Is Income-Driven Repayment Worth It?

FT Contributor
A document labeled "student loan repayment."

Income-driven repayment plans (IDR plans) help borrowers keep the monthly payments on their student loans manageable. These plans allow you to take your income into account when calculating monthly payments. With these programs, you typically have to pay 10% to 15% of your discretionary income into your student loans each month. This cap on payment amounts can help make loans more manageable and lower the risk of default

The Department of Education oversees four income-driven repayment plans. Each of these plans has slightly different traits that make them ideal for student loan debtors in specific situations. However, in some cases, IDR plans can have a negative impact on a borrower’s repayment efforts.

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What Are the Four Types of IDR Plans?

The Department of Education offers four income-driven repayment plans:

  • Pay As You Earn (PAYE);
  • Revised Pay As You Earn (REPAYE); 
  • Income-Contingent Repayment Plan (ICR);
  • Income-Based Repayment Plan (IBR).

PAYE caps your payment at 10% of your discretionary income. Even if your income increases, your monthly payments can never exceed what they would have been on a standard repayment plan. The repayment period for all PAYE loans is 20 years, after which the remaining loan balance will be forgiven.

This plan is best if you’re married with two incomes, have graduate loans, or have low earning potential. If your income increases significantly, your loan may get transferred to a standard repayment plan. PAYE is for loans that started after October 2011 and contain consolidated loans from no earlier than October 2007.

REPAYE plans are similar to PAYE plans, but there are a few important differences. First of all, if you have a loan that includes graduate school tuition, the repayment period and loan forgiveness threshold is 25 years. Also, REPAYE does not have the same time restrictions as PAYE. You can qualify for REPAYE regardless of when your loan began. There is no payment maximum for REPAYE plans, so you could potentially make very large payments if your income grows significantly.

Income-Based Repayment (IBR) plans cap monthly payments at 10% of discretionary income for loans after July 1, 2014, or 15% for loans that started before that date. The repayment period is 20 years for the newer loans and 25 years for pre-2014 loans. If you do not qualify for PAYE or REPAYE plans, IBR plans may be the best option. These plans also cover Federal Family Education Loans (FFEL), which do not qualify for PAYE.

Income Contingent Repayment (ICR) plans act as a catch-all for people who want an income-driven repayment option but do not qualify for the other three plans. With this plan, you may have to pay as much as 20% of your discretionary income. However, payments get capped if they exceed the amount that you would pay on a 12-year fixed payment plan.

The repayment period is 25 years. ICR plans may help some borrowers reduce monthly payments slightly. Because of the higher payment percentage, however, you may still be able to pay off your loan within the payback period.

If you work in a qualifying public service or nonprofit job, you may qualify for the Public Service Loan Forgiveness (PSLF) program. You can combine this program with any of the IDRs. It allows you to have your loan amount forgiven in 10 years, provided you remain in the job for long enough and make payments on time every month.

Disadvantages of IDR Plans

Before you choose an IDR plan, you should be aware of the drawbacks.

It may take longer to pay off your loans

While payments are low with IDRs, they also take longer than the standard 10 years to pay off. They all involve repayment periods of either 20 or 25 years. You could potentially be paying off your own student loans when your children enroll in college.

They might involve higher interest payments

The longer you are in debt, the more interest you will have to pay. With repayment periods of up to 25 years, you might end up paying more in interest on IDRs than on a standard repayment plan. If your income is modest enough, then the bulk of your debt will be forgiven at the end of the period. In this case, an IDR is a great idea.

There is a lot of paperwork

All IDRs require you to recertify your plan every year. This process involves providing proof of your family size and income, and you will have to do it annually for 20 to 25 years. With standard non-income-based repayment plans, you do not have to provide these documents.  

Your payments could change significantly from year to year

Since you need to recertify every year, your payments could change significantly. The PAYE and IBR plans will never let your payments exceed what you might have paid on the 10-year standard repayment plan. However, REPAYE plans do not have these caps. With these plans, a substantial salary increase could mean much higher monthly loan payments.

There is a tax bill at the end

You do not have to pay any remaining balance at the end of the 20 or 25-year repayment period. However, the forgiven amount will count as income on your next tax returns. If you still have a significant balance, the tax hit could be an unwelcome surprise.

Not all loans are eligible

Parent PLUS Loans and private loans are all ineligible for IDRs. You may also have difficulty including older loans that you consolidated with newer loans in IDR plans. For example, loans that started before October 2007 are ineligible for PAYE plans.

Who Should NOT Use an Income-Driven Repayment Plan?

Income-driven repayment plans make the most sense if you are struggling to balance regular living expenses and student loan payments. These plans make monthly payments more manageable, but they will lead to higher overall interest payments. Furthermore, the repayment periods are longer than standard loans, and tax obligations could negate some of the benefits of loan forgiveness.

If you can make payments on a standard repayment plan without causing yourself undue hardship, then you should avoid the drawbacks of IDR plans. You will finish paying off your loans in roughly half the time with less overall interest if you opt for a standard repayment plan.

Other Repayment Plans

If you do not need the income-based payments from an IDR plan, then you have three options for standard loan repayment plans.

Standard Repayment Plan

The Standard Repayment Plan is the most common option. It spreads equal payments out over the term of the loan. In terms of interest and payback period, this is the most economical plan. If you have a reliable income and expect your salary to grow as your career progresses, this option is the most logical and economical one.

Graduated Repayment Plan

The Graduated Repayment Plan is ideal for new graduates who expect to earn more as their career develops. This plan starts with low monthly payments. The amount due monthly increases gradually over time. Payments increase every 24 months. Overall, the cost, in terms of interest, will be higher under this plan than under the Standard Repayment Plan.

Extended Repayment

The Extended Repayment Plan is an option for those with Direct Loans and FFEL loans exceeding $30,000. This plan makes monthly payments for these loans lower. However, the lower monthly payments extended the repayment period to 25 years. Extended Repayment Plans are flexible. With this arrangement, you can choose either equal payments or graduated payments that increase every 24 months.

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