I remember the months leading up to Monica starting dental school like it was just a few weeks ago. We had textbooks to buy, an apartment to lease, car payments to make, and a class schedule to adjust to. One thing we didn’t have – the money to pay for it all. So when we started looking at the various options and terms surrounding student loans (i.e. federal loans, university loans, private loans, fixed rates, loan forgiveness, income driven repayment, etc.) my head started spinning and I wept for our negative net worth and the mountain of debt we began incurring.
At that point, we had no idea what a ‘reasonable’ interest rate was, the perils or benefits of refinancing our original loans, or how long and to what amplitude these loans would impact our lives.
To say we were overwhelmed was the understatement of the century.
But over time we lived through our experiences, talked with friends in different situations, and we’ve studied up. All of which have helped us up our student loan vernacular.
That financial education took place over the previous 9 years and continues today. So if you’re starting out and completely overwhelmed – that’s 100% understandable and reasonable.
But fear not! Because today we’ve brought in the experts to help us with one critical component of the student loan payment game: Income Driven Repayment.
Nate Matherson is a Co-founder of LendEDU, a personal finance blog originally focused on everything financial aid including student loan debt. Nate graduated in ’16 with more than $50k in student debt, and is more than 50% done paying off his loans, and today he’s here to outline the full details surrounding income driven repayment.
Take it away, Nate!
When Income Driven Repayment is the Option for You and Why
Student loan debt is on the rise, with total outstanding student loan debt increasing by $79 billion in 2018 according to the New York Federal Reserve. The total outstanding balance of student loan debt hit $1.49 trillion in the first quarter of 2019 and unfortunately, many young people are struggling to pay what’s owed. In fact, Bloomberg Businessweek reported a record $166 billion in delinquent U.S. student loans in the fourth quarter – and these delinquency rates actually underestimate the problem.
When student loans become delinquent, the consequences are serious
Delinquent borrowers could experience damaged credit scores while borrowers who are don’t make payments for at least 270 days are classified as in default.
Borrowers who are in default will no longer be eligible for deferment or forbearance; won’t be eligible for additional federal aid; and will find their entire loan balance – plus interest – is due immediately. Not only that, but the default can lead to seizure of tax refunds and federal benefits; wage garnishment; lawsuits; and withholding of your academic transcript. Moreover, default could largely make it impossible to refinance student debt in the future.
Avoiding delinquency and default is essential for any borrower, and fortunately, there’s a good way to stay out of default – you can sign up for an income driven repayment plan. Income driven repayment plans base your monthly payment on your income, capping the amount you owe at an affordable cost.
There are different income-based plans you could be eligible for, though, so it’s important to understand what your options are and how these plans could help make your loans affordable for you.
What are Income-Driven Repayment Plans?
The ability to choose a payment plan is one of the best features of federal student loans. While the standard repayment plan involves paying a fixed amount over 10 years to retire your debt, income-driven plans are an alternative option.
As the Department of Education explains, the majority of federal student loans are eligible for income-driven payment plans that limit the amount of money you have to pay towards your loans each month. These income-driven plans are ideal for borrowers whose payments are high relative to their earnings – and payments could be capped as low as $0 per month depending on how much money you bring in.
Different Types of Income-Based Repayment Plans
There are four different income-based repayment plans available to federal student loan borrowers. They include:
- Revised Pay As You Earn Repayment Plan (REPAYE Plan)
- Pay As You Earn Repayment Plan (PAYE Plan)
- Income-Based Repayment Plan (IBR Plan)
- Income-Contingent Repayment Plan (ICR Plan)
With each plan, you must meet certain eligibility requirements. You’ll also pay your loans only for a limited duration of time, after which any remaining loan balance is forgiven if your loans haven’t been fully repaid yet. Periods when your loan is deferred due to economic hardship and periods when your loan payment is $0 per month will count towards your maximum total repayment time, as will periods of time when you were paying your loan back under certain other repayment plans.
Any payments made under income-driven repayment plans also count towards payments you need to get Public Service Loan Forgiveness (PSLF). PSLF allows you to qualify for loan forgiveness after 10 years of qualifying payments.
Revised Pay as You Earn (REPAYE)
- Your payment amount is generally capped at 10% of your discretionary income
- The maximum repayment period is 20 years if all of your loans were provided for your undergraduate education or 25 years if any of your loans were for graduate or professional school.
- Any borrower with eligible federal student loans can choose the REPAYE plan. Eligible loans include Direct Subsidized and Unsubsidized Loans; Direct PLUS loans made to graduate or professional students; Direct Consolidation Loans that didn’t repay Parent PLUS loans; consolidated Subsidized and Unsubsidized Federal Stafford Loans from the FFEL Program; FFEL Consolidation Loans that didn’t repay Parent PLUS Loans; and Federal Perkins Loans that were consolidated.
Pay As You Earn Repayment (PAYE Plan)
Under the PAYE Plan:
- Your payment is capped at 10% of discretionary income
- Your payment can’t ever exceed the payment you’d make under the 10-Year Standard Repayment Plan and you’re eligible only if the payment you’d owe under the PAYE plan is less than the payment you’d owe under the Standard Plan.
- The maximum repayment period is 20 years
- You are eligible only if you had no outstanding loan balance on a Direct Loan or FFEL program when receiving a Direct Loan or FFEL Program Loan after October 1, 2007, and only if you took out a Direct Loan disbursed after October 1, 2011.
- Eligible federal loans for the PAYE Plan include Direct Subsidized and Unsubsidized Loans; Direct PLUS loans made to graduate or professional students; Direct Consolidation Loans that didn’t repay Parent PLUS loans; consolidated Subsidized and Unsubsidized Federal Stafford Loans from the FFEL Program; FFEL Consolidation Loans that didn’t repay Parent PLUS Loans; and Federal Perkins Loans that were consolidated.
Income-Based Repayment (IBR Plan)
With the IBR plan:
- Your payment is capped at 10% of discretionary income if you first took out federal student aid after July 1, 2014. It’s capped at 15% of discretionary income if you took out loans prior to July 1, 2014
- Your payments are never more than they would be under the 10-year Standard Repayment Plan and you’re eligible only if the payment you’d owe under the IBR plan is less than the payment you’d owe under the Standard Plan.
- The maximum repayment period is 20 years if you’re a new borrower after July 1, 2014 or 25 years if you’re not a new borrower
- Eligible federal loans for the PAYE Plan include Direct Subsidized and Unsubsidized Loans; Direct PLUS loans made to graduate or professional students; Direct Consolidation Loans that didn’t repay Parent PLUS loans; Subsidized and Unsubsidized Federal Stafford Loans from the FFEL Program; FFEL Consolidation Loans that didn’t repay Parent PLUS Loans; and Federal Perkins Loans that were consolidated.
Income-Contingent Repayment (ICR Plan)
Under the ICR Plan:
- Your payment is capped at the lesser of 20% of discretionary income or the amount you’d pay on a repayment plan with fixed payments on a 12-year repayment schedule.
- The maximum repayment period is 25 years
- Any borrower with eligible federal student loans can choose the ICR Plan. Unlike other income-based plans, Direct PLUS plans and FFEL Plus Loans made to parents are eligible for income-contingent repayment if those loans are consolidated. Direct Consolidation and FFEL Consolidation loans are also eligible for ICR even if those consolidation loans include Parent PLUS Loans.
How Income-Driven Payment Plans Can Help Keep You Out of Default
Since every income-based plan is capped at either 10% or 20% of discretionary income, you don’t need to worry about making very high payments you cannot afford. Virtually every federal student loan borrower is eligible for at least one of these income-driven plans and these plans help to ensure your monthly payment fits within your budget.
Because loan forgiveness is available, these income-based plans also ensure you won’t be stuck paying your student loan payments forever. You will pay substantially more interest in most cases than if you’d stuck to the standard repayment plan, but this could be a small price to pay for making sure you have enough money to cover student loans and other essential bills.
The key is, however, that you need to sign up for these income-driven plans before your loan is in default. So, if your monthly payments are high relative to what you’re earning, you should contact your loan servicer right away to switch to the payment plan that’s right for you.
What Other Options Do You Have to Avoid Default?
Income-driven plans aren’t the only option you have to avoid default. You can also pause payments altogether by putting loans into deferment or forbearance. To qualify for either deferment or forbearance, you must meet certain requirements. And, there are time limits on how long you can be in either program.
While both deferment and forbearance allow you to stop making payments for a period of time, interest is subsidized on Direct Subsidized Loans placed into deferment. Interest does continue accruing on Direct Unsubsidized Loans during deferment. And, interest continues accruing both on subsidized and unsubsidized loans in forbearance. This can make loan repayment significantly more expensive.
Income-based plans are often a better option than either deferment or forbearance as time in an income-based plan counts towards earning loan forgiveness even if your monthly payment is $0 because your discretionary income is very low.
Unfortunately, it’s up to you to be proactive in choosing the right payment plan, as a government report found some loan servicers were improperly steering borrowers to forbearance – and increasing their total interest costs – even when income-driven repayment was available and would have made repayment more affordable.
Loan Refinancing as an Alternative to Income-Driven Payment Plans
Finally, refinancing federal student loans is another alternative to income-driven plans. Refinancing could allow you to reduce your interest rate and change your repayment terms, which could potentially make your monthly payment more affordable.
Refinancing is often not an ideal solution, though, as loans can only be refinanced with private financial services companies – and you lose many borrower protections when you refinance including income-driven payment options and the chance at loan forgiveness. Refinancing should generally be considered only if you won’t take advantage of loan forgiveness, deferment or forbearance and if you can’t qualify for an affordable payment under any of the income-driven plans.
You should shop carefully for a refinance loan if considering this solution and should make sure to look at both monthly payment and total loan cost when deciding if refinancing is the best approach.