Once it’s time to start making payments on your federal student loans, your loan service will automatically enroll you in a Standard repayment plan. Under this plan, your loan balance is divided into 120 equal, fixed payments that you pay monthly for 10 years.
But this isn’t necessarily the only repayment plan at your disposal. While the Standard plan has its benefits—paying less interest overall and paying off your loans faster—it also has the largest monthly payments of all the plans. Income-driven repayment plans are another option that lessen the monthly burden of loan repayment, but they come with other considerations that warrant a closer look.
Before we get into those details, let’s get up to speed on income-driven repayment.
Income-Driven Repayment in a Nutshell
Put simply, an income-driven repayment (IDR) plan aims to make your monthly student loan payment more affordable by lowering it to an amount based on your income and family size. The federal government currently offers four types of IDR plans: Revised Pay as You Earn (REPAYE), Pay as you Earn (PAYE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR).
Under an IDR plan, you’ll generally pay between 10% and 20% of your “discretionary income” a month on your student loans. The Department of Education defines discretionary income as your annual income minus either 100% or 150% (it depends on the plan) of the poverty guideline for your family size and state. Since the payments are smaller, your repayment term will be extended to 20 or 25 years—but you’ll also have any remaining balance forgiven at the end of that period. However, the forgiven balance can be taxed as income.
Now that we’ve covered the fundamentals of IDR plans, let’s get into when it does and doesn’t make sense to enroll in one.
When to Consider Income-Driven Repayment
Given that the primary benefit of IDR is lower monthly payments, IDR can be a great option in the following situations:
- Your current payments under the Standard repayment plan are too high for your income, and you’re worried about falling behind on payments and defaulting on your loans.
- You’ve lost your job or had a decrease in your salary; since you have to recertify your income annually in order to stay in an IDR plan, your monthly payment amount will be lowered the next time you recertify. Monthly payments on an IDR plan can be as low as $0 per month, and will still count toward the timeline for forgiveness.
- You want to take advantage of Public Service Loan Forgiveness (PSLF) and have your student loan balance forgiven after 10 years, so you have to be enrolled in an IDR plan.
It’s important to note that if your monthly payment amount under IDR is lower than the interest that accrues on your loan(s) each month, you will see your balance grow—rather than decrease—over time. This can be demoralizing, especially if you’ve been making payments for years. Just remember: under IDR, any balance that remains at the end of your repayment period will be forgiven. You may have to pay taxes on that debt, but, if needed, you can enroll in a payment plan rather than paying the bill in full.
When Not to Consider Income-Driven Repayment
While smaller monthly payments sound appealing, IDR doesn’t always help borrowers pay less each month:
- If you’re married and file taxes jointly and your spouse has a high salary, IDR may not work for you. That’s because your joint income, rather than your salary alone, will be used to calculate how much you can afford to pay toward your loan(s) each month—so you may not get a lower payment after all.
- If you’re a high earner, 10% of your discretionary income could be greater than your monthly payment amount under the standard plan. Refinancing your loans can help you get a lower monthly payment amount in this situation; keep in mind that once you refinance your loans, you won't be eligible for any loan forgiveness.
- If you expect your salary to increase significantly in the future, your monthly payment will also grow under IDR due to the annual income recertification. In some cases, the amount you pay under IDR could even exceed what you’d pay under the Standard repayment plan. You can always leave an IDR plan, though doing so will trigger unpaid interest capitalization. This means the unpaid interest that accrued during your time in IDR will be added to your remaining student loan balance, increasing the amount you owe overall.
Good for Some, Not for All
Income-driven repayment has minimized financial stress for many borrowers by lowering their monthly payments, but that doesn’t make it the right choice for everyone. Ultimately, what works best depends on your unique financial situation. If you have a Summer account, you can use our free tool to see an estimate of how much you’d pay under an IDR plan. You can also check out our “Income-Driven Repayment Guide” for more details on each of the four IDR plans mentioned in this blog.
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