How Do Income Driven Plans Work?

Are you drowning in your federal student loan payments? If so, then you may want to consider enrolling in an income-driven repayment (IDR) plan. An IDR plan might be able to get you the lowest monthly payment on your student loans, so your payments can be affordable with your current income.

Before you make the change, you should make sure you understand the different IDR plans and how they will affect your financial situation and your federal student loans. This article is meant to demystify IDR plans for you, so you can figure out the best option for your situation.

What is IDR?

The U.S. Department of Education offers income-driven repayment (IDR) plans to student loan borrowers who qualify for them. Just like the federal student aid programs you were offered when you enrolled in school, these plans are meant to help you. These IDR plans can lower your monthly payments to a smaller % of your discretionary income (we will cover more on how this income is calculated). There are four types of IDR plans offered by the U.S. Department of Education that offer different repayment options. Under an IDR plan, you also have the benefit of seeking loan forgiveness after a relevant number of years, though the amount of student loans forgiven is currently taxable.

How do you qualify for an IDR plan?

To qualify for an IDR plan you will need to:

• Have federal student loans (private student loans do not qualify)
• Understand that certain types of loans qualify for different IDR programs
• Apply and get approved for an IDR plan before you start making payments (through your loan servicer and at Student Aid Gov site)
• Certify your income when you initially enroll and recertify your annual income to stay on the plan (so the U.S. Department of Education can calculate how much you need to pay)
• Recertification can also happen if your income suddenly changes (e.g., job loss) from the annual income you reported

How does an IDR plan lower your student loan monthly payment amount?

If you have a high student loan outstanding balance and you stick to the default 10-year standard repayment plan, your monthly payment amount will be high. This is tough to pay if you have a lower income compared to your federal student loans. If you are in this situation, an IDR plan can help you since monthly payments are meant to be affordable by taking account your income and family size to calculate your monthly payments.

For example, the IBR repayment plan (one of four IDR plans with different repayment options) will set monthly payments at 10 to 15% of your discretionary monthly income. The U.S. Department of Education calculates discretionary income by getting the difference of your adjusted gross income (or AGI which you can usually find on your federal income tax return that you file with the IRS) and 150% of the annual poverty guideline for a family of your size and in your state. If your discretionary income is calculated as $2,000/month, your monthly payment at 10% of discretionary income would be $200.

What are the different IDR plans?

There are currently four types of IDR plans. Depending on the type of student loan you have, you can qualify for different plans.

Income-Based Repayment (IBR plan):

• Monthly payments are capped at 10% to 15% of your discretionary income
• For new borrowers on or after July 1, 2014*, IBR is capped at 10% of discretionary income and borrowers receive forgiveness after 20 years of repayment
• For borrowers before July 1, 2014, IBR is capped at 15% of discretionary income and borrowers receive forgiveness after 25 years of repayment
• Monthly student loan payments in IBR plan cannot be equal or exceed what you would pay under the 10 year standard repayment plan
• Loan eligibility and requirements for IBR (e.g., FFEL program loans, Direct loans)

Pay As You Earn (PAYE plan):

• Monthly payments are capped at 10% of your discretionary income and borrowers receive forgiveness after 20 years of repayment
• Monthly student loan payments in IBR repayment plan cannot be equal or exceed what you would pay under the 10-year standard student loan repayment plan
• Loan eligibility and requirements for PAYE (e.g., Graduate Plus loans, Direct loans)

Revised Pay As You Earn (REPAYE plan):

• Monthly payments are capped at 10% of discretionary income and undergraduate borrowers receive forgiveness after 20 years of repayment while graduate borrowers receive forgiveness after 25 years of repayment
• Also includes a student loan interest subsidy (this can range from 100% to 50% depending on the type of loan, whether the loan is subsidized or unsubsidized, and period) for unpaid interest
• Loan eligibility and requirements for REPAYE plan (e.g., Graduate Plus loans, Direct loans)

Income-Contingent Repayment (ICR plan):

• Monthly payments are capped at either the lesser of 20% of discretionary income or monthly payments when the loan is on a 12 year student loan repayment plan. Borrowers receive forgiveness after 25 year years
• Loan eligibility and requirements for ICR plan (e.g., Parent Plus loans)

You can learn more detail about the different IDR repayment plans.

What are the benefits and drawbacks of switching to an IDR repayment plan?

You should understand the pros and cons of enrolling in an IDR repayment plan before you make the switch. Although an IDR repayment plan can be hugely beneficial if you can’t afford your payments, it can also prolong the length of your loan and the amount you pay in total.

Benefits:

• You can lower your monthly payment if you have a low income compared to your student loan debt
• You can adjust your monthly payments when your income or family size changes
• You can qualify for student loan forgiveness (but remember that this forgiven remaining balance will be taxed as income when it is forgiven) * You can take advantage of a public service loan forgiveness (PSLF) or similar program if you work in a qualifying job. For example, you can take advantage of lower payments, get PSLF student loan forgiveness after 10 years, and not get taxed on the forgiven remaining balance because of the PSLF program.

Drawbacks:

• Because you are paying less each month, it will take you longer to pay off your loans.
• When your federal student loans are forgiven under IDR, the balance is considered taxable income. This can be a large tax bill for you at the end of the repayment term.
• You could actually end up paying more over the long term, because you are also paying more interest over a longer period of time (the student loan repayment period can be 10 to 15 years longer than the 10-year standard student loan repayment plan)
• If your payments don’t cover interest, your student loan outstanding balance can actually keep on growing instead of getting smaller because unpaid interest will be added to your outstanding student loan balance
• You will need to apply for an IDR repayment plan. Recertification will also happen every 12 months

How do I decide if an IDR repayment plan is right for me?

To understand whether an IDR repayment plan is right for you, you should first try to understand your financial situation. Are your monthly student loan payments unmanageable for you? For example, are you getting into extra debt to cover your monthly living expenses, dipping into your emergency savings, or not able to afford your rent? If so, it might make sense to look into an IDR repayment plan so you can get the lowest monthly payment. You can check out Snowball Wealth’s repayment estimator, to see what payment might make sense for you.

You can also consider deferment or forbearance if you want to temporarily stop payment on your federal student loans because you cannot afford them. Either way, it’s important that if you can’t afford your student loan payments you should figure out a way to address this. That way you can make sure you are not late on your payments and your credit score won’t be affected.

For the IBR plan, you are considered a “new borrower” on or after July 1, 2014, if you had no outstanding balance on a Direct Loan or FFEL loan when you received the Direct Loan on or after July 1, 2014.

This post was updated March 4, 2021. Federal repayment programs may be subject to change.