
Conclusion
While income-driven repayment plans can provide significant savings on monthly student loan payments, they do come with downsides like increased interest costs over the loan term.
Given the complexities of evaluating these federal repayment options, it is prudent to seek professional guidance before enrolling.
Consult with a financial advisor to analyze your budget, debts, and long-term goals when weighing an income-driven plan.
Projecting your expected monthly payment under different plans based on your income and family size is crucial. Also, discuss the tax implications of potential loan forgiveness in the future.
Additionally, get counsel from a legal professional to ensure you understand the repayment plan eligibility fine print, annual recertification requirements, and any program changes on the horizon.
With wise input from financial and legal experts, you can determine if an income-driven repayment strategy truly benefits your personal financial situation.
Don’t go it alone when navigating these challenging choices. Seek out personalized advice so you can make an informed decision.
