The Real Deal on Student Loan Income-Driven Repayment Plans
It’s no secret that many U.S. student loan borrowers are in crisis mode.
According to a 2018 survey of 7,095 adults by Student Debt Crisis, a nonprofit group, a majority of college loan borrowers are struggling to repay their student loan debts. Although the survey is not necessarily scientific due to the self-selecting sample population, it reported that
- 65% of student loan borrowers reported having less than $1,000 in their bank account
- 30% reported having a student loan bill higher than their rent or mortgage bill
- 56% reported having a student loan bill higher than their health insurance bill
- 20% reported being unable to make their next loan payment, while 44% reported that making their next payment would be a struggle
- 65% reported having a student loan bill higher than their monthly food budget
One way student loan borrowers grinding away at burdensome debt levels can cut a deal is through income-driven repayment plans.
These repayment plans establish a more affordable student loan payment. They base the monthly loan payment on the borrower’s ability to pay, as a percentage of the borrower’s discretionary income. The discretionary income is based on the borrower’s income-level and size of his or her family.
Let’s take a real-world look at income-driven student loan repayment plans and see how they may – or may not – work for you:
Bypass Limited to Federal Loans Only
Only federal student loans qualify for income-driven repayment plans. It’s also worth noting that the Federal Perkins loan does not directly offer an income-driven repayment option, although a Federal Perkins loan can qualify for income-driven repayment if it is included in a Federal Direct Consolidation loan.
Consequently, if you’re repaying a private student loan, you’re out of luck in qualifying for an income-driven repayment plan. If you are paying off a federal student loan, and are looking for some financial breathing room, Uncle Sam has several primary income plan-related options for you, as follows.
- Revised Pay as You Earn Repayment Plan (REPAYE Plan) – This plan locks in 10% of the borrower’s annual discretionary income, and provides a loan forgiveness kick-in at 20-to-25 years, depending on whether the borrower has just undergraduate loans or also graduate school loans.
- Pay as You Earn Repayment Plan (PAYE Plan) – This plan offers the same conditions as the REPAYE plan, but limits plan approvals to eligible borrowers who became new borrowers on or after October 1, 2007, and must have received a disbursement of a Direct Loan on or after October 1, 2011. The remaining debt is cancelled after 20 years.
- Income-Based Repayment Plan (IBR Plan) – The IBR plan requires loan repayment based on a rate level of 10% or 15% of discretionary income, depending on whether the borrower is a new borrower as of July 1, 2014 or not. Loan forgiveness kicks in after 20 or 25 years, respectively.
- Income-Contingent Repayment Plan (ICR Plan) – The ICR plan provides a student loan payment based on 20% of the borrower’s discretionary annual income. Loan forgiveness kicks in after 25 years.
In for the Long Haul
There is no turning back once you opt for an income-driven repayment plans, because it can be challenging to leap back and forth from an income-driven repayment plan. When a borrower switches from an income-driven repayment plan to another repayment plan, the monthly payment can jump a lot.
The good news for student loan borrowers locked into an income-driven repayment plan is that when you do get out of the financial doldrums and start earning a more robust income, there’s no reason you can’t pay more cash on top of minimum loan repayment amounts.
Paying extra will get the loan paid off more quickly, which not only helps your bank account, it will boost your credit score, too.
Income-driven student loan repayment plans also include key variables, conditions and caveats among the different Federal Student Aid loan repayment plans, that go beyond discretionary income rates and loan forgiveness options.
For example, there’s a load of paperwork and red tape to clear before a borrower earns a green light on an income-driven loan repayment deal. If you’re late in submitting the annual paperwork, you will get mauled by your student loans. At best, the loans will be in a forbearance, with interest piling on. At worst, your loan payment will skyrocket.
Then, there are the loan payment caps. The ICR and REPAYE repayment plans allow the loan payment to grow in unlimited fashion, as your income increases, while IBR and PAYE cap the monthly payments at the standard payment amount.
Plus, a married borrower may see his or her income-driven repayment plan calculated based on joint income with his or her spouse, and not individual income. If a married borrower files federal income tax returns as married filing separately, the ICR, IBR and PAYE repayment plans base discretionary income on individual income. Unfortunately, REPAYE bases discretionary income on joint income even if the borrower files a separate return.
Pay More Tolls in the Slow Lane
Factor in longer repayment timetables and more interest payments. Once you agree to an income-driven student loan repayment plan, expect some twists and turns that you didn’t count on.
- Your total student loan debt will take longer to pay. Some income-driven repayment plans will stretch out to 20 or 25 years – way longer than the standard 10-year loan repayment timetable on the original federal student loan.
- More interest paid. Also, since the repayment terms are extended by as much as 10 or 15 years, you’ll pay more in interest over the repayment term.
- Taxes owned on forgiven loan balances. Although the remaining loan balance will be forgiven at the end of the 20 or 25 year repayment term, the cancelled debt is treated as income by the IRS. In other words, while you may curb your total student loan debt by having some of the balance forgiven, expect a fat tax bill from the IRS based on the amount of loan money forgiven.
Caution: Road Work Ahead
This is not to say that income-driven student loan repayment plans can’t help in a wide variety of instances – they can.
The takeaway, though, is that it helps to bring a healthy dose of skepticism and rational thought when mulling over a student loan income-driven repayment option.
If you’re not paying attention, taking an income-driven repayment deal could be more trouble than it’s worth.