Income-driven repayment: Everything you need to know

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Income-driven repayment plans for student loans work exactly as they sound: Each of these plans calculates your monthly repayment amount based on how much you earn. This is one of the main benefits of income-driven repayment. Because the monthly payments are calculated based on your earnings, payments become more affordable during lean financial times.

What is income-driven repayment?

Income-driven repayment plans are a federal student loan repayment option that sets your monthly student loan payment at an amount that’s intended to be affordable based on your income and family size.

While income-driven repayment plans have different repayment periods, they generally ask you to make your adjusted monthly payment for about 20 to 25 years, at which point any remaining loan amounts will be forgiven. However, there’s one major downside that comes with having loans forgiven through income-driven repayment plans: The forgiven amounts may be treated as taxable income.

How does it work?

Income-driven repayment plans set your monthly loan payment at a percentage of your discretionary income. The exact percentage varies depending on the specific plan you sign up for but generally ranges from 10 to 20 percent of your discretionary income.

Discretionary income is the difference between your annual income and 100 percent to 150 percent of the poverty guideline, depending on the repayment plan, your family size and where you live.

Some income-driven repayment plans, however, establish monthly loan payments based on what’s often referred to as a marriage penalty.

“This is when the loan payments are based on the joint income of married borrowers, thereby increasing the loan payment,” says Mark Kantrowitz, publisher of PrivateStudentLoans.guru. “However, some income-driven repayment plans base the monthly loan payments on just the borrower’s income, if the borrower files income tax returns separately from their spouse, in other words, married filing separately.”

Why is it important?

Income-driven repayment plans are important for federal student loan borrowers who need a lower monthly payment on their loans more than anything else. Since these plans base your monthly student loan installment on how much you actually earn, the amount you pay may only be a fraction of what you would pay on a standard 10-year student loan repayment plan. Depending on your income and family size, you may not even have a monthly payment at all.

Further, income-driven repayment plans are a requirement if you plan to pursue Public Service Loan Forgiveness (PSLF) with qualified employment in a public service field. With PSLF, you would only make 10 years of payments (or 120 payments) on your income-driven repayment plan before having the loan balances forgiven. As an added bonus, the amounts forgiven aren’t considered taxable with this option.

Types of income-driven repayment plans

There are four types of income-driven repayment plans you can apply for:

  • Pay As You Earn (PAYE): Pay 10 percent of your discretionary income for 20 years.
  • Revised Pay As You Earn (REPAYE): Pay 10 percent of your discretionary income for 20 to 25 years, depending on whether you have undergraduate or graduate loans.
  • Income-Based Repayment (IBR): New borrowers after July 1, 2014, pay 10 percent of their discretionary income for 20 years (borrowers who predate July 1, 2014, pay 15 percent of their discretionary income for 25 years).
  • Income-Contingent Repayment (ICR): Pay the lesser of 20 percent of your discretionary income or what you would pay on a fixed repayment plan for 12 years, adjusted according to your income, for 25 years.

How to calculate income-based repayment

Loan servicers will set payments based on your discretionary income. All servicers use a standard formula to determine this amount, so it’s easy to figure out what yours would be with some basic information.

To determine your discretionary income, you’ll look for the difference between your adjusted gross income (AGI) and 100 to 150 percent of the federal poverty level for your family size and where you live.

Here’s an example based on 150 percent of the federal poverty level:

Imagine your adjusted gross income is $40,000 and you live in Indianapolis, Indiana. You have $45,000 in eligible federal student loans.

According to the U.S. Department of Education, 150 percent of the 2020 poverty guideline is $19,140 for a family of one. The difference between your AGI and this amount is $20,860. This is your discretionary income. If you paid 10 percent of this amount under an income-driven repayment plan, you would owe $2,086 for the year, or $173.83 per month.

But the math changes if you have three kids. If you’re a family of four, 150 percent of the 2020 poverty guideline works out to $39,300. The difference between this amount and your AGI is only $700, and this is your discretionary income. If you owed 10 percent of this amount on an income-driven repayment plan, you would only owe $70 on your student loans for the year. That’s only $5.83 per month.

How to apply for income-driven repayment

The first step in applying for an income-driven repayment plan is contacting your loan servicer to find out what options may be available to you. Your choices will depend on the type of federal loan you have and when you borrowed the money.

No matter which option you’re pursuing, in order to begin the application process you must submit an Income-Driven Repayment Plan Request. This application can be submitted online or via hard copy. Paper copies of the application can be obtained from your loan servicer.

The application allows for selecting an income-driven repayment plan by name. You can also ask that your loan servicer identify the most appropriate income-driven plan (or plans) for your individual situation and have the servicer put you into the income-driven plan that provides the most affordable monthly payments.

It’s important to understand that if you hold loans with multiple servicers, you must repeat this process with each of them.

Also keep in mind that when submitting an application, you will need to provide income information. These details will help the servicer gauge your eligibility for the various programs and calculate your monthly payments.

It generally takes a few weeks for the servicer to make a decision regarding your income-driven repayment application.

Alternatives to income-driven repayment

If an income-driven repayment plan does not work for you, or if you’re not eligible, there are a few other options that may also help reduce monthly loan payments. A few options include:

  • Graduated repayment plan. Under this plan, loan payments start out low and increase every two years. Payments are made for up to 10 years on most loans (up to 30 years on consolidation loans).
  • Extended repayment plan. This approach involves a longer repayment term, which reduces the monthly payment amount but ultimately will increase the total interest paid over the life of the loan. Payments are made for up to 25 years.
  • Student loan refinancing. While refinancing your federal student loans with a private lender will eliminate the option of income-driven repayment plans or loan forgiveness, it may be worth it if you can get a much lower interest rate.

Final considerations

Before you decide to pursue an income-driven repayment plan, double-check that you have the right kind of federal student loans. Note that Direct Subsidized Loans and Direct Unsubsidized Loans qualify for all of the income-driven repayment plans, as do Direct PLUS Loans and Direct Consolidation Loans. However, other types of loans may or may not qualify for income-based repayment plans. You can find out more on the U.S. Department of Education’s website.

Generally speaking, however, most federal loans can qualify for income-driven repayment plans if you consolidate them with a Direct Consolidation Loan first. That may sound like a hassle, but the time you invest can pay off if you need a lower monthly payment and you hope to have your student loans forgiven one day.

FAQ about income-driven repayment

Does income-driven repayment include spousal income?

Whether or not your spouse’s income affects your income-driven repayment plan depends on the plan you select.

“ICR, IBR and PAYE base the loan payment on just the borrower’s income, if the borrower files a separate income tax return,” says Kantrowitz. Otherwise, the payment is based on the joint income. “REPAYE bases the loan payment on joint income, regardless of whether the borrower files a separate or joint return.”

What is the maximum income for income-driven repayment?

The good news is that there’s no explicit income cutoff when it comes to qualifying for income-driven repayment plans. The loan payments will simply increase as your income increases. However, if your income increases enough, your income-driven repayment may no longer be less than what you’d pay with the standard 10-year plan.

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