Pros and Cons of Income-Driven Repayment Plans for Student Loans

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Mark Kantrowitz

By Mark Kantrowitz

December 4, 2020

Income-driven repayment plans are payment options for many federal student loan borrowers. As the name suggests, if you enroll in an Income-Driven Repayment plan, your monthly payment is based on your income and family size.

The monthly payment on an income-driven repayment plans will be lower than the standard repayment plan. The payment may even be zero for borrowers with low or no income. There are many benefits of income-driven repayment plans, but also some drawbacks to consider, too.

The lower loan payments may make income-driven repayment plans a good option for borrowers who are struggling to repay their student loans, especially after the end of the COVID-19 payment pause

However, even though the remaining debt is forgiveness after 20 or 25 years in repayment, the loan forgiveness may be taxable. 

What Is Income-Driven Repayment?

Income-driven repayment plans base the monthly loan payment on the borrower’s income, not the amount of debt owed. This can make the loan payments more affordable if your total student loan debt is greater than your annual income.

There are four income-driven repayment plans.

These repayment plans differ in the percentage of discretionary income, the definition of discretionary income and the repayment term, among many other details. Discretionary income is the income that remains after subtracting allowances for mandatory expenses, such as taxes and basic living expenses. 

This chart below illustrates some important differences in the various income-driven repayment plans.

Important differences in the various income-driven repayment plans table

See also: What are the Differences Between ICR, IBR, PAYE Student Loan Repayment

Here are some pros of income-driven repayment plans:

Advantages of Income-Driven Repayment Plans

Another repayment option if you’re unemployed

Income-driven repayment plans are good for borrowers who are unemployed and who have already exhausted their eligibility for the unemployment defermenteconomic hardship deferment and forbearances. These repayment plans may be a good option for borrowers after the payment pause and interest waiver expires. Since the payment is based on your income, your payment could even be $0.

Lower monthly payments

Income-driven repayment plans provide borrowers with more affordable student loan payments. The student loan payments are based on the your discretionary income. These repayment plans usually provide borrowers with the lowest monthly loan payment among all repayment plans available to the borrower. 

Generally, borrowers will qualify for a lower monthly loan payment under income-driven repayment if their total student loan debt at graduation exceeds their annual income

Payments could be $0

Low-income borrowers may qualify for a student loan payment of zero. The monthly loan payment under an income-driven repayment plan is zero if the borrower’s adjusted gross income is less than 150% of the poverty line (IBR, PAYE and REPAYE) or 100% of the poverty line (ICR). If your monthly payment is zero, that payment of zero still counts toward loan forgiveness. 

Borrowers who earn the federal minimum wage, which is currently $7.25 per hour, and work 40 hours per week earn less than 150% of the poverty line for a family of one. Borrowers who earn $15 per hour earn less than 150% of the poverty line for a family of three. 

See also: My IDR Payment is $0. Now What?

The remaining balance is forgiven

After 20 or 25 years in repayment, the remaining student loan balance is forgiven. The repayment term depends on the type of income-driven repayment. The repayment term is 25 years for ICR and IBR, and for borrowers who have graduate school loans under REPAYE. The repayment term is 20 years for PAYE and for borrowers who have only undergraduate loans under REPAYE. However, this balance is taxed unless you qualify for public service loan forgiveness.

The income-driven repayment plans provide tax-free student loan forgiveness after 10 years for borrowers who qualify for public service loan forgiveness (PSLF). To qualify, the loans must be in the Direct Loan program while being repaid in an income-driven repayment plan and the borrower must work full-time in a qualifying public service job or a combination of qualifying public service jobs. PSLF eliminates debt as a disincentive to pursuing a public service career.

The economic hardship deferment counts toward the 20 or 25-year forgiveness in income-driven repayment plans, but not toward public service loan forgiveness.

Interest is paid on subsidized loans

The federal government pays all or part of the accrued but unpaid interest on some loans in some of the income-driven repayment plans. 

  • During the first three years, the federal government pays 100% of the accrued but unpaid interest on subsidized loans in IBR, PAYE and REPAYE and 50% of the accrued but unpaid interest on unsubsidized loans in REPAYE. 
  • For the remainder of the repayment term, the federal government pays 50% of the interest on all federal student loans in REPAYE. All other interest remains the responsibility of the borrower and may be capitalized if it remains unpaid, depending on the repayment plan. 

Credit scores aren’t negatively impacted

Income-driven repayment plans will not hurt the borrower’s credit scores. Borrowers who make the required monthly loan payment will be reported as current on their debts to credit bureaus, even if the required payment is zero. 

Disadvantages of Income-Driven Repayment Plans

Although income-driven repayment plans help borrowers who experience financial difficulty, these repayment plans come with several disadvantages.

You might not qualify

Eligibility for income-driven repayment is limited mostly to federal student loan borrowers. 

Federal Parent PLUS loans are not directly eligible for income-driven repayment, but may become eligible for ICR by including the Parent PLUS loans in a Federal Direct Consolidation Loan.

Most private student loans do not offer income-driven repayment plans. Although IBR is available for both FFELP and Direct Loans, ICR, PAYE and REPAYE are available only for Direct Loans. 

See also: Are Parent Loans Eligible for Income-Driven Repayment?

Your total balance can increase

It is possible for student loans to be negatively amortized under the income-driven repayment plans. Negative amortization occurs when the loan payments you are making are less than the new interest that accrues that month. This causes the loan balance to increase.

This won’t matter much, if the borrower eventually qualifies for loan forgiveness. But, still, borrowers may feel uneasy seeing their loan balance increase, since they will be making no progress in paying down their debt. 

You’ll pay taxes on your forgiven balance

Unlike forgiveness with Public Service Loan Forgiveness, the loan forgiveness after 20 or 25 years in an income-driven repayment plan is taxable under current law. The IRS treats the cancellation of debt as income to the borrower.

In effect, the taxable student loan forgiveness substitutes a smaller tax debt for the student loan debt. There are several options for dealing with the tax debt.

  • If the borrower is insolvent, with total debt exceeding total assets, the borrower can ask the IRS to forgive the tax debt by filing IRS Form 982
  • The taxpayer might propose an offer in compromise by filing IRS Form 656.   
  • The final option, other than paying off the tax bill in full, is to seek a payment plan of up to six years by filing IRS Form 9465 or using the Online Payment Agreement Tool. The IRS charges interest on the payment plans. The borrower may be required to sign up for auto-debit if the tax debt is $25,000 or more. 

See also: Common Mistakes Involving Income-Driven Repayment Plans

It could be a confusing process

There are too many income-driven repayment plans, making it harder for borrowers to choose which plan is best for them.

There are many details that differ among the income-driven repayment plans. PAYE provides the lowest monthly payment, but eligibility is limited to borrowers with loans disbursed since October 1, 2011.

For other borrowers, either IBR or REPAYE will offer the lowest cost, but which is best depends on borrower specifics, such as whether the borrower is married or will eventually get married, whether the borrower’s income will increase, and whether the borrower has any federal loans from graduate school.

Married borrowers could have a higher payment

Some of the income-driven repayment plans suffer from a marriage penalty. If the borrower gets married and their spouse has a job, the monthly loan payment may increase.

If you file a joint return, the loan payment is based on the combined income of you and your spouse.

With ICR, IBR and PAYE, the loan payment is based on just the borrower’s income if the borrower files federal income tax returns as married filing separately. However, filing a separate tax return causes the borrower to miss out on certain federal income tax deductions and tax credits, such as the Student Loan Interest Deduction, American Opportunity Tax Credit (AOTC), the Lifetime Learning Tax Credit (LLTC), the Tuition and Fees Deduction, the Education Bond Program and various child and adoption tax credits.

With REPAYE, the loan payment is based on joint income regardless of the tax filing status. 

See also: Whose Income Counts for Income-Driven Repayment Plans?

Payments can increase

Loan payments will increase as income increases under certain income-driven repayment plans. There is no standard repayment cap on the loan payments in the ICR and REPAYE repayment plans, so loan payments can increase without bound as income increases.

See also: How to Reduce Loan Payments in an Income-Driven Repayment Plan

You need to qualify every year

There is an annual paperwork requirement. Borrowers must recertify their income and family size every year. If you miss the deadline, your loans will be placed in the standard repayment plan. If you file the recertification late, the accrued but unpaid interest will be capitalized, adding it to the loan balance. 

See also: How Do I Recertify for Income Driven Repayment for Student Loans?

If you’re seeking forgiveness, it’s a long time to carry debt

The repayment term of 20 or 25 years is more than half of the average work-life for college graduates. Some borrowers have compared the repayment plans with indentured servitude, saying that it feels like they are in debt forever. Certainly, borrowers who choose an income-driven repayment plan will be in debt longer than in the standard repayment plan and may pay more interest due to the longer repayment term. 

Borrowers in a 20 or 25-year repayment term will still be repaying their own student loans when their children enroll in college. They are less likely to have saved for their children’s college education and will be less willing to borrow to help them pay for school.

Once you choose an income-driven repayment plan, you are locked into that repayment plan. Repayment plan lock happens because the loan payments will jump if you switch from an income-driven repayment plan to another repayment plan. The loan payments will be based on the loan balance when you change repayment plans, not the original loan balance. This can make the new monthly loan payments unaffordable. 

As you are deciding what repayment plan is right for you, use our repayment calculators. We have a repayment calculator for each income-driven plan:

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