If you're struggling to pay back your federal student loans on the standard 10-year repayment plan, income-based repayment can offer you a reprieve. Rather than paying a fixed amount each month for 10 years, you pay an amount that's tied to your income and you get a longer loan repayment term. But it's not a good fit for everyone, and depending on how much you earn and what type of loan you have, you may not even be eligible for income-based repayment (IBR). Here's what you need to know to decide if it's right for you.
How income-based repayment works
IBR is only available for federal Direct loans issued to students, including Direct Consolidation loans, and Federal Family Education Loan (FFEL) Consolidation loans. Private student loans and federal student loans made to parents are not eligible for IBR.
The IBR plan caps payments at 10% of your discretionary income for all qualifying loans issued after July 1, 2014. Your discretionary income is defined as the difference between your income and 150% of the poverty guideline for your state and family size. Your spouse's income may also count as your income for the purposes of this calculation if you file a joint tax return. If you took out a qualifying loan before July 1, 2014, payments are capped at 15% of your discretionary income. If your payments under this plan are equal to or greater than what you'd pay under the standard 10-year repayment plan, you won't be eligible for IBR.
You must submit an application to switch to the IBR plan and then you must file yearly income certifications so the government can reassess your monthly student loan payments. You can also file new income certifications at any time, which can be useful if you suddenly lose your job. For loans issued after July 1, 2014, you'll have a 20-year repayment term while loans issued before this date have a 25-year repayment term. Any amount leftover after this time is automatically forgiven, but the forgiven amount is added to your taxable income that year and this can raise your tax bill significantly.
Who income-based repayment is a good fit for
IBR is a good fit if you're struggling to keep up with your payments on the standard repayment plan and you'd like to reduce the amount you owe each month. You can calculate how much you will owe under the IBR plan by looking up the poverty guideline for your state and family size. Subtract this from your annual income and multiply the difference by 10% (or 15% if you took out your loan before July 1, 2014). If this number is significantly lower than what you'd pay under the standard repayment plan, it may be worth switching.
IBR is also a good choice if you anticipate growing your family in the near future. Every year when you submit your income certification, the government takes into account your current family size when calculating your new student loan payment. The standard repayment plan doesn't offer any adjustments made for family size and this could strain your budget.
If you qualify for Public Service Loan Forgiveness (PSLF), IBR is a qualifying repayment plan you may want to consider. As long as you work for a qualifying organization for at least 10 years, submit the appropriate paperwork annually, and make 120 on-time payments, the government will forgive any outstanding student loan debt and it won't add the forgiven amount to your taxable income in that year.
Who income-based repayment isn't a good fit for
The IBR plan isn't a good choice if you can afford your payments under the standard repayment plan and you're trying to pay back your loan as quickly as possible. The smaller monthly payments and longer repayment terms mean you'll pay more overall. It's even possible that your student loan balance could grow over time if your IBR payments aren't enough to cover the monthly interest your loan is accruing.
It's also not a good fit if your monthly payments on the IBR plan aren't significantly different from what they would be under the standard repayment plan. It's not worth all the extra you'll pay in interest plus the hefty tax bill you'll pay after the government forgives your outstanding balance just to save a couple dollars each month.
Alternatives to income-based repayment
If the income-based repayment plan isn't a good fit for you and you can't keep up with your payments under the standard plan, try one of these alternatives instead:
- Graduated Repayment Plan: You pay off your loan in 10 years (or within 10 to 30 years for Direct Consolidation loans), but your payments start out lower and increase every two years.
- Extended Repayment Plan: Payments may be fixed or graduated and you have 25 years to pay back what you owe. You must have at least $30,000 in Direct student loans in order to qualify.
- Revised Pay as You Earn (REPAYE) Plan: This is similar to the IBR plan in that you pay 10% of your discretionary income every year for 20 years (or 25 for graduate loans). The government recalculates your payments each year and forgives any outstanding balance after the repayment period is up. If you're married, the government counts your spouse's income when calculating your discretionary income, regardless of whether you file taxes jointly or separately.
- Pay as You Earn (PAYE) Plan: This plan also requires you to pay 10% of your discretionary income per month for 20 years. The government recalculates your payments every year and forgives any outstanding balance after the 20-year period is up. Spousal income only counts toward your discretionary income if you file a joint tax return.
- Income-Contingent Repayment (ICR) Plan: You pay the lesser of 20% of the difference between your income and the poverty guideline for your state and family size or the amount you'd pay on a fixed 12-year repayment plan. There's a 25-year repayment term and the government recalculates your payments annually.
Explore all of these options and see which offers you the best deal. Choose the one that has the highest monthly payments you can comfortably afford so you can minimize how much you pay overall.