To avoid credit damage and delinquency, it is important to choose the right repayment plan(Income Based Student Loan Repayment).
According to data from the Department of Education, student debt has been repaid more through income-based repayment programs than any other repayment method. Each plan has its own guidelines and there are four different plans.
While income-based repayment plans might make it easier to manage your federal loan payments month-to-month, there are serious financial implications if you choose to opt-in to one of these plans.
What is the difference between standard and income-based repayment plans?
Here are some details about the tradeoffs between income-based repayment plans and standard repayment of student loans after your grace period ends.
|Income-Based Repayment Plans||Standard Repayment|
|Payment Amounts||The payments are calculated annually and are based on a portion of discretionary income (between 10% and 20%).||The amount and rate of the loan determine the payment.|
|Repayment Period||The repayment period is usually between 20 and 25 years. After that, interest and any remaining debt are forgiven. Your loan balance could be forgiven if you work for the government or non-profit sector.||Federal loans have a standard repayment period of up to 10 years.|
|How to Qualify||You must demonstrate partial financial hardship to qualify.||Federal loans automatically enroll you in this repayment plan, unless you choose to change it.|
|Benefit||Standard Repayment will see you pay more in the long term.||Over time, you’ll pay less than with other IBR plans.|
Which Repayment Plan Is Best for You?
If you are in financial trouble or have a lower income than your student loan balance, one of the income-based repayment programs may be an option. Your monthly payment can be as low as $0, depending on your income. You might not be able to cover the interest on student loans if you make a low monthly payment. Your overall balance may increase over time.
Standard Repayment will generally result in higher monthly payments than under an income-based plan. However, you are more likely to repay your student loan balance in less time and with lower interest.
Another option is refinancing student loans with private lenders. Refinancing may lower your interest rate and allow you to tailor your monthly payment according to your budget.
Is your budget able to handle a non-fixed amount of payment?
Income-based repayment requires you to recertify your income every year in order for your servicer to calculate your monthly payment according to program guidelines.
Some life events, such as a marriage or filing taxes together, can make your monthly payments go up significantly or make it impossible to pay your salary.
It’s important to understand that your monthly payments won’t exceed the standard 10-year plans. However, non-fixed student loans –– which means payments that can change based on your income each year –– can make managing your budget difficult, especially if there’s another debt such as a car or mortgage.
How about loan forgiveness?
You may be eligible to have your loan balance forgiven if you work for the government or non-profit sector. This is possible with income-based repayment. The public-service loan forgiveness does not tax.
Your loan will be forgiven if you are not employed in the public sector. However, the loan balance will still be subject to tax, which could lead to a large tax bill in that year.
There are many factors that will determine whether income-based repayment is the right option for you. You should not borrow more student loans if you are still in school.
You should weigh the advantages of paying less now versus the possible impact on your debt burden over a longer time period if you have already graduated. Refinancing student loans might be an option to lower your interest rate and pay down your balance quicker.
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The 4 types of income-based student loan repayment plans
After deciding that an income-based plan is right for you, you will need to choose which flavor. There are four choices, each with its own pros and cons.
Income-Based Repayment Plan (IBR Plan).
Similar to the PAYE program, the IBR plan requires that your monthly payments be lower than the Standard Repayment plan over a 10-year period. This means that your federal student loan debt should not exceed your annual discretionary income or be a substantial portion of your income. Your discretionary income is the difference between your adjusted income and 150% of the federal poverty guidelines depending on your family size and your state.
There are technically two types of IBR plans. One is for borrowers who borrowed their first loan prior to July 1, 2014, and have partial financial hardship (Original IBR) and the other for borrowers who borrowed their first loan after July 1, 2014. (2014 IBR). You should be aware that there are differences between these plans.
Your repayment amount is one of the following:
- If you are a new borrower after July 1, 2014*, generally 10% of your discretionary income, but not more than the 10-year Standard Repayment Plan, or
- If you aren’t a new borrower after July 1, 2014, but have not earned more than the 10-year Standard Repayment Plan amount, then 15% of your discretionary income will be used.
- The amount paid on either plan should not exceed the standard 10-year repayment plan. The 2014 IBR plan’s duration is 20 years and 25 years for Original IBR plans.
The IBR Plan can lower your monthly payments. At the end of the plan, your loans will be forgiven. You should consider the interest that you will have to pay over the repayment period. The amount forgiven at repayment may be taxable income.
Income-Contingent Repayment Plan (ICR Plan)
The ICR Plan doesn’t have an income eligibility requirement. This makes it a great fit for people who aren’t eligible for other plans but want to lower their monthly payments. To use the ICR Plan, borrowers can consolidate their PLUS loans into direct loans. This is not possible with the other three plans.
Your repayment amount is one of the following:
- 20% of your discretionary income
- What you would pay for a 12-year repayment plan that has a fixed monthly payment, adjusted for your income.
- The repayment term is 25 years. After that, you might be eligible to get loan forgiveness for any amount remaining. The ICR plan is the most income-driven and has the highest possible payment amount. It might even be higher than Standard Repayment. The amount of the loan forgiven at the completion of your repayment plan may be taxable income, as with all plans.
Pay As You Earn Repayment Plan (PAYE Plan)
You must also demonstrate financial need to be eligible for PAYE, just like IBR. Also, you must be a new borrower on Oct. 1, 2007, and have received a Direct Loan disbursement on or after Oct. 1. 2011. You must also pay less under the PAYE plan than you would on the Standard Repayment Plan.
The repayment amount you will pay is:
- You will pay 10% of your discretionary income but not more than the 10-year Standard Repayment Plan amount
- The term of the PAYE plan is 20 years. During this time, you may be eligible to get loan forgiveness for any amount left. The plan offers the lowest monthly payment for all eligible borrowers but it is only available to the most limited number of borrowers. The loan amount forgiven at your repayment plan’s end might be taxable income. This should be taken into consideration when signing up.
Revised Pay As you Earn Repayment Plan (REPAYE Plan).
REPAYE, the latest addition to the federal income-driven repayment plan, was launched in December 2015. Borrowers can be eligible no matter when they borrowed their first federal student loan. They don’t need to prove financial need to be eligible.
The repayment amount you will pay is:
- In general, 10% of your discretionary income is tax-deductible
- The REPAYE plan’s duration is 20 years for undergraduate loans and 25 years for loans for professional or graduate degrees. After the REPAYE period, the loans are eligible for loan forgiveness. REPAYE is a program that takes into account the marital adjusted gross income. This is regardless of how you file taxes. This is not true for IBR and PAYE plans. It should be considered when deciding on a repayment plan.