About 30-40% of undergraduate students take out federal student loans each year. Over the years, these loans can start to pile up, making for a hefty monthly payment once repayment starts. If you are in the market for a more affordable repayment plan for your federal student loans, consider an income-driven repayment plan.
In this blog, we’ll dive into what an income-driven repayment plan is, the four different options, and the pros and cons of opting into it.
What Is An Income-Driven Repayment Plan?
An income-driven repayment (IDR) plan is a federal loan repayment option. Unlike the standard repayment plans, IDR bases your monthly payment on your income instead of how much you owe.
How Is Income-Driven Repayment Calculated?
Along with your income, the federal government will look at other factors. They will look at the specific repayment plan you choose, your family size, and your location. If applicable, they’ll also look at your tax status with your spouse and your spouse’s federal student loan debt. The combination of these factors is what determines your payment amount.
The 4 Income-Driven Repayment Options
There are four different income-driven repayment plans to choose from. Each repayment option has its own terms and requirements to qualify. Here is a quick overview of each one.
Income-Based Repayment (IBR)
Income-Based Repayment is one of the more flexible options. You can get it regardless of when you received your loans, but you will have to demonstrate financial need. The payment amount is 10-15% of your discretionary income. The repayment period is about 20-25 years.
Pay as You Earn (PAYE)
The Pay As You Earn plan is one of the newer IDR plans, coming into effect in 2012. To qualify, you must be a borrower from after October 1, 2007 with a disbursement date on or after October 1, 2011. You must also demonstrate financial need. The payment amount is 10% of your discretionary income. The repayment period is about 20 years.
Revised Pay as You Earn (REPAYE)
The Revised Pay As You Earn plan is the newest plan, coming into effect in 2015. You’re eligible regardless of when you first got the loan, and you don’t have to demonstrate financial need. The REPAYE plan payment amount is 10% of your discretionary income. The repayment term is about 20-25 years.
Income-Contingent Repayment (ICR)
The ICR plan is a good option if you want to lower your monthly payment but don’t qualify for the other IDR plans. For an ICR plan, you don’t have to demonstrate financial need, which makes it easier to qualify for. Additionally, the ICR plan payment amount is either 20% of your discretionary income or what you would pay monthly on a 12-year fixed repayment plan, whichever is lesser. The repayment period is about 25 years.
Pros and Cons of an Income-Driven Repayment Plan
Income-driven repayment plans are great, but they may not be right for everyone. Here are some things to consider when deciding if an income-driven repayment plan is right for you.
Pros of Income-Driven Repayment Plans
Good if You are Unemployed
An income-driven repayment plan is a good option if you are unemployed. Since the payment is based on your income and financial situation, it will be adjusted to something that you can afford while unemployed.
Lower Monthly Payments
Monthly payments on an IDR plan are much more likely to be lower. In fact, IDR plans offer the lowest monthly payments out of all repayment options. As long as your student debt exceeds your income, you’ll qualify for lower monthly payments.
Payments Can Be $0
If you are a low-income borrower, you can qualify for a $0 student loan payment. This is done by comparing your income with the poverty line. Generally, if your income is between 100-150% less than the poverty line relative to your location and family size, you will qualify for $0/month payments.
Remaining Balance is Forgiven
After 20-25 years of repayment on an IDR plan, your remaining student loan balance can be forgiven. There’s even the Public Service Loan Forgiveness (PSLF) program, which, if you qualify, will grant you loan forgiveness after only 10 years.
Your Credit Score Isn’t Negatively Impacted
IDR plans won’t hurt your credit score. Since the monthly payment amount is based on your financial situation, they’ll be a lot more affordable. This means it’ll be easier to make the monthly payment. And as long as you make the payments, even if it’s $0, your credit score won’t be affected.
Cons of Income-Driven Repayment Plans
You May Not Qualify
There are certain eligibility requirements to access IDR plans. For one, IDR plans are only available for federal student loans. Even then, eligible loans are largely only Direct Loans. If you don’t have a Direct Loan, you may have to consolidate to qualify. Additionally, each individual plan may have its own requirements to qualify.
Your Overall Balance Could Increase
Although a big advantage of an IDR plan is that your payments might decrease, it could cause your overall balance to increase. This is called negative amortization. Negative amortization happens when your monthly loan payment isn’t enough to cover the interest that accrues each month. So, while you may be making monthly payments on an IDR plan, your total loan balance may still increase in the meantime.
You’ll Have to Pay Taxes on the Forgiven Balance
Unless you qualify for PSLF and choose to do that, your forgiven balance from an IDR plan is taxable. This is because the IRS treats this canceled debt as income. Under law, then, you’ll have to pay taxes on any forgiven balance.
Payments Can Increase
Generally speaking, if your income increases, your monthly payment will too. Additionally, there is no standard cap for income-driven repayment plan loan payments. This means that there is no limit on how much your monthly payment can be.
You Need to Recertify Your Income Every Year to Qualify
You will need to recertify your income and family size every year to continue on an IDR plan, which includes filling out annual paperwork. There is also a strict deadline, and if you miss it, you will be placed back in the standard repayment plan.
Commonly Asked Questions About Income-Driven Repayment
Will Income Driven Repayment Hurt My Credit Score?
Switching to an income-driven repayment plan won’t directly affect your credit score. But, a lowered monthly payment will lower your debt-to-income ratio. That can be good for your credit. On the other hand, you will get an extended loan term, so you’ll have the debt for longer. You can see these changes on a credit report.
How Long Can You Stay on Income-Driven Repayment?
Right now, the maximum repayment period is 25 years. After 25 years, any remaining loan balance will be forgiven.
How Long Does an Income-Driven Repayment Plan Last?
It depends on the plan that you have. For example, the Income-Contingent Repayment Plan has a repayment period of 25 years. Meanwhile, the Pay As You Earn Plan only has a repayment period of 20 years. Generally, it’ll be anywhere from 20-25 years.
Can I Make Extra Payments on an Income-Driven Repayment Plan?
Yes, you can make extra payments. Making an extra payment won’t lower your monthly payment. But, it will save some interest and help you to pay off your loans sooner.
Why Did My IDR Payment Go Up?
Because your IDR payment is based on your income, the payment may increase as your income does. Each year, you have to recertify your income in order to continue to qualify. So, if you got a promotion, a new job, or took on a second job and your income increased, then so will your payment.
Final Thoughts from the Nest
IDR plans are a great option if you’re struggling to make loan payments. They adjust to your financial situation, making it a more affordable repayment option. Of course, these plans are only available for your federal student loans. If you have private student loans, talk to your lender about repayment options. Many of our partnering lenders offer a wide variety of payment options. Sign up with Sparrow and fill out the free application to see what you qualify for with any of our 15+ lenders.