As today’s college graduates leave school with more student loan debt than ever, selecting the right repayment plan for your needs is crucial to avoid delinquency and serious damage to your credit.
For the first time, more student debt is now being repaid through one of the government’s income-based repayment programs than any other re-payment method, according to data from the Department of Education. There are four distinct plans, and each has slightly different guidelines.
Although using one of the income-based repayment plans may make your federal loan payments more manageable month to month, the long-term implications of opting into one of the plans can have serious financial consequences.
What are the differences between Income-Based and Standard Repayment plans
Below, read more about the general tradeoffs between Income-Based Repayment plans and Standard Repayment of student loans when your grace period comes to an end.
|Income-Based Repayment Plans||Standard Repayment|
|Payment Amounts||Payments are based on a percentage of discretionary income (between 10 and 20%) and are recalculated annually.||Payments are fixed based on the amount of the loan and rate.|
|Repayment Period||Repayment period is typically 20-25 years, after which remaining debt and interest are forgiven. (If you work in the government or nonprofit sector, your loan balance may be forgiven after 10 years.)||Standard repayment period is up to 10 years for federal loans.|
|How to Qualify||You must demonstrate partial financial hardship to qualify.||For federal loans, you’re automatically enrolled in this repayment plan unless you make another selection.|
|Benefit||You’ll pay more over time than you would under Standard Repayment.||You’ll pay less over time than you would under other IBR plans.|
Which repayment plan is best for you?
Using one of the government’s income-based repayment plans can be an option if you’re experiencing financial difficulty or earning a low salary compared to your student loan balance. Depending on your income, your payment could be as low as $0 per month. However, by making a very low payment, you might not be covering even the interest on your student loans and your overall balance could grow over time.
With Standard Repayment, your monthly payments are generally higher than they would be under an income-based plan (if you qualify), but you’re more likely to pay off your student loan balance in a shorter amount of time and with less interest.
Can your budget handle a non-fixed payment amount?
Under income-based repayment, you’re required to recertify your income and family size every year so your servicer can recalculate your monthly payment based on program guidelines.
Certain life changes – including a new marriage and filing taxes jointly – can cause your monthly payment to increase substantially or even make you ineligible to make payments tied to your salary.
If that happens, it’s important to know your monthly payments will never exceed what you would pay with the standard 10-year plan; however, non-fixed student loan payments — meaning payments that could change every year based on your annual income — can make it difficult to manage your budget, especially if you’ve taken on other debt, such as a mortgage or car loan.
What about loan forgiveness?
If you work in the government or nonprofit sector, you may be able to have your loan balance forgiven after 10 years with income-based repayment. With public service loan forgiveness, the amount forgiven is not taxable.
If you don’t work in public service, your loan may be forgiven in 20 to 25 years but the loan balance will be taxed, which could result in a considerable tax bill that year.
Whether income-based repayment is right for you depends on a variety of factors. If you’re still in school and applying for loans, don’t let the allure of possible loan forgiveness available under income-based repayment cause you to take on more student debt than you otherwise would.
If you’ve already graduated, you need to weigh the benefits of a lower payment now against the potential impact of a higher debt load over a longer period of time. You might also consider refinancing your student loans to reduce your overall interest rate and pay off your balance faster.
A guide to the 4 types of income-based student loan repayment plans
Once deciding that an income-based repayment plan is a strong fit for you, now you need to pick which flavor. There are four options to pick from, each with their own pros and cons.
Income-Based Repayment Plan (IBR Plan)
Similar to the PAYE plan, to be eligible for the IBR plan the payments you be making must be less than what you would pay under a Standard Repayment plan during a 10-year period. This means that generally your federal student loan debt is higher than your annual discretionary income, or represents a significant portion of your annual income. Your discretionary income is calculated as the difference between your adjusted gross income and 150% of the federal poverty guideline for your family size and state.
Technically there are two different IBR plans, one for borrowers who took out their first loan before July 1, 2014, and have a partial financial hardship (Original IBR), and another for those who took out their first loan on or after July 1, 2014 (2014 IBR). There are some differences between the plans to be aware of.
Your repayment amount will be one of the following:
- Generally 10% of your discretionary income if you’re a new borrower on or after July 1, 2014*, but never more than the 10-year Standard Repayment Plan amount, or
- Generally 15% of your discretionary income if you’re not a new borrower on or after July 1, 2014, but never more than the 10-year Standard Repayment Plan amount
In both cases, the amount should never exceed the 10-year amount you would pay on a standard repayment plan. The duration of the 2014 IBR plan is 20 years, and 25 years for the Original IBR plan.
If you qualify for the IBR Plan it can help lower your monthly payments and at the end of the plan, your loans are eligible for forgiveness. However, you should calculate the amount of interest you will pay during your repayment period, and the amount forgiven at the end of your loan repayment plan might be taxable income.
Income-Contingent Repayment Plan (ICR Plan)
The ICR Plan does not have an income eligibility requirement, so it can be a good fit for those who don’t qualify for other plans but do want to lower their monthly payments. Borrowers can also consolidate their PLUS Loans into a Direct Loan to use the ICR Plan. This is not an option for the other three plans.
Your repayment amount will be one of the following:
- 20% of your discretionary income, or
- What you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income
The repayment duration is 25 years, and afterward, you may be eligible for loan forgiveness for the amount leftover. One important consideration is that the ICR plan has the highest potential payment amount of all the other income-driven plans, and might even be more than Standard Repayment for some. As with all the plans, the loan amount forgiven at the end of your repayment plan might be taxable income.
Pay As You Earn Repayment Plan (PAYE Plan)
Like IBR, to be eligible for PAYE you must demonstrate financial need. You also must be a new borrower as of Oct. 1, 2007, and have received a disbursement of a Direct Loan on or after Oct. 1, 2011. Your payments under the PAYE plan must also be less than they’d be on the Standard Repayment Plan.
Your repayment amount will be:
- Generally 10% of your discretionary income, but never more than the 10-year Standard Repayment Plan amount
The duration of the PAYE plan is 20 years, at which time you may be eligible for loan forgiveness for the amount leftover. This plan generally offers the lowest payment amount for all eligible borrowers, but is also only to the smallest group of borrowers at this time. Again, the loan amount forgiven at the end of your repayment plan might be taxable income, which should be considered when signing up.
Revised Pay As You Earn Repayment Plan (REPAYE Plan)
Launched in December 2015, REPAYE the newest addition to the federal income-driven repayment plan offers. Borrowers are eligible regardless of when they took out their first federal student loan, and are not required to demonstrate financial need to be eligible.
Your repayment amount will be:
- Generally 10% of your discretionary income
The duration for the REPAYE plan is 20 years for undergraduate loans, or 25 years if any of your loans were for graduate or professional degrees. The loans are again eligible for loan forgiveness after the full duration of the REPAYE plan. However, with REPAYE, no matter how you file your taxes, the married joint Adjusted Gross Income is what is taken into consideration for your monthly payment calculation. This is not the case for IBR or PAYE plans and should play a part in your calculations when picking a repayment plan.