Knowing what your discretionary income is (and how to calculate it) can help you make decisions about how to best repay your loans. Essentially discretionary income is money left after all essential expenses have been taken care of.
When it comes to individuals who are considering repaying federal student loans with an income-driven repayment plan, discretionary income can be a major factor in how much they’ll owe each month. That’s because the government uses a borrower’s discretionary income to determine their monthly payments.
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.
What Is Discretionary Income?
Discretionary income can be defined as money left after necessary expenses, like housing and food, are paid. Think of this as the money that can be put into a savings account and to pay for wants (versus needs). This is different from disposable income, which is what’s left after taxes, not including any essential spending.
When it comes to federal student loans, the government has an actual formula that’s used to calculate discretionary income. Here’s more about the why and the how.
How Is Discretionary Income Calculated?
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-driven 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 example, an income-contingent repayment (ICR) plan, you subtract 100% of the federal poverty guideline from your adjusted gross income (AGI). For all other income-driven 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 ($12,880), to get an official discretionary income of $32,120. Monthly, that is a discretionary income of a little under $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.
What Income-Driven Repayment Plan are You Eligible For?
There are four federal income-driven repayment plans that have different eligibility criteria and terms. These income-driven repayment plans can reduce monthly payments for people with incomes below a certain threshold.
Related: Understanding How Income Based Repayment Works
It should be noted that income-driven repayment plans don’t apply to private student loans. They’re only an option for federal student loans.
Income-Driven Repayment Plans for Federal Student Loans
The four options available for federal student loan borrowers are:
• Revised Pay As You Earn Repayment Plan (REPAYE Plan).
• Pay As You Earn Repayment Plan (PAYE Plan).
• Income-Based Repayment Plan (IBR Plan)
• Income-Contingent Repayment Plan (ICR Plan).
For all income-driven repayment plans, discretionary income is used to determine monthly payments. So, if there is a change in a borrower’s income or family size, their monthly payment could increase or decrease, depending on the change. Borrowers enrolled in an income-driven repayment plan are required to recertify their income and family size each year.
The REPAYE and ICR plans are open to anyone with eligible federal loans. Under these two repayment plans, the amount owed each month is always tied to a borrower’s discretionary income. This could mean that if an individual’s income increases over time, they may end up paying more each month than they would under the 10-year Standard Repayment plan.
For the PAYE plans and IBR plans, eligibility is determined based on income and family size. As a general rule, to qualify, borrowers must not pay more under PAYE or IBR than they would under the 10-year Standard Repayment Plan. Under these plans, the amount owed each month will never exceed what a borrower would owe under the Standard Repayment Plan.
For guidance in how this might work for you, the federal government offers its version of a discretionary income calculator: its loan simulator feature .
Pros and Cons of Income-Driven Repayment Plans
Income-driven plans come with trade-offs. 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-driven 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.
How Does Discretionary Income Affect 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.
Related: How is Income Based Repayment Calculated?
Using the example above with a 20% cap of your discretionary income, an ICR plan would cap your monthly payment at a little below $540—and it 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.
How Else Can Borrowers Lower Their Student Loan Payment?
Another potential way for borrowers to reduce their student loan payment is by refinancing 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.
Depending on your financial profile, refinancing could result in a lower interest rate or a lower monthly payment depending on which terms you choose. Securing a lower monthly payment is generally the result of extending the loan’s term, which in the long-term, could increase the cost of borrowing the loan. To see what refinancing could look like for you, take advantage of the student loan calculators available online.
However, when a borrower refinances federal student loans, they’ll no longer be able to take advantage of the protections that come with federal loans, including income-driven repayment plans, forbearance and deferment.
But for borrowers with a steady job and strong credit, refinancing with a private lender may have its own benefits. Ultimately, refinancing is another option to consider that may help borrowers manage their student loans.
The Takeaway
Discretionary income, what’s left over after someone takes care of all of their necessary expenses, is an important factor for borrowers enrolled in an income-driven repayment plan. The government uses discretionary income to calculate how much a borrower owes each month on their student loans. As a borrower’s discretionary income chances, so may the amount they owe on an income-driven repayment plan.
Some student loan borrowers may also consider student loan refinancing when looking to lower their monthly payments on student loans. As mentioned, it’s also important to understand that refinancing federal student loans will result in the loss of federal benefits, including income-driven repayment plans.
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If you are looking to refinance federal student loans, please be aware that the White House has announced up to $20,000 of student loan forgiveness for Pell Grant recipients and $10,000 for qualifying borrowers whose student loans are federally held. Additionally, the federal student loan payment pause and interest holiday has been extended beyond December 31, 2022. Please carefully consider these changes before refinancing federally held loans with SoFi, since the amount or portion of your federal student debt that you refinance will no longer qualify for the federal loan payment suspension, interest waiver, or any other current or future benefits applicable to federal loans. If you qualify for federal student loan forgiveness and still wish to refinance, leave unrefinanced the amount you expect to be forgiven to receive your federal benefit.
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Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
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