•  Income-driven plans allow you to make your monthly payments based on how much money you make.

•  These plans are beneficial if you plan to apply for Public Service Loan Forgiveness.

•  These are helpful to manage your short term cash flow, but will increase the amount of interest you pay over time.

Does your job pay too little to cover your student loan payments? Don’t worry – you don’t have to miss payments and take a hit to your credit score. The government provides income-driven repayment plans to lower your monthly payment amount.

Income-Driven Repayment Plans

The four main income-driven repayment plans are called Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR). Only federal student loans are eligible for these plans – private loans do not qualify.

Income-driven programs are designed for borrowers who have a large loan balance relative to their income, and all of them will forgive your remaining balance after 20 or 25 years, depending on the plan. To apply, you first need to create a Federal Student Aid (FSA) ID, then fill out the Income-Driven Repayment Plan Request.

If you’re not sure which income-driven plan to choose, you can request the plan that provides the lowest payment amount. Your servicer will determine which plans you qualify for and will then place you on the plan with the lowest monthly payment.  

Pay As You Earn Plans

 

In both Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE) plans, your monthly payments will be 10% of your discretionary income. Your balance will be forgiven in full after 20 years of payments, regardless of degree, under the PAYE plan. For the REPAYE plan, your balance is forgiven after 20 years for undergrad loans or 25 years for graduate school loans.

Income-Based Repayment (IBR) and Income-Contingent Repayment (ICR)

 

Under Income-Based Repayment, if you received your first student loan after July 1, 2014, your monthly payments will be 10% of your discretionary income over a 20-year period. If you received your initial student loan before July 1, 2014, your monthly payment will be 15% of your discretionary income over a 25-year period. Under the Income-Contingent Plan, your monthly payment will be 20% of your discretionary income over a 25-year period.

Your discretionary income is the difference between your adjusted gross income on your tax return and 150 percent of the U.S. Poverty Guideline amount for your family size and state. For a family of one living in the lower 48 states, 150 percent of the Poverty Guideline for 2016 is $17,820. So if you make $40,000 per year, your discretionary income would be $22,180. If you need to pay 10% of your discretionary income, that would be $2,218 per year, or $184.83 per month. In this example, if your income is lower than $17,820, your monthly payments would actually be zero. 

Loans can be forgiven after 10 years if you qualify for the Loan Forgiveness program.

 

For all of these plans, your payment amount will be recalculated each year based on your income. You must submit a new Income-Driven Repayment Plan Request each year to update your income and family size information. If you do not submit this form, your monthly payment will return to the amount under the 10-year Standard Repayment Plan.

Is the Standard Plan or Income-Based Repayment Better? 

Under the PAYE or IBR plans, if your income rises to a level where your monthly payments exceed the amount you would pay for in the Standard Plan, your payments will automatically default to the Standard Plan monthly payment amount.

Under REPAYE or ICR plans, if your income increases over time, so does your monthly payment amount. This means that your monthly payments could actually exceed what you would have paid under the Standard Plan. This can actually be a good thing as it automatically sets aside a portion of your money for student loan payments and allows you to pay off the debt faster.

 You will need to pay income tax on the forgiven amount in each of these plans, unless you are part of the Public Service Loan Forgiveness Program.

Keep in mind that you will need to pay income tax on the forgiven amount in each of these plans, unless you are part of the Public Service Loan Forgiveness Program. If you expect your income to increase over time, these income-driven plans could significantly increase the amount of interest you pay over the life of the loan. Because of this, we would advise you to stay away from these plans unless you work for the government or a nonprofit and know that you will be applying for the Public Service Loan Forgiveness program.

To minimize the amount of interest you pay over the life of the loan, it’s best to stick with the Standard Repayment Plan  and look to refinance your loans once you meet the qualifying criteria. Income-driven plans are a good short-term option to manage your cash flow and avoid defaulting on your loans. This will ensure your credit score isn’t negatively affected, and will position you to pay off your loans at a faster rate once your income increases.

Summary:

  • Income-driven plans allow you to pay back your student loans based on how much money you make.
  • These plans are beneficial if you eventually plan to apply for Public Service Loan Forgiveness.
  • They can be helpful in the short term to manage your cash flow, but could drastically increase the amount of interest you pay over the life of the loan.
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