Many people with student loan payments don’t realize they have multiple options for repaying their student loans easier. One option is the income-driven repayment plan that the federal government offers for loans owned by the US Department of Education.
The key to income-driven student loan payment is that your student loans are forgiven at the end of the repayment period even if you still owe more money on your student loans. These loan repayment options are a helpful choice for those who have a high-student loan balance, and a career with little chance for a high salary.
How Can I Lower My Student Loan Payments With a Different Loan Repayment Plan?
There are actually several different ways to repay your student loans over time. Most borrowers just go with a 30-year repayment plan and essentially take on an additional mortgage. However, there are numerous different plans, including plans based upon your income.
Financial advisors and those who writing about financial independence are often rightly dinged for not writing about how to help those with lower incomes. Income-driven repayment plans are one way to help those with lower incomes repay their student loans faster and easier.
As the name suggests, income-driven student loan repayment options tie your student loan payment to your income. As you can imagine, this works out much better for those with lower incomes than those with higher incomes.
Income-Driven Repayment Plan Options
There are four different income-driver repayment plan options available for student loan borrowers.
- Pay As You Earn Repayment Plan (PAYE)
- Revised Pay As You Earn Repayment Plan (REPAYE)
- Income-Based Repayment Plan (IBR)
- Income-Contingent Repayment Plan (ICR Plan)
Pay As You Earn Repayment Plan (PAYE)
The Pay As You Earn Repayment Plan offers a payment equal to 10% of your discretionary income for the year, divided by 12. To qualify you have to have gotten a disbursement (payout) from your Direct Loan after October 1, 2011, and you cannot have had a student loan before October 1, 2007.
So, this plan does not work for students who had student loans, and then went back to school when they were older.
Generally speaking, your student loan payment under the PAYE plan is set to be equal to 10% of your discretionary income. Your student loan balance is forgiven after 20 years of payments under the PAYE repayment plan regardless of the remaining balance.
Keep in mind, while this sounds like a very long time, the standard extended repayment plan takes 30 years, and may require higher monthly loan payments on a large student loan balance.
As you can guess, the “discretionary” part of this repayment plan is based on a government formula, and not your actual discretionary income. The formula is Income – 150% of your state’s poverty level for your family size. Don’t bother trying to figure this out. Use the Student Loan Department’s student loan payment calculator instead.
This payment plan can be problematic for those with unusual income circumstances, or unusual expenses. It is generally easier to pick a different student loan payment option than to fight the government’s formula.
This plan works best for a W2 wage earner, who has a larger family, without a high income.
Pay As You Earn (PAYE) Catch
The catch to the Pay As You Earn repayment plan is that your monthly payment is tied to your income. That means every time you get a raise, your student loan payment goes up, because your income increases. The maximum student loan payment under this plan is capped at what your loan payment would be under the standard 10-year repayment plan option.
Also, anytime your family size gets smaller (a child goes out on their own), your payment goes up because your expenses are lower, and thus your discretionary income is higher.
The final catch is that after 20 years the remaining balance of your student loans will be forgiven. While getting your student loans forgiven is great, you do owe taxes on any forgiven amount. That can be a lot of money.
Revised Pay As You Earn (REPAYE)
If you are eligible for PAYE, it is better than REPAYE. Do that.
If you are not eligible for PAYE, you might be eligible for REPAYE, which expanded the pay as you earn option.
All federal student loan borrowers are eligible for REPAYE no matter when you took out your student loans, or first became a student loan borrower.
REPAYE is the best student loan repayment options for borrowers whose student loan interest is higher than their student loan payments. If you have been paying on your student loans and saw your balance going up, this is an issue for you.
PAYE versus REPAYE
Differences between PAYE and REPAYE include:
- No payment cap at the 10-year repayment plan, so if your income goes high enough, you could end up paying more monthly than you would have with a non-income based repayment plan.
- Your spouse’s income counts against your payments, even if you file separately.
- REPAYE extends the loan term until you get loan forgiveness to 25 years for graduate student loans. (It is still 20 years for undergraduate loans.)
While REPAYE can lower your payments initially, it isn’t as much as an advantage as PAYE. Consider other options fully, especially if there is a chance of your income increasing substantially during the 25 year repayment schedule.
Income-Based Repayment Plan (IBR Plan)
The Income-Based Repayment Plan (IBR Plan) depends on if you are a new borrower or not.
To qualify as a new borrower, you needed to start borrowing on or after July 1, 2014.
Under this plan, your payment is 10 percent of your discretionary income.
The payment is capped at what the payment would be under the 10-year standard repayment plan.
You pay student loans for a maximum of 20 years then the remaining balance of your student loans is forgiven.
If you are an old borrower (you had any student loan balance before July 1, 2014), then you would pay 15 percent of your discretionary income, but not more than the 10-year standard repayment monthly payment.
You have to pay for 25 years before loan forgiveness.
Both plans subsidize your student loan interest. That means that if your loan payment does not cover your interest costs each month, the government just waives that interest.
Income-Contingent Repayment Plan (ICR Plan)
Income-Contingent Plan versus Income-Based Plan
The Income-Contingent Repayment Plan (ICR Plan) is available to all federal student loan borrowers, old or new.
The ICR loan payments equal 20 percent of your income.
This plan does NOT subsidize your student loan interest, so if your monthly payment does not cover the monthly interest costs, it get gets added to the balance of your student loans.
The US Department of Education Student Loan Payment Calculator is a great way to look at what your best student loan repayment option is.