Repaying Student Loans? Find Out Which Income-Driven Plan Might Be Best

By Louis DeNicolaOctober 23rd, 2019Student Loans

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You can use different types of plans to repay federal student loans. The standard plan means making equal payments for 10 years and can result in paying the least interest. However, if you’re struggling to afford payments or think you’ll qualify for loan forgiveness, one of the income-driven repayment (IDR) plans could make more sense and save you thousands of dollars.  

Pros and Cons of Switching to an Income-Driven Plan

While an income-driven plan can sometimes be a good idea, there are both benefits and drawbacks to consider. 

Pros

• Can lower your monthly payments. 

• Your remaining loan balance is forgiven after 20 to 25 years (depending on the plan). 

• Could save you money if you’re eligible for Public Service Loan Forgiveness. 

Cons

• You could end up paying more in interest versus the standard 10-year repayment plan.

• Forgiven loan amounts may be taxable income. 

• You may need to consolidate your loans first. 

• You have to recertify your eligibility every year. 

The Four Options

There are currently four IDR plans available to federal student loan borrowers:

• Revised Pay As You Earn Repayment (REPAYE)

• Pay As You Earn Repayment (PAYE)

• Income-Based Repayment (IBR)

• Income-Contingent Repayment (ICR)

With an IDR plan, your monthly payment will depend on which plan you use and your discretionary income. The Department of Education (ED) determines you discretionary income by comparing your adjusted gross income (AGI) to a percentage of the poverty line based on your family size and what state you live in. 

Depending on the plan, your monthly payment is then capped at 10 to 20 percent of your discretionary income. There’s no minimum, either. Your payment amount could be as low as $0 a month — and these monthly payments still count as on-time payments for the loan forgiveness timelines.

Revised Pay As You Earn Repayment 

Anyone with eligible federal student loans can qualify for REPAYE, and the plan caps your monthly payments at 10 percent of your discretionary income. Your loan balance will be forgiven if you’ve made payments under the plan for 20 years — or 25 years if you’re repaying loans you used for graduate or professional school. 

Pay As You Earn Repayment

To qualify for PAYE, you must be considered a new borrower, meaning you didn’t have outstanding federal student loans on or after October 1, 2007 and you received an eligible loan on or after October 1, 2011. 

Also, your monthly payment amount (which is 10 percent of your discretionary income) must be lower than what you’d pay if you stay on the standard repayment plan. If you do qualify, your loan balance is forgiven after 20 years.  

Income-Based Repayment

The IBR plan also requires your payment amount to be less than you’d pay with the standard plan. With IBR, your monthly payment will be 10 or 15 percent of your discretionary income, and your balance is forgiven after 20 years if you took out the loans on or after July 1, 2014. 

If your loans are from before then, your payment amount is 15 percent of your discretionary income, and the balance is forgiven after 25 years. 

Income-Contingent Repayment

You can use the ICR plan regardless of when you took out your loans, but it may be the least favorable option. Your monthly payment is the lesser of 20 percent of your discretionary income or a monthly payment that would lead to paying off the loan in 12 years. The forgiveness timeline is 25 years. 

Get a Quick Comparison

You can get a quick estimate of your monthly payment amount with different plans by using the online Repayment Estimator tool on the ED’s website.

Joshua Cohen, a consumer rights attorney who specializes in student loan law, says, “It’s a good start, but it can’t run scenarios and it doesn’t tell you how a household payment looks if both spouses have loans.” With marriage, for example, whether you choose to file jointly or separately can impact your AGI and both of your payment amounts.  

To get a more accurate comparison of your payment amounts, you may need to do some digging on your own. The ED has a blog post that can walk you through some of the differences and options you’ll want to consider as you compare plans. 

Which Plan is Best?

Cohen says one of the biggest factors in choosing the right plan is what kind of loan you took out to pay for school. 

For example, if you have a Parent PLUS loan that you borrowed to help a child pay for school, your only option is the ICR plan. Even then, you’ll first need to consolidate your loan through the federal Direct Consolidation Loan program. 

But generally, he says the REPAYE plan is the best option as your monthly payment will be just 10 percent of your discretionary income. The IBR plan’s 15 percent mark makes it a good option as well. 

Of course, the specifics of your situation matter. Cohen points to a scenario where borrowers may be able to switch to the REPAYE plan and lower their monthly payment, but they’ve already made years’ worth of payments toward forgiveness on their current plan. 

“Switching to REPAYE at that stage would require consolidation, which resets the clock,” he says. “Does the client want forgiveness pushed back?” Even that doesn’t have a clear answer. 

If your student loans are forgiven through an IDR plan, the forgiven amount will be taxable income for the year. With the current plan, that could mean a large amount of taxable income while they’re still working and in a high tax bracket. Cohen points out that strategically resetting the clock and pushing the forgiveness into their retirement years might actually make more sense. 

Overall, if you’re having trouble affording your student loans, switching to an IDR plan might lower your payment amount and make it easier to manage your loans. Sometimes, the plan choice is clear. But if you have questions or want advice from someone who specializes in student loans, a Money Management International counselor can help.