Student Loan Repayment Options

Over the past decades, the total amount of student loan debt in the United States has more than doubled to over 1.3 trillion dollars (i). Although 67% of borrowers owe less than $25,000 (ii), for many who attend graduate or professional school, balances can grow much larger and payments can make up a large portion of monthly income.

For federal loans, which include loans made directly by the federal government as well as the older FFEL program, the number of options for managing those payments has expanded rapidly over the past few years. Income Contingent Repayment (ICR), the oldest of the plans that tie monthly payments to the borrower’s income, has been around since 1995, but the payments under ICR are fairly expensive and it often did not provide the relief that borrowers needed.

Since 2009, though, the number of options has grown dramatically. In addition to ICR, the new plans include Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), and Income Based Repayment (IBR). The last of those, IBR, was modified in 2010 with the new provisions only applying to the most recent of borrowers while the previous rules continue to apply to those who took out loans prior to 2014.

Not only have the number of options expanded, but so has the potential for confusion. It can be overwhelming for a graduate to figure out what options are available let alone which may be best for his or her financial situation.

What Loans Are Eligible?

It is important to note that all of the income driven repayment options discussed here only apply to FEDERAL loans made directly to student borrowers (iii) . The other options are restricted to loans taken out by students for their own education. While technically IBR (Income Based Repayment) is the only program available for FFEL loans, FFEL loans may be consolidated into a direct loan which may then be eligible for PAYE (Pay As You Earn) or REPAYE (Revised Pay As You Earn).Private loans, unfortunately, do not qualify for any of these options and cannot be consolidated into federal loans.

Private lenders often do not offer any flexibility if payments are taking up a large portion of your income and making it hard to balance your budget or achieve long term financial goals. Thus, it is important to be very careful when consolidating federal direct or FFEL loans into a private loan. While the interest rate may be lower, if your income is uncertain or may drop over time, giving up access to income driven repayment options and other favorable provisions that federal loans offer can be very risky!

How the Payments Are Calculated

All three newer programs calculate payments based on the same measure - discretionary income. Discretionary income has a very specific definition here: it is your Adjusted Gross Income minus 150% of the Health & Human Services poverty guideline for your family size. For 2016, the guideline for a single adult is $11,880 in the contiguous US (it is somewhat higher in Alaska and Hawaii) (iv). For example, if you have an income of $50,000 and are single without children, your discretionary income would be $32,180. The income driven repayment calculation would be 10-20% of this $32,180 discretionary income amount.

IBR and PAYE also cap the amount that you can be required to pay if your income rises. This cap is based on the payment you would be making based on your loan balance and interest rate if you were in the standard 10 year repayment plan. These plans also require you to have a “Partial Financial Hardship” to qualify. To be eligible, you would need to have a lower payment under IBR or PAYE than you would make under the 10 year standard plan.

To take a look at how this works, if a borrower has $25,000 outstanding at 5% interest, the monthly payment to pay off the loan in 10 years would be around $265. If your income is high enough that you would pay more than $265 under IBR or PAYE, you do not qualify for those programs. If you qualify, enroll in the program, and your income then rises to the point where your income-based payment is more than $265/month, you would pay $265/month instead.

Loan Forgiveness

There are two ways to qualify for loan forgiveness using income driven repayment plan. The first, and most generous, is Public Service Loan Forgiveness. Qualification for this program is based on job type and employer as well as payment plan. In order to apply for loan forgiveness, you must make 120 qualifying payments. A payment is “qualifying” if it is made while enrolled in an income driven plan and while working full time for a government or 501(c)3 organization. This can take as little as ten years, though payments do not need to be consecutive (so those who move from the public sector to the private sector and back again could still be eligible).

Public Service Loan Forgiveness must be applied for after the 120 payments are made and is non-taxable. If you are working towards this type of forgiveness, it is strongly recommended to apply for certification annually to be sure that your payments are counted correctly.

In addition, each of these plans offers a route to loan forgiveness for borrowers who do not make enough to pay off their loans in 20-25 years. This is available to all borrowers repaying through income driven plans, regardless of their type of employment. It is important to note that unlike Public Service Loan Forgiveness, the balance (including any accrued interest) is taxed as income when the loan is forgiven.

Let’s take a closer look at three newest and most affordable plans. While they are similar in many ways, each has a different way of calculating payments, a different number of years before loan forgiveness occurs, and a different way of treating the interest that accrues if your monthly payment does not cover the interest due.

Income-Based Repayment (IBR)

IBR is actually not one but two separate plans. In order to determine which applies to you, look at when your loans were taken out. If you do not remember this, you can get the information online from the National Student Loan Data System at NSLDS.gov. Did you have any outstanding loans on July 1, 2014? If the answer is yes, you are subject to the old IBR rules. If the answer is no, you get the new ones.

Old IBR

For older borrowers, IBR caps payments at 15% of your discretionary income. For our single borrower with $50,000 in income, this calculation leads to monthly payments of around $400/month. If that borrower had $25,000 in loans at 5% interest, he or she would not qualify for IBR since $400 is more than the $265 he or she would owe under the 10 year standard plan. If that borrower had $100,000 in federal loans, however, this would provide tremendous relief from the $1,060 monthly payment under the 10 year plan (v) .

If you are married and file your taxes jointly, IBR uses your joint income. If you file married separately, only your own income is taken into account. While there may be a reduced payment if filing separately, that could increase your taxes. It is best to talk to a tax professional to determine whether the benefit is worth the cost in your situation.

Forgiveness under the old IBR plan occurs after 25 years of payments if you are not eligible for Public Service Loan Forgiveness and have not paid off the loan balance before then.Those who are considering this plan will not be eligible for PAYE or the new IBR provisions.