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There are moments when you may feel as if you are bad with money: You overdraft your account, pay a bill late, can’t put any cash towards retirement, or realize your savings account balance hasn’t budged in months.

If you feel as if you aren’t managing your money as well as you could in these instances, you might be right. But by taking a closer look at these signals and then shifting your course, you can get on a better track to taking control of your cash, building wealth, and reaching your financial goals.

So instead of just thinking, “I’m bad with money” and sidestepping the issue, read on to learn the signs that you could boost your money management. Then try the simple strategies that can help you improve.

4 Signs You’re Bad With Money

Sometimes the signs are clear, like getting multiple notifications for overdraft fees in a week. Sometimes, however, being bad with money is less obvious. Here are some red flags that can indicate you’re heading down the wrong financial path.

You Tend to Live Paycheck to Paycheck

Even if you are able to pay your bills in full each month, if you’re often broke after paying them, it can be a sign that you’re not all that financially stable.

Whatever your income or budget is, it can be wise to always have at least a little bit of extra money to put into savings. If that extra doesn’t exist, then you could be walking a financial tightrope, where a major crisis could be waiting just around the corner.

You Don’t Have an Emergency Savings Fund

Not starting an emergency fund (rainy-day money tucked away in a separate savings account) is an indication that you’re living too close to the edge. It’s important to have that cash to cover an unexpected expense, such as a medical bill, car repair, or sudden loss of income.

Although the specific dollar amount you should have in your emergency fund varies from person to person, many financial experts say you should try to have at least three months’ worth of living expenses set aside to cover the unexpected.

Without this cushion, a single large expense or loss of paycheck even for a couple of months could put you in a debt spiral that can be hard to get out from under. You might be tempted to put too much on your credit card and wind up with high-interest debt.

You Only Make the Minimum Payment on Your Credit Cards

Speaking on high-interest debt: Here’s another sign that you may be bad with money. Paying the minimum on your credit cards may seem like you’re keeping up, but in reality you are gradually getting further and further behind.

If you don’t pay the card in full each month, every dollar you put on a card can end up costing you many times more in interest charges over time. Credit card debt that you can’t get rid of can be a clear sign that you’re not being as good with your money as could be.

You Often Overdraft Your Account

If you’re gotten into the habit of spending almost everything you earn, it can be easy to overdraft your account. This often results in a high overdraft or NSF fee, which can make keeping up with your expenses even harder.

Overdrafts can also result from disorganization. Maybe you have the money, but didn’t transfer it over to your checking account in time. This can be a sign that you’re not keeping close enough tabs of your money.

Recommended: How to Avoid Overdraft Fees

How to Be Better With Money: 11 Tips

Becoming better at money management doesn’t have to happen overnight. In fact, the best approach to lasting change is often to take one small step at a time. This can be much easier to do and, as you start to see the rewards (more money, less stress), you will likely be inspired to keep going.

The following tips can help put you on the path to being good with money.

1. Setting Some Specific Money Goals

You likely have a few things you’d like to do in life that having enough money can help you accomplish. Maybe you want to take a great vacation next year, buy a home in a few years, or retire early.

Setting financial goals, both for the short- and long-term, can give you something to work towards — or, in other words, a reason to be better with your money.

Recommended: What is Financial Therapy?

2. Tracking Your Cash Flow

In order to get better with money, it can help to know exactly where you currently stand.

You can do this by gathering all your financial statements for the past several months, and then adding up all of your after-tax income to see how much is coming in each month.

Next, you can tally up how much you are spending each month. To do this, you may want to make a list of all your spending categories and then come up with an average amount you’ve been spending on each.

You may find it helpful to actually track your spending for a month or two, either by journaling or using an app that tracks spending right on your phone.

Ideally, you’ll want to have more coming in than going out each month. That means you have money you can siphon off into saving and investing, which can help you build wealth over time.

3. Coming Up With a Budget Method That Works for You

Once you have a clear picture of what’s coming and going out each month, you can create a budget for your money moving forward — in other words a budget.

While budgeting may sound onerous, it’s simply a matter of going through your expenses, seeing where you may be able to cut back, and then coming up with target spending amounts for each category.

One budgeting framework that may help you get started is a 50/30/20 budget breakdown. The idea is that 50% of your after-tax income should go to necessities, 30% goes to fun spending or “wants,” and 20% goes to savings goals.

These percentages may not work for everyone, especially if you live in an area with a high cost of living, but they can give you a general rule of thumb as you get started with budgeting.

4. Curbing Impulse Purchases

If you tend to shop without a plan, it can be easy to grab this and that without realizing how quickly these small costs can add up. A perfect example is going grocery shopping. But the same thing can happen if you are mindlessly browsing shops at the mall or online.

Making a list — and sticking to it — whenever you shop can help you avoid overspending. If you see something you really want but you weren’t planning to buy, it can be a good idea to put the purchase on pause for a day or two.

Once you have a cool head and a fresh perspective, you can then ask yourself if you’ll actually use this item and if you can afford it, meaning you can pay cash for it now. If not, it may be a good idea to skip it.

5. Thinking About Larger Spending Cuts

There are only so many lattes you can skip or cents per gallon you can save by heading to the cheaper gas station around the corner. So when you’re trying to find places to save money in your budget, you may also want to think bigger.

For example, you might decide to ditch your car in favor of biking to work — a move that means you save not only what you’d be spending on gas each month, but also insurance, registration, and likely a monthly car payment. (And you might even be able to ditch your gym membership, with all that moving around!) Or, you might consider moving to a less-trendy neighborhood or getting a roommate to help split the rent and other household expenses.

While lifestyle changes might be harder to enact up front, once you commit to them, they can help you save large amounts of money on a regular basis.

6. Automating Your Savings

Building an emergency fund and saving for future financial goals are key steps toward fiscal wellness. So once you have graduated from being at risk of overdrafting your accounts, a great next step can be to automate your savings.

That means setting up an automatic transfer of money from your checking account (or wherever your money is deposited) to one or more accounts designated for saving. This can be done on a monthly (or bimonthly) basis, and can be timed to happen right after your paycheck hits.

If saving is a chore that you have to remember to do every month, you may get busy and forget. Why not let technology do the heavy lifting for you?

7. Bringing in More Income

Do you feel like you’re cutting back on spending as much as possible but not getting anywhere? You may need to work on earning more money.

How exactly you go about this goal is up to you, of course. Maybe this means sitting down with a boss and creating a path towards earning more money. Or, it could mean picking up some freelance work in your profession, or starting a side hustle (like pet-sitting or signing up with a ride-share or delivery app).

8. Listing All of Your Debts

Many bad financial habits are born from the easy access consumers have to money that isn’t theirs — and the need to pay those debts back, with interest.

As with budgeting, the first step in conquering your debts is knowing exactly what you’re up against. To get the big picture, you may want to create a computer spreadsheet (or just make a chart with pen and paper) and then list each source of debt that you currently hold.

This includes student loans, credit cards, car loans, and any other debts you may have. You may also want to include the loan servicer, the size of the debt, the interest rate, and the amount and date of the monthly payment on each debt.

9. Knocking Down Debt One at a Time

If you’re paying the minimum on more than one high interest credit card, you may want to focus on getting rid of one entirely. It could be the debt with the highest interest rate, or it might be the smallest overall balance to give you the psychological victory of kicking a source of debt to the curb.

Whichever one you choose, you can then put as much extra money as you can towards the balance (principal) of that debt, while paying the minimum amount due on all the others. Once you pay that debt off, you can move on to the next one.

10. Avoiding More Credit Card Debt

Getting better at managing your money can be hard to do when you’re adding to your credit card balance. Credit cards are notoriously difficult to pay back when you’re only making the minimum payments and can be nearly impossible if you’re doing that while adding to the balance.

So, you may want to use your newfound money management skills to find ways around going further into credit card debt. Maybe there are more cuts that can be made to your budget or some overall shifts in lifestyle that could help. No matter how you do it, it can be helpful to focus on spending only the money you actually have.

11. Contributing More to Your 401(k)

You might think saving for retirement is something you don’t really need to focus on until you’re older. But the truth is that the earlier you start saving for retirement, the easier it will generally be to save enough to retire well. That’s thanks to the magic of compounding interest, which is when the interest you earn on your money earns its own interest.

If your company offers a 401(k), it can be a good idea to contribute at least a small percentage of each paycheck. If your employer offers matching funds, you may want to take full advantage of this perk by contributing the max amount your company will match.

Recommended: When to Start Saving for Retirement

The Takeaway

You don’t have to master all of the above concepts right away. Becoming a person who is “good with money” is a journey. Start with one area and move on to the next as you feel you have mastered each financial tool.

One simple step that can make it easier to manage your money is to find the right banking partner, one who can help you with tools for tracking and managing your cash.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Whether you’re borrowing money from a lender or depositing money in a savings account, interest rates will play into your financial picture. And understanding exactly how they work is crucial to making the best possible decisions for your money.

Here’s the scoop.

Interest Rate Definition

Interest rate is the cost of borrowing or the payoff of saving. Specifically, it refers to the percentage of interest a lender charges for a loan as well as the percentage of interest earned on an interest-bearing account or security.

Interest rates change frequently, but the average personal loan interest rate is dependent on several factors, including the amount borrowed, credit history, and income, among others. A borrower with an excellent credit score and a dependable income, for instance, will likely be considered low risk and may be offered a lower interest rate. On the flip side, some vehicles like payday loans are considered riskier for lenders and tend to have higher interest rates.

Recommended: What Is a No-Interest Loan? A Personal Loan Guide

How Interest Rates Work

Whether you’re borrowing or saving money, the interest rate is applied to the balance during set periods of time called compounding periods.

For borrowers, this extra charge can add to outstanding debt. For savers, savings interest can be one way to earn money without much effort.

Let’s look at some specific examples.

You might take out a personal loan with an APR of 5.99%. That means you’ll pay an additional 5.99% of the loan balance each year in addition to the principal payments, which is paid to the lender for servicing the loan.

Or, if you hold a high-yield savings account that offers a 1% APY return, you can expect that account to grow by 1% of its balance each year.

Of course, the interest you might earn in a savings account is usually substantially lower than what you might earn on higher-risk investments.

And when it comes to any of the multiple uses of a personal loan, paying interest means you’re paying substantially more than you would if you were able to cover the expense out of pocket.

Fixed vs Variable Interest Rates

Lenders charge fixed or variable interest rates. What’s the difference between the two? Let’s take a look.

As the name suggests, fixed interest rates remain the same throughout a set period of time or the entire term of the loan. Fixed rates can be higher than variable rates. Borrowers who prefer more predictable payments — or are borrowing when interest rates are low — may decide to go with a fixed-rate loan.

Variable interest rates change periodically, depending on changes in the market. This means the amount of your payments will vary. Generally speaking, variable-rate loans can be riskier for consumers, so they tend to have lower initial rates than fixed-rate loans. However, it’s important to note that when interest rates rise, so can the cost of borrowing. When borrowers decide to renegotiate from a variable-rate to a fixed-rate loan, they may face additional fees and a new loan length.

A variable-rate loan may be a good move for borrowers who plan to pay off the loan quickly or can take on the risk.

Types of Interest

While all interest does one of two things — accrue as a result of saving money or in payment to the bank for a loan — it can be calculated and assessed in different ways. Here are a few common types of interest rates explained.

Simple Interest

Simple interest is interest that is calculated, simply, based on the balance of your account or loan. This is unlike compound interest, which is based on the principal balance (the original money you borrowed) as well as interest accrued over time.

Most mortgages and auto loans are calculated using simple interest. That means you won’t pay additional interest on any interest charged on the loan.

For example, let’s say a driver takes out a simple interest loan to pay for a new car. The loan amount is $31,500, and the annual interest rate on the loan is 4%. The term of the loan is five years. The driver will pay $580.12 per month. After five years, when the loan is satisfied, they will have paid a total of $34,807.23.

Compound Interest

Compound interest, on the other hand, means that interest is charged on not only the principal but also whatever interest accrues over the lifetime of that loan.

Say you take out an unsecured personal loan in the amount of $20,000 to pay for home remodeling. The loan is offered to you at an interest rate of 6.99% compounded monthly, and you must also pay an upfront fee of $500 for the loan. You’ll pay it back over the course of five years.

Over the course of those 60 payments, you’ll pay $3,755.78 in interest, not including the $500 extra you paid in fees. Each month, you’ll pay back some of the principal as well as the interest charged to you.

By the time you’re done with your home remodel, you’ll have paid $24,255.78 altogether, and that’s on a personal loan with a fairly low rate. In other words, you’ll have paid 20% more for the project than you would have if you’d funded it out of pocket.

Recommended: Simple Interest vs. Compound Interest

Amortized Interest

Amortizing loans are common in personal finance. If you have a home loan, auto loan, personal loan, or student loan, you likely have an amortizing loan.

Amortization is when a borrower makes monthly (usually equal) payments toward the loan principal and interest. Early payments largely go toward the calculated interest, while payments closer to the end of the loan term go more toward the principal.

The interest on an amortized loan is calculated based on the balance of the loan every time a payment is made. As you make more payments, the amount of interest you owe will decrease.

To see how payments are spread out over the life of the loan, borrowers can consult an amortization schedule. A mortgage calculator also shows amortization over time for a loan.

But here’s a look at a sample calculation:

Let’s say you take out a $200,000 mortgage over 10 years at a 5% fixed interest rate. Your monthly payments will be $2,121.31. Next, divide the interest rate by 12 equal monthly payments. That equals 0.4166% of interest per month. This means that in the first month of your loan, you’ll pay $833.33 toward interest and the remaining $1,287.98 toward your principal.

Now, how about the second month? To calculate what you’ll owe, deduct your monthly payment from the starting balance. (This will give you the “balance after payment” for the chart.) Be sure to add to the chart the $833.33 you paid in interest and the $1,287.98 you paid toward the principal. Repeat the calculation of monthly interest and principal breakdown for the rest of the chart, which includes 12 months of payments.

Precomputed Interest

Loans that calculate interest on a pre-computed basis are less common than loans with either simple or compound interest. They’re also controversial and have been banned in some states. Precomputed interest has been banned nationally since 1992 for loans with terms longer than 61 months.

This method of computing interest is also known as the Rule of 78 and was originally based on a 12-month loan. The name is taken from adding up the numbers of the months in a year (or a 12-month loan), the sum of which is 78.

Interest is calculated ahead — precomputed — for each month and added to each month’s payment, giving more weight to interest in the beginning of the loan and tapering off until the end of the loan term. In the case of a 12-month loan, the first month’s interest would be 12/78 of the total interest, the second month’s interest would be 11/78 of the total interest, and so on.

Here’s an example: Let’s say a borrower takes out a personal loan with a 12-month term that will accrue $5,000 in interest charges. According to the Rule of 78, here’s what the borrower would pay in interest each month:

A loan with precomputed interest has a greater effect on someone who plans to pay off their loan early than one who plans to make regular payments over the entire life of the loan.

APR vs APY

Whether compound or simple, interest rates are generally expressed as APR (Annual Percentage Rate) or APY (Annual Percentage Yield). These figures make it easier for borrowers to see what they can expect to pay or earn in interest over the course of an entire year of the loan or interest-bearing account’s lifetime.

However, APY takes compound interest into account, whereas usually APR does not — but on the other hand, APR takes into account various loan fees and other costs, which APY might skip.

Recommended: APY vs. Interest Rate: What’s the Difference?

How Are Interest Rates Determined?

Lenders use several factors to determine the interest rate on a personal loan, including details about your financial background and about the loan itself. What kind of financial questions can you expect?

When lenders talk about a borrower’s creditworthiness, they’re usually referring to elements of your financial background. This may include:

•   Your credit history

•   Your income and employment

•   How much debt you already have

•   Whether you have a cosigner

The loan terms can also affect the rate. For example, personal loan rates can be affected by:

•   The size of the loan

•   The duration of the loan

Loan term is something borrowers should be thinking about as well. A longer loan term might sound appealing because it makes each monthly payment lower. But it’s important to understand that a longer-term loan may cost you significantly more over time due to interest charges.


💡 Quick Tip: In a climate where interest rates are rising, you’re likely better off with a fixed interest rate than a variable rate, even though the variable rate is initially lower. On the flip side, if rates are falling, you may be better off with a variable interest rate.

Interest Rates and Discrimination

Generally speaking, the higher your credit score and income level, the easier it is to qualify for loans with better terms and lower interest rates — which, of course, can make it more difficult for people in lower socioeconomic positions to climb their way out.

Discriminatory lending has had a long history in the U.S. Before federal laws protecting against discrimination in lending practice, lenders would regularly base credit decisions on factors such as applicant’s race, color, religion, sex, and other group identifiers rather than their creditworthiness.

The practice of “redlining” was begun in the 1930s as a way to restrict federal funding for neighborhoods deemed risky by federal mortgage lenders. It persisted for decades, and the detrimental effects can still be felt today by residents of minority neighborhoods.

Since residents of redlined neighborhoods were excluded from approval for regular mortgage loans, they were forced to look for other financing options, which were often exploitive. If they could not find any lender willing to loan to them, they continued renting, unable to gain equity in homeownership.

The Takeaway

The interest rate is the cost of borrowing money — it’s a percentage of the total amount of the loan. It can also refer to the rate at which interest is earned on money in a savings account, certificate of deposit, or certain investments. The amount of interest you’ll pay is usually expressed using percentages, which will be listed as either APR (Annual Percentage Rate) or APY (Annual Percentage Yield), depending on which kind of financial product you’re talking about.

Lenders charge fixed or variable interest rates. Fixed interest rates remain unchanged for a set period of time or for the life of the loan, and may be a smart choice for borrowers who want a predictable payment schedule or are taking out a loan when interest rates are low. Variable interest rates can change depending on the market, which means the payment amount will vary. Though potentially riskier, these loans may offer lower initial rates. However, when interest rates rise, so can the cost of borrowing.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

FAQ

What is the definition of interest rate?

An interest rate is expressed as a percentage and is used to calculate how much interest you would pay on a loan in one year (APR), or how much you would earn on an interest-bearing account in one year (APY).

What is an example of an interest rate?

Simple, compound, or precomputed interest rates are types of interest rates commonly used.

What is the difference between interest and interest rate?

Interest is the money you’re charged when you take out a loan — or earn for leaving your money in a deposit account to grow. Interest rate is the percentage you’re being charged or are earning.

What happens when interest rates are high?

Interest rate increases tend to lead to higher interest rates on personal loans, mortgages, and credit cards. It can also mean costlier financing for borrowers.

Can you adjust the interest rate on a personal loan?

Possibly. One way to lower the interest rate on a personal loan is to refinance it with another lender.

Photo credit: iStock/Remitski

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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If you’re on the standard 10-year repayment plan and your federal student loan payments are high relative to your income, a student loan income-based repayment plan may be an option for you.

New changes to the plans, including a new plan called SAVE that was introduced by the Biden Administration, will reduce many borrowers’ payments. Read on to learn whether income-based student loan repayment might be right for your situation.

What Is Income-Based Student Loan Repayment?

Income-based student loan repayment plans were conceived to ease the financial hardship of government student loan borrowers and help them avoid default when struggling to pay off student loans.

Those who enroll in the plans tend to have large loan balances and/or low earnings. Graduate students, who usually have bigger loan balances than undergrads, are more likely to enroll in a plan.

The idea is straightforward: Pay a percentage of your monthly income above a certain threshold for 20 or 25 years and you are eligible to get any remaining balance forgiven. (The SAVE plan would forgive balances after 10 years for borrowers with original loans of $12,000 or less.)

By the end of 2022, 45% of Direct Loan borrowers were enrolled in an income-based repayment plan, according to Federal Student Aid, an office of the U.S. Department of Education. But borrowers have often failed to recertify their income each year, as required, and are returned to the standard 10-year plan.


💡 Quick Tip: Often, the main goal of refinancing is to lower the interest rate on your student loans — federal and/or private — by taking out one loan with a new rate to replace your existing loans. Refinancing makes sense if you qualify for a lower rate and you don’t plan to use federal repayment programs or protections.

2 Income-Driven Student Loan Repayment Plans

While people often use the term “income-based repayment” generically, the Department of Education calls them income-driven repayment (IDR) plans. There are four, but two plans recently stopped accepting new borrowers. We’ll focus on the two that are still open to you:

•   Income-Based Repayment (IBR)

•   Saving on a Valuable Education (SAVE), which replaces the previous Revised Pay As You Earn (REPAYE) plan

Your payment amount is a percentage of your discretionary income, defined for IBR as the difference between your annual income and 150% of the poverty guideline for your family size.

For the SAVE plan, discretionary income is the difference between your annual income and 225% of the poverty line for your family size. This new plan could substantially reduce borrowers’ monthly payment amounts compared to other IDR plans. For IBR and SAVE, the payment is 5% to 10% of your discretionary income.

Got it? But wait; there’s more. Note the number of years in which consistent, on-time payments must be made and after which a balance may be forgiven, as well as who qualifies.

How Income-Based Student Loan Repayment Works

In general, borrowers qualify for lower monthly loan payments if their total student loan debt at graduation exceeds their annual income.

To figure out if you qualify for a plan, you must apply at StudentAid.gov and submit information to have your income certified. Your monthly payment will then be calculated. If you qualify, you’ll make your monthly payments to your loan servicer under your new income-based repayment plan.

You’ll generally have to recertify your income and family size every year. Your calculated payment may change as your income or family size changes.


💡 Quick Tip: When rates are low, refinancing student loans could make a lot of sense. How much could you save? Find out using our student loan refi calculator.

What Might My Student Loan Repayment Plan Look Like?

Here’s an example:

Let’s say you are single and your family size is one. You live in one of the 48 contiguous states or the District of Columbia. Your adjusted gross income is $40,000 and you have $45,000 in eligible federal student loan debt.

The 2023 government poverty guideline amount for a family of one in the 48 contiguous states and the District of Columbia is $14,580, and 150% of that is $21,870. The difference between $40,000 and $20,385 is $18,130. That is your discretionary income.

If you’re repaying under the IBR plan, 10% of your discretionary income is about $1,813. Dividing that amount by 12 results in a monthly payment of $151.08.

Under the SAVE Plan, however, your discretionary income is the difference between your gross income and 225% of the poverty line, which comes out to $32,805. The difference between $40,000 and $32,805 is $7,195, which is your discretionary income; 5% of your discretionary income is about $360. That amount divided by 12 results in a monthly payment of $30.

The Federal Student Aid office recommends using its loan simulator to compare estimated monthly payment amounts for both repayment plans.

Which Loans Are Eligible for Income-Based Repayment Plans?

Most federal student loans are eligible for at least one of the plans.

Federal Student Aid lays out the long list of eligible loans, ineligible loans, and eligible if consolidated loans under each plan.

Of course, private student loans are not eligible for any federal income-driven repayment plan, though some private loan lenders will negotiate new payment schedules if needed.

Pros and Cons of Income-Based Student Loan Repayment

Pros

•   Borrowers gain more affordable student loan payments.

•   Any remaining student loan balance is forgiven after 20 or 25 years of repayment; and, as of July 2024, after 10 years of repayment for those in the SAVE plan with original loan balances of $12,000 or less.

•   An economic hardship deferment period counts toward the 20 or 25 years.

•   The plans provide forgiveness of any balance after 10 years for borrowers who meet all the qualifications of the Public Service Loan Forgiveness (PSLF) program.

•   The government pays all or part of the accrued interest on some loans in some of the income-driven plans.

•   Low-income borrowers may qualify for payments of zero dollars, and payments of zero still count toward loan forgiveness.

•   New federal regulations will curtail instances of interest capitalization and suspend excess interest accrual when monthly payments do not cover all accruing interest.

Cons

•   Stretching payments over a longer period means paying more interest over time.

•   Forgiven amounts of student loans are free from federal taxation through 2025, but usually the IRS treats forgiven balances as taxable income (except for the PSLF program).

•   Borrowers in most income-based repayment plans need to recertify income and family size every year.

•   On some plans, if a borrower gets married and files taxes jointly, the combined income could increase loan payments. (This is not the case with the SAVE Plan.)

•   The system can be confusing to navigate.

Student Loan Refinancing Tips From SoFi

Income-driven repayment plans were put in place to tame the monthly payments on federal student loans for struggling borrowers. For instance, the new SAVE Plan offers the lowest monthly payments of all IDR plans. (Those who have private student loans don’t qualify for IDR plans.)

If your income is stable and your credit is good, and you don’t need federal programs like income-driven repayment plans or deferment, refinancing your student loans is an option. (To be clear, refinancing federal student loans makes them ineligible for federal protections and programs like income-driven repayment and loan forgiveness for public service.) With refinancing, the goal is to pay off your existing loans with one new private student loan that ideally has a lower interest rate.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.

FAQ

Is income-based repayment a good idea?

For borrowers of federal student loans with high monthly payments relative to their income, income-based repayment can be a good idea. Borrowers may want to check out the new SAVE Plan, which provides the lowest monthly payments of the income-driven repayment options.

What is the income limit for income-based student loan repayment?

There is no limit. If your loan payments under the 10-year standard repayment plan are high for your income level, you may qualify for income-based student loan repayment.

What are the advantages and disadvantages of income-based student loan repayment?

The main advantage is lowering your monthly payments, with the promise of eventual loan forgiveness if all the rules are followed. A disadvantage is that you have to wait for 10, 20, or 25 years depending on the plan you’re on and how much you owe.

How does income-based repayment differ from standard repayment?

With the standard repayment plan, your monthly payments are a fixed amount that ensures your student loans will be repaid within 10 years. Under this plan, you’ll generally save money over time because your monthly payments will be higher. With income-based repayment, your monthly loan payments are based on your income and family size. These plans are designed to make your payments more affordable. After a certain amount of time ranging from 10 to 25 years, depending on the plan, any remaining balance you owe is forgiven.

Who is eligible for income-based repayment plans?

Under the new SAVE plan, any student loan borrower with eligible student loans can participate in the plan. With the PAYE and IBR plans, in order to be eligible, your calculated monthly payments, based on your income and family size, must be less than what you would pay under the standard repayment plan. Under the ICR plan, any borrower with eligible student loans may qualify. Parent PLUS loan borrowers are also eligible for this plan.

How is the monthly payment amount calculated in income-based repayment plans?

With income-based repayment, your monthly payment is calculated using your income and family size. Your payment is based on your discretionary income, which is the difference between your gross income and an income level based on the poverty line. The income level is different depending on the plan. With the SAVE Plan, for instance, your discretionary income is the difference between your gross annual income and 225% of the poverty line for your family size.

For IBR and SAVE, your monthly payment is 5% to 10% of your discretionary income.

SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.