When it comes to budgeting, most people are focused on the bottom line: the necessary expenses that have to be paid each month. There’s usually rent, utilities, insurance, groceries, and, for a lot of us, student loan payments.
If you’re just starting your career, there might not be a lot left over once all the necessary bills are paid. It might be just enough for a few dinners out, the occasional weekend getaway, or enough to start building up your emergency fund bit by bit.
But your discretionary income does have significance when it comes to your student loan payment. This is particularly true for those who might be considering an income-driven repayment plan to lower their monthly payment. With these plans, your discretionary income plays a pretty big role in how your monthly payment is calculated.
Knowing what your discretionary income is (and how to calculate it) can help you make decisions about how to best repay your loans. In this article, we’ll discuss the different income-driven repayment plans, and the ins and outs of discretionary spending, so you can figure out a repayment strategy that works for you and your budget.
How Do you Calculate your Discretionary Income?
What’s considered essential to one person may not be considered essential to another (or to the government). In order to determine eligibility and benefits for certain income-driven public programs, like income-based repayment plans, the government has a way of standardizing discretionary income.
The way that student loan servicers typically calculate discretionary income depends on the type of income-driven repayment plan you are considering. For an income-contingent repayment (ICR) plan, you subtract 100% of the federal poverty guideline from your adjusted gross income (AGI). For all other income-based repayment plans, you subtract 150% of the poverty guideline from your AGI.
So, let’s say you’re in a one-person household and have a starting salary of $45,000. If you are considering an ICR plan, you would subtract 100% of the poverty guideline ($12,140), to get an official discretionary income of $32,860. Monthly, that is a discretionary income of a little over $2,700.
This would be the number that loan servicers use to determine your monthly payment on an ICR plan. If you’re filing jointly, or you have dependents, that will impact your discretionary income calculations. For married couples filing together, your combined AGI is used when calculating discretionary income. Under an income-driven plan, filing with a spouse can drive up your income-driven monthly payments because of your combined AGI.
How does Discretionary Income Affect your Student Loan Payments?
Income-driven repayment plans use your discretionary income to set a cap on the amount you’re required to repay each month. In the case of ICR plans, it’s whichever is lower, a 20% cap or what you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income.
Using the example above with a 20% cap of your discretionary income, an ICR plan would cap your monthly payment at around $540—but it still might be less, depending on your student loan balance. (And don’t worry, they’ll calculate it for you. But understanding the math can help you estimate what your payment might be. Also, it never hurts to check the government’s math.) If you have a high student loan balance, but don’t make a lot of money yet, an income-contingent repayment plan may get you a significantly more manageable monthly payment.
What Income-Driven Repayment Plan are you Eligible For?
There are four federal income-driven repayment plans that have different eligibility criteria and terms. For Pay As You Earn (PAYE) plans and income-based repayment (IBR) plans, eligibility is determined based on income.
These plans reduce monthly payments for people with incomes below a certain threshold. Revised Pay As You Earn (REPAYE) plans and income-contingent repayment (ICR) plans are open to anyone with eligible federal loans. For all plans, your discretionary income is used to determine how much your monthly payments will be. It should be noted that income-driven repayment plans don’t apply to private student loans. They’re only an option for your federal student loans.
Income-based plans come with trade-offs, like just about everything in life. While they can lower your monthly payment and help free up your cash flow now, they may extend the life of your loan. The standard student loan payoff plan is based on a 10-year repayment timeline. An income-based repayment plan can extend your payment timeline to up to 25 years.
This means you’ll be paying off the loan longer and possibly paying more in interest over time. If you stay on an income-driven repayment plan, the government might forgive any remaining balance after 20 or 25 years of payments. But the amount that is forgiven may be taxed as income—which can lead to a pretty hefty tax bill.
How Else Can you Lower Your student Loan Payment?
Another potential way to reduce your student loan payment is to refinance your student loans. When you refinance your student loans, you take out a new loan with new terms from a private lender. The new loan is used to pay off your existing student loans.
Then, you just have to focus on paying off your one new loan, as opposed to paying multiple student loans. Depending on your financial profile, refinancing can result in a lower interest rate and a lower monthly payment depending on which terms you choose, which means you could save a lot of money to best suit your financial needs.
However, when you refinance, you will no longer be able to take advantage of some of the protections that come with federal loans, including forbearance and deferment. These benefits can help you pause payments if you are experiencing financial hardship or returning to school.
But if you have a steady job and good credit, refinancing with a private lender may have a lot of its own benefits. Ultimately, refinancing is yet another option out there that may save you money—and at a possibly lower interest rate.
Whether you need help paying for school or help paying off the loans you already have, SoFi offers competitive interest rates and great member benefits as well.
SoFi does not render tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.
The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.