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Pros and Cons of Income-Driven Repayment Plans

02/05/2015 09:52 am ET | Updated Apr 07, 2015
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With the national student debt now exceeding $1 trillion, the need for repayment plans to suit diverse financial situations is growing. Although most borrowers choose to follow the 10-year Standard Repayment Plan, a fixed monthly payment of at least $50 over the course of 10 years which is the default repayment plan for federal loans, there is an array of repayment options available to fit everyone's needs. Don't worry if the options seem overwhelming, and the details appear indistinguishable. Keep reading; it is well-worth the time it takes to find the best plan for your situation because it could mean significantly less stress in your life.

In order to make loan repayment more manageable, the US Department of Education has started offering more repayment options individualized for each borrower's current financial situation: Income- Driven Plans.

The federal government offers three different Income-Driven Repayment Plans for federal student loans. Here is a breakdown of the three plans:

Income Based Repayment (IBR):

  • For borrowers with an outstanding balance on eligible loans on or after July 1, 2014, there is a 25-year repayment plan option that requires 15% of your discretionary income.
  • For borrowers with no outstanding balance on eligible loans after July 1, 2014, there is a 20-year repayment plan option that requires 10% of your discretionary income.

Both options never require more than the 10-year Standard Repayment Plan monthly payment amount.

Pay As You Earn:

  • 20-year repayment plan that requires 10% of your discretionary income; never more than the 10-year Standard Repayment Plan monthly payment amount.

Income-Contingent Repayment (ICR):

  • 25-year repayment plan that requires the lesser of either what you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income or 20% of your discretionary income.

To be eligible for the IBR and Pay As You Earn plans, you must demonstrate a "partial financial hardship" as determined by income, family size, and loan amount. Any borrower may utilize the ICR plan as an option. To help you decide what plan might be best for you, we have outlined the pros and cons of these Income-Driven Repayment Plans:

PROS:

  • Lower Monthly Payments: By definition, you monthly payments under the IBR and Pay As You Earn plans must be lower than they would be under the 10-year Standard Repayment Plan. This should make your payments more manageable and can free up money to put towards other expenses.
  • Loan Forgiveness: If you have a remaining loan balance after the 20-25 year term, the balance will be forgiven. This applies to all three of the Income-Driven Repayment Plans.
  • Public Service Forgiveness Program: By repaying your loans through one of the Income-Driven Repayment Plans, you may be eligible for your loan balance to be forgiven after 10 years of timely payments through the Public Service Loan Forgiveness Program. This, of course, only applies to certain career fields. An extra pro to this is that the forgiven balance is tax-free!
  • Payments Change With Income: With all three Income-Driven Repayment Plans, you are not locked-in to fixed monthly rates. Your payments will change as your income changes, ensuring that your monthly payments are always affordable. Even if your income drops to zero, your payment will be adjusted to zero and still count as a timely payment towards your loan.

CONS:

  • Larger Overall Interest: Because you will be making smaller payments over a longer period of time through these repayment plans, the total amount of interest you will pay over the life time of the loan will be higher compared to the 10-year Standard Repayment Plan. Though no one wants to pay more than they have too, it may be worth the trade-off of having affordable monthly payments.
  • Longer Loan Term: All three of the Income-Driven Repayment Plans extend the term of the loan to 20-25 years, twice as long as with the 10-year Standard Repayment Plan.
  • Taxes on Forgiven Debt: Though these repayment plans may allow any remaining loan balance to be forgiven after the set 20-25 year term, the forgiven balance may be taxable as income. The Public Service Loan Forgiveness Program is entirely tax-free, though.
  • Required to Provide Income Information: You are required to provide updated income and family size information to your loan servicer annually in order to continue to qualify for these repayment plans. This may not be a major con for everyone, but it can add to the headache of loan repayment. If you forget to provide this information, you will be dropped from your current plan and put on the 10-year Standard Repayment Plan.
  • Not All Loans Qualify: These Income-Driven Repayment Plans are only available for federal student loans, and not all federal student loans qualify.

In general, these Income-Driven Repayment Plans are best for borrowers whose monthly payment on their federal loans is more than or a sizable portion of their discretionary income. Remember that signing up for these plans does not mean you have to stick with them forever; you can always reevaluate in a few years when your financial situation may have changed.

For more information, visit Credible or studentaid.ed.gov

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