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Income-Based Repayment for Student Loans: Understand the Tradeoffs

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 five different plans, and each has slightly different guidelines.

income based repayment graphic

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.

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
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 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.
You must demonstrate partial financial hardship to qualify. For federal loans, you’re automatically enrolled in this repayment plan unless you make another selection.
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.

What can you afford?

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.

Another option is refinancing your student loans with a private lender. Refinancing can help lower your rate and allow you to customize your monthly payment based on your own budget.

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.

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