Income-Driven Repayment (IDR) plans first came about in the 1990s and 2000s, but the Obama administration promoted IDR in recent years to combat a sharp increase in defaults by federal student loan borrowers. These defaults were brought about primarily by the 2008 economic collapse. Today, millions of borrowers have taken advantage of IDR options, including those enacted by Congress since 2008, but borrower defaults continue to be a national economic issue. To curb and prevent defaults, it is important that all federal borrowers be well-informed about their options to lower, and even eliminate, their monthly payments based upon their income level.
What is an Income-Driven Repayment Plan?
There are currently four types of IDR plans. Most federal loans are eligible for one or more IDR plans, and many are eligible for any of the four. However, only federal loans can be placed on IDR plans offered by the federal government – never private loans. Borrowers can find out what plans their loans are eligible for, as well as apply for IDR plans, by contacting their federal student loan servicer. IDR allows borrowers to lower their monthly payments and extend the term of their repayment beyond the standard ten-year repayment plan. To do so, borrowers provide proof of income to their servicers along with information on their family size. Depending upon the plan selected, a borrower’s monthly payment will be anywhere from 10 to 20 percent of their discretionary income. In some cases, a borrower’s monthly payment may only be $0 a month on an IDR plan. The four plans currently available to borrowers are the Income-Contingent Repayment (ICR) Plan, Income-Based Repayment (IBR) Plan, Pay As You Earn (PAYE) Plan, and Revised Pay As You Earn (REPAYE) Plan.
Different Income-Driven Repayment Options
The various plans are similar in that they all allow borrowers to potentially lower their payments based upon discretionary income, and all allow a borrower to extend the repayment term. However, some plans are only available to borrowers who are considered “new borrowers” after a certain date, and some plans base a borrower’s monthly payments on 10 percent of discretionary income while others base payments on 15 or even 20 percent. Different borrowers may have different motivations for entering into an income-driven repayment plan, but most borrowers are looking for the plan they are eligible for that lowers their monthly payments by the greatest amount. In order to choose the right plan to achieve that goal, first a borrower should eliminate from consideration any plans they are not eligible for, either because of the type of federal loans they have or because the time in which they first became borrowers makes them ineligible. Then, compare the remaining plans to see which one offers the lowest payment option and also consider the time period of repayment.
Income-Contingent Repayment (ICR) Plan
Under ICR, a borrower’s payment will be the lesser of 20 percent of their discretionary income or the amount they would pay under a standard repayment plan having a 12-year repayment period multiplied by a percentage based upon their income. There are no income requirements for ICR, unlike some of the other plans, and also no cap on how high a monthly payment can go based upon income. Entering into an ICR plan can sometimes result in a borrower eventually making payments that are greater than what he or she would make under a standard ten-year repayment plan. But for borrowers in ICR who make lower payments, and do not pay off their entire balance before 25 years, the remaining balance is then forgiven.
Not all federal loans are eligible for this plan. Loans in the Direct Loan Program are eligible for ICR, with the exception of Parent PLUS Loans. In order for Parent PLUS Loans to become eligible for ICR, they need to be consolidated as part of the Direct Loan Consolidation Program. If a borrower has consolidated loans that were used to repay Parent PLUS Loans, the consolidated loan must have been made after July 1, 2006, in order to be eligible for ICR.
ICR has been around longer than any of the other plans, and generally offers monthly payments that are higher. For borrowers eligible for other plans, ICR usually does not offer the best available terms. But for some borrowers, such as Parent PLUS Loan borrowers who consolidate their loans, ICR is the only income-driven repayment plan available.
Income-Based Repayment (IBR) Plan
Borrowers entering IBR will pay either 10 or 15 percent of their discretionary income. The percentage that applies will depend upon whether a borrower is considered a “new borrower” on or after July 1, 2014. A new borrower is one who did not have an outstanding balance on a Direct Loan or a Federal Family Education Loan (FFEL) as of the date in question. Borrowers who were new borrowers will make payments based upon 10 percent of their discretionary income, and will be eligible for loan forgiveness after 20 years. Those who were not new borrowers will make payments based upon 15 percent of their discretionary income and can apply for forgiveness after 25 years.
In order to get onto an IBR plan, a borrower’s income must be low relative to his or her student loan debt. A borrower’s monthly repayment is capped under IBR, meaning it will never be a higher monthly payment than would have been made under a standard ten-year repayment plan. Almost all loans in the Direct Loan program are eligible for IBR, with the exception of Parent PLUS Loans and consolidation loans used to repay Parent PLUS Loans. Unlike ICR, consolidation of Parent PLUS Loans will not make them eligible for IBR. However, IBR is available for borrowers with FFEL Program loans.
Like ICR, this program has been around longer than the PAYE and REPAYE programs. It offers more payment protection than ICR, because under IBR a borrower knows that their payment will not go higher than it would under a standard plan. There are no minimum or maximum income requirements for IBR. Instead, a borrower’s income will always be considered relative to their eligible student loan debt to determine whether they qualify for IBR.
Pay As You Earn (PAYE) Plan
The PAYE Plan offers payments based upon 10 percent of a borrower’s discretionary income, and loan forgiveness after 20 years of qualifying payments. Just like IBR, a borrower’s income will be compared to their eligible loan balance to determine whether they qualify for PAYE, and no income cap applies. Borrowers who enter this plan must have been “new borrowers” (using the definition described above) on or after October 1, 2007, who received a loan disbursement on or after October 1, 2011.
The only loan program eligible for PAYE is the Direct Loan program. This includes loans consolidated into a Direct Loan, except for those consolidated in order to repay Parent PLUS Loans. Parent PLUS Loans themselves are also excluded from eligibility in the PAYE program. As long as a borrower took out only loans from the Direct Loan program for their own education, and fulfills the “new borrower” requirement, their loans will be eligible for repayment under PAYE.
Repayment under this plan will never result in higher monthly payments than the borrower would have made under a standard repayment plan, because the PAYE payment amount is capped at whatever that amount would be. PAYE offers the lowest payments possible, at 10 percent of discretionary income, and the quickest loan forgiveness available, with the exception of the Public Service Loan Forgiveness Program. The catch is, only certain borrowers who can fulfill the “new borrower” requirements can enroll in PAYE. For those that are eligible, it is often the best choice to lower their monthly payment and achieve loan forgiveness the quickest.
Revised Pay As You Earn (REPAYE) Plan
REPAYE was created as an alternative to ICR and IBR for those borrowers who cannot qualify for PAYE because of the dates in which they took our their student loans, but it has significant differences other than the new borrower requirement. REPAYE uses 10 percent of a borrower’s discretionary income to calculate their monthly payment amount. Loan forgiveness depends upon whether the borrower’s eligible loans were all taken out for undergraduate study or included loans for graduate or professional school. For those borrowers without graduate or professional school loans, the soonest they can apply for loan forgiveness is 20 years; for those with those types of loans, they may apply after 25 years.
As opposed to PAYE, under this plan there is no cap on monthly payment amounts and a borrower could end up making payments that are greater than what would be required under a standard repayment plan. And REPAYE also has no requirement that a borrower’s income be relatively low compared to their student loan debt, which means more borrowers are eligible to enter the program. All loans from the Direct Loan program are eligible except Parent PLUS loans and consolidated loans used to pay back Parent PLUS loans.
REPAYE has no “new borrower” requirement, and no low income requirement, and so it is an option available to a greater number of borrowers than PAYE. For those borrowers who qualify for PAYE, that is usually a better option to lower monthly payments. However, many borrowers took out student loans prior to the requisite date for PAYE, and those borrowers may find that REPAYE offers the lowest payments and quickest loan forgiveness – especially if they are carrying only undergraduate loan debt. There is one last way that REPAYE differentiates itself from ICR, IBR, and PAYE. Under REPAYE, a spouse’s income is almost always counted for income calculation purposes along with the borrower’s, even if their tax returns are filed separately. This can cause discretionary income, and thus payments, to be higher under REPAYE than they might be under ICR or IBR if spouses file separately.
When to (and When Not to) Convert to an Income-Driven Repayment Plan
The main reason borrowers seek out IDR is to lower their monthly payments. Especially for those students who have recently graduated, and may be starting careers with lower salaries than they hope to one day be making, monthly payments under a standard plan can be entirely unfeasible. However, some borrowers get on an IDR plan without fully understanding what effect lowering and extending their monthly payments has on the amount of money they eventually must repay.
All ICR plans will extend the term of a borrower’s repayment past the standard 10 year plan. Extending the term of a loan will lower monthly payments because the same amount of money is spread over a longer time period. However, that means that the borrower will pay more in interest over the life of the loan. Many borrowers entering plans requiring monthly payments of only a percentage of their discretionary income could afford to pay a greater amount but chose not to because they don’t understand just how much more in interest they pay. When deciding whether to enter into an IDR plan, it’s important for a borrower to weigh the benefits of a more manageable loan payment against the disadvantages of paying more money over the long run.
Another important consideration is the tax bill borrowers may be hit with when any remaining loan balance is forgiven after 20 or 25 years. Depending upon a borrower’s starting balance and the amount they pay, some will still be carrying a loan balance by the time the loans on their IDR plan are eligible for loan forgiveness. The way the tax code is currently written, all loans except those on the Public Service Loan Forgiveness Program will be taxable as forgiven debt. In most instances, when the borrower’s monthly payment is less than the amount of interest accruing monthly on the loan, the interest is then capitalized and causes the overall loan balance to grow. This can result in a greater-than-anticipated tax bill down the road.
Applying for an Income-Driven Repayment Plan
An IDR plan must be applied for directly with the borrower’s federal student loan servicer. Along with the initial application, the borrower will need to provide their family size, including spouse and dependents, and proof of their income. IDR applications can be submitted electronically through the servicers’ websites and income information can be submitted through the IRS Retrieval tool. Or, paper applications can be mailed or faxed to the servicer along with paper copies of the borrower’s latest tax return. When the borrower has had a drastic change in income since the last filing of their taxes (such as new employment or job loss) they can use alternative income verification, such as paystubs or a letter describing their loss of employment. And, importantly, each and every borrower is required to recertify their family size and income with their servicer each year in order to stay in their IDR plan.
Public Service Loan Forgiveness and Income-Driven Repayment Plans
There is a great benefit to borrowers who are able to combine the Public Service Loan Forgiveness (PSLF) program with one of the IDR plans. Under PSLF, borrowers who work for the government or eligible non-profit entities can apply for loan forgiveness after only 10 years, or 120 qualifying payments. Amazingly, payments made under IDR plans qualify under PSLF as well – even “payments” of $0 a month for the most low-income borrowers. And the loan forgiveness available under PSLF after 10 years is tax-free. The first borrowers who can apply for loan forgiveness under PSLF will be eligible in October 2017.
IDR is available in a myriad of choices so that nearly every federal student loan borrower has at least one option to make monthly payments based upon their income. Over 5 million federal borrowers have enrolled in IDR plans, with more enrolling all the time as awareness of these options continues to grow. When deciding upon an individual IDR plan, a borrower should carefully consider their personal circumstances, including the trade-off between lowered payments and increased accrual of interest, and solicit advice from their servicer.