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Understanding How Income Based Repayment Works

April 13, 2021 · 5 minute read

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Understanding How Income Based Repayment Works

If you graduated recently, you’re gearing up to launch your career and start a new chapter of your life. But graduating may also mean it’s time to start paying back your student loans, which is less exciting.

If you have unconsolidated federal student loans, you are likely signed up for the standard 10-year repayment plan. Upon graduation or once your grace period ends, you begin making payments in order to pay back your loans in 10 years.

Many grads will not make tons of money right out of the gate, of course, and that can make paying off student loans at the beginning of a career challenging. If your loan payments with the standard plan are high in proportion to your income, an income-based repayment plan might be an option.

The Four Income-Driven Repayment Plans

While people often use the term “income-based repayment” generically, there are actually four income-driven repayment plans for federal student loans:

•   Income-Based Repayment, or IBR
•   Pay As You Earn, or PAYE
•   Revised Pay As You Earn, or REPAYE
•   Income-Contingent Repayment, or ICR

The number of people on income-driven repayment plans has risen dramatically, a 2020 report from the Congressional Budget Office found. The volume of loans in income-driven plans has grown even faster than the number of borrowers because borrowers with larger loan balances—such as those who took out loans for graduate studies—are more likely to select such plans, the CBO said.

Not only do the plans limit payments to a percentage of borrowers’ income, but they promise loan forgiveness after 20 or 25 years.

The CBO report estimates that $40 billion worth of federal loans disbursed from 2020 to 2029 will be forgiven. The forecasted figure is much higher for graduate borrowers—$167 billion of their student loans forgiven.

As of now, though, very few of the 8 million-plus borrowers enrolled in an income-driven repayment plan—including 2 million who have been in repayment for 20 years or longer—have seen balances canceled. (In fact, the National Consumer Law Center counted 32, and blames federal student loan servicers for steering borrowers “away from IDR and into high-cost repayment options such as forbearance that are temporary in nature and offer no long-term path to debt cancellation.”)

How Does Income-Based Repayment Work?

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

An income-driven repayment plan adjusts monthly student loan payments based on your discretionary income, family size, and state. Essentially, if too much of your income is going toward student loan payments, qualifying for an income-based repayment plan might make your monthly payments more manageable.

Income-based repayment plans allow borrowers to make monthly payments equal to 10% to 20% of monthly discretionary income and have any balance forgiven after 20 or 25 years of on-time payments.

(All new borrowers in the federal student loan program as of 2014 can use the most generous version of the program, IBR, which sets payments at 10% of discretionary income and vows loan forgiveness for any unpaid balance after 20 years.)

To figure out if you qualify for a plan, you must apply and submit information to have your income certified. Your monthly payment will then be calculated.

If you qualify, you’ll simply make your monthly payments to your loan servicer under your new income-based repayment plan.

You’ll have to recertify your income and family size yearly. Your calculated payment may change as your income changes.

What Might My Payment Be?

Qualifying for income-driven repayment depends on your income—specifically how much of your discretionary income goes toward student loan payments.

For the IBR, PAYE, and REPAYE plans, the required monthly payment is generally a percentage of your discretionary income. (Discretionary income is the difference between your adjusted gross income and 150% of the poverty guideline for your family size and state of residence.)

For the IBR plan, the monthly payment is 10% of discretionary income for someone who borrowed on or after July 1, 2014. If a student took out loans before that date, the monthly payment is 15% of discretionary income.

Under the PAYE and REPAYE plans, the monthly payment is 10% of discretionary income.

An example:

•  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.
•  You have $45,000 in eligible federal student loan debt.
•  The 2021 HHS Poverty Guideline amount for a family of one in the 48 contiguous states and the District of Columbia is $12,880, and 150% of that is $19,320. The difference between $40,000 and $19,320 is $20,680. This is your discretionary income.
•  If you’re repaying under the PAYE or REPAYE plan or if you’re a newer borrower with the IBR plan, 10% of your discretionary income is $2,068. Dividing that amount by 12 results in a monthly payment of $172.33.

Under the ICR plan, the monthly payment will be the lesser of 20% of discretionary income or the amount a borrower would pay under a standard repayment plan with a 12-year repayment period, adjusted using a formula that takes income into account.

For the ICR plan, discretionary income is the difference between adjusted gross income and 100% of the federal poverty guideline amount for your family size and state.

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

Which Loans Pertain to Which Plan?

Most federal student loans are eligible for at least one of the plans. For the details, see this Federal Student Aid chart .

Private loans are not eligible for any federal income-driven repayment plans—though some private loan lenders will negotiate new payment schedules if needed.

Potential Drawbacks of Income-Driven Repayment

Income-based repayment usually lowers your monthly payment, but stretching payments over a longer period means probably paying more in interest over time. In some cases, your minimum payment might not even cover all the interest on your loan.

Even if income-based repayment makes sense for you, you’ll need to recertify your income and family size every year.

If a borrower gets married and files jointly, the combined income could increase his or her monthly loan payment.

Finally, the process can be pretty darned confusing.

The Takeaway

Income-driven repayment plans have surged in popularity. Low payments tied to income and a promise of loan forgiveness after 20 or 25 years make the plans attractive to many, but they sometimes give borrowers reason to hesitate.

Borrowers with one or more student loans, especially loans with higher rates of interest, could consider refinancing instead. With refinancing, a private lender pays off loans with a new one, hopefully with a lower interest rate.

You can calculate how much you might save by refinancing your student loans with SoFi’s student loan calculator.

Maybe your income doesn’t qualify you for an income-driven repayment plan. If not, consider refinancing with SoFi.

You can refinance both private and federal student loans. Just realize that refinancing federal student loans with a private lender renders them ineligible for federal repayment plans, but if you don’t plan to use those benefits, refinancing might be a good option.

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IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS PLEASE BE AWARE OF RECENT LEGISLATIVE CHANGES THAT HAVE SUSPENDED ALL FEDERAL STUDENT LOAN PAYMENTS AND WAIVED INTEREST CHARGES ON FEDERALLY HELD LOANS UNTIL THE END OF SEPTEMBER DUE TO COVID-19. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE IN DOING SO YOU WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. CLICK HERE FOR MORE INFORMATION.
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