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Understanding How Income Based Repayment Works

July 25, 2018 · 6 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 also means it’s time to start paying back your student loans, which is somewhat less exciting.

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

However, most of us don’t make tons of money right out of the gate. And that can make paying off student loans at the beginning of your career challenging. Since 2009, changes to federal income based repayment plans have helped relieve the burden of student loan payments. If your loan payments on the standard plan are too high in proportion to your income, then qualifying for income based repayment might be an option.

While people often use the term “income based repayment” generically, there are actually a number of income driven repayment plans for federal student loans.

Income based repayment is the most common type of income driven repayment plan. The other plans are Pay As You Earn repayments plans, the revised Pay As You Earn repayment plan, and income-contingent repayment plans.

Income based repayment limits the amount of your income that goes toward student loan repayment, and typically stretches your loan payments out over a 20 or 25 years. Since 2010, the number of people on income driven repayment plans has risen dramatically .

There are also many graduates who would qualify for income based repayment, but are not in the program because they are simply not making payments at all, which is never a good option.

There are likely to be changes to the federal repayment plans in the coming years under the current administration, but until they do, understanding how the plans work could help you save money.

What Is Income Based Repayment?

An income based repayment plan adjusts your monthly student loan payments based on your discretionary income and family size. 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.

Depending on when your student loans started, either before 2014 or after, income based repayment is either capped at 10% or 15% of your discretionary income. And after 20 or 25 years of qualifying monthly payments, anything you still owe will be forgiven. (However, the amount forgiven is considered taxable income.)

If your income goes up and your calculated monthly payment on an income based plan would exceed the amount you’d pay on the standard 10-year plan, then you’d be required to switch plans.

This is not true for every income driven repayment plan, though. If you are on an income-contingent or revised Pay As You Earn plan, instead of the income based plan, you could end up paying more than the standard monthly payment if your income goes up.

How Does Income Based Repayment Work?

Most federal loans operate on a standard 10-year default repayment plan. However, if your student loans are high in proportion to your income, an income based repayment plan caps what you pay per month based on your discretionary income. Your discretionary income calculated based on the federal poverty guidelines .

To figure out if you qualify for an income based repayment plan, you first have to apply and submit information to have your income certified. Your monthly payment will then be calculated. Use the federal government’s student loan repayment calculator to figure out how much you’d owe under an income based repayment plan. If you qualify, you’ll then have to recertify your income and family size every year under the plan. Your calculated payment may change as your income changes.

You will then simply make your monthly payments to your loan servicer under your new income based repayment plan. If your loans started after July 1, 2014, then your loans will be forgiven after 20 years of qualifying payments. (For loans you took out before July 1, 2014, you’ll have to make 25 years of qualifying payments under an income based repayment plan.)

Who Qualifies For Income Based Repayment?

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

The federal government defines discretionary income as the amount of your income above 150% of the poverty line. For example, if you’re in the contiguous 48 United States and your household is two people, then 150% of the poverty line in 2018 ($16,460) is $24,690 (pre-tax).

Anything you make above $24,690 is considered discretionary income, i.e. income not necessary for essential living expenses. The poverty guidelines are laid out by the federal government for every household size , and you can calculate 150% based on your situation.

For an income based repayment plan, there is a cap on the amount of your discretionary income that can go to student loan payments. For borrowers who took out loans after July 1, 2014, income based repayment is capped at 10% of discretionary income. For those who took out loans before that date, it’s capped at 15% of discretionary income.

Only federal direct loans (subsidized or unsubsidized), PLUS loans, and Stafford loans are eligible for income based repayment . Federal Family Education Loans (FFEL) are only eligible for income based repayment, not for other kinds of income driven repayment plans.

Parent loans are not eligible. Also, private loans are not eligible for any federal income driven repayment plans—though some private loan lenders will negotiate new payment schedules if you need them.

What Are The Other Income Driven Repayment Options?

There are a few federal repayment plan options tied to income : income based repayment, income contingent repayment, Pay As You Earn, and revised Pay As You Earn. These are all known generally as “Income driven repayment plans,” but their qualifications and benefits vary.

For example, the revised Pay As You Earn plan was introduced in 2015 and offers an interest subsidy in case your capped monthly payment doesn’t cover the interest on your student loan. It also caps your monthly payment at 10% of your discretionary income, whereas the income contingent plan caps your monthly payment at 20% of your discretionary income. With the income based repayment plan, your monthly payment cannot exceed what you would pay on the 10-year standard plan.

Private student loans do not offer income based repayment plans. If you can’t make your private student loan payments, then you might be able to negotiate a deferment or revised payment schedule with your lender.

If you have federal loans, student loan forbearance can also be an option if you’re experiencing temporary financial hardship. However, forbearance is not typically available for private loans, some lenders do. The easiest way to reduce your private student loan payments may simply be to refinance your student loans at a lower interest rate.

When Does Income Based Repayment Not Make Sense, And What Are The Alternatives?

Income based repayment can lower your monthly payment, but the downside is that it also stretches your payments out over a longer period of time. In the long run, you could end up paying more in interest. And 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 every year. When you’re on a standard repayment plan, you can typically set up auto-payments and stop worrying about it, which isn’t the case for an income based repayment plan. Another thing to consider is that when your loans are forgiven 20 or 25 years down the road, you may be stuck paying a hefty tax bill on the forgiven amount.

That doesn’t mean you can’t save money on your student loans, though. If you’re looking to save money or are having trouble making your payments, another option is refinancing your student loans vs income-based repayment. Refinancing with a lower interest rate could lower your payments and decrease the amount of interest you pay.

You can calculate how much you might save by refinancing your student loans with SoFi’s student loan calculator. You can also refinance both private and federal student loans. However, refinancing federal student loans with a private lender turns them into private loans and renders them ineligible for federal repayment plans, but if you don’t plan to use those benefits, refinancing might be the option for you.

If your income doesn’t qualify you for an income based repayment plan, consider student loan refinancing. It can lower your monthly payment.

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.

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.


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