Is an Income-Driven Repayment Plan Worth It?

Income-Driven Repayment (IDR) plans adjust federal student loan payments based on a borrower’s income and family size. These plans aim to make repayment more affordable, providing financial relief when earnings are low. This helps prevent default and offers a pathway toward eventual loan resolution for those who consistently make payments.

Types of Income-Driven Repayment Plans

Several federal Income-Driven Repayment plans are available. These plans ensure a borrower’s monthly payment is a percentage of their discretionary income. The specific plan a borrower qualifies for depends on factors like loan types and disbursement dates.

The Pay As You Earn (PAYE) Repayment Plan caps monthly payments at 10% of a borrower’s discretionary income. This plan is available to new borrowers who received their first federal student loan on or after October 1, 2007, and a Direct Loan disbursement on or after October 1, 2011. Qualification requires demonstrating a partial financial hardship, meaning their IDR payment would be lower than the standard 10-year repayment plan amount. Any remaining loan balance is eligible for forgiveness after 20 years of qualifying payments.

The Saving on a Valuable Education (SAVE) Plan, which replaced the Revised Pay As You Earn (REPAYE) Plan in August 2023, offers low monthly payments. For undergraduate loans, payments are 5% of discretionary income; for graduate loans, they are 10%, or a weighted average for both. This plan is available to most Direct Loan borrowers. The SAVE Plan eliminates 100% of remaining interest after a scheduled payment, preventing the loan balance from growing. Forgiveness under SAVE occurs after 10 to 25 years, depending on the original loan amount.

The Income-Based Repayment (IBR) Plan limits monthly payments to 10% of discretionary income for new borrowers on or after July 1, 2014, and 15% for those before that date. This plan requires a partial financial hardship and is available for Direct Loans and some Federal Family Education Loan (FFEL) Program loans. Loan forgiveness under IBR occurs after 20 or 25 years of qualifying payments.

The Income-Contingent Repayment (ICR) Plan sets monthly payments at either 20% of discretionary income or what a borrower would pay on a fixed 12-year repayment plan, whichever is less. This plan is available to most Direct Loan borrowers and offers forgiveness of any remaining balance after 25 years of payments. Parent PLUS Loans can be repaid under ICR if first consolidated into a Direct Consolidation Loan, making it the only IDR option for parent borrowers. This plan does not require a partial financial hardship for eligibility.

Calculating Your Monthly Payment

Determining the monthly payment under an Income-Driven Repayment plan involves calculating a borrower’s discretionary income. This amount is derived by subtracting a percentage of the federal poverty guideline for a borrower’s family size from their Adjusted Gross Income (AGI). The federal poverty guidelines vary based on household size and state of residence.

A borrower’s AGI is obtained from their most recently filed federal income tax return. If income has significantly changed since the last tax filing, borrowers may provide alternative documentation of current income, such as recent pay stubs or a letter from their employer. This ensures the payment calculation reflects their current financial situation.

The percentage of the federal poverty guideline subtracted from AGI to determine discretionary income varies by IDR plan. For the Income-Contingent Repayment (ICR) Plan, discretionary income is the difference between AGI and 100% of the poverty guideline. For Income-Based Repayment (IBR) and Pay As You Earn (PAYE) plans, it is the difference between AGI and 150% of the poverty guideline. The Saving on a Valuable Education (SAVE) Plan uses a more generous threshold, subtracting 225% of the poverty guideline from AGI, which can result in significantly lower monthly payments.

Once discretionary income is established, the IDR plan’s percentage is applied to calculate the monthly payment. For instance, if a plan uses 10% of discretionary income and that income is $1,000, the monthly payment would be $100. This calculation directly links the payment amount to a borrower’s ability to pay, fluctuating as income or family size changes.

Each year, borrowers must recertify their income and family size to ensure their monthly payments remain accurate. This annual review ensures payments continue to align with the borrower’s financial circumstances, potentially increasing if income rises or decreasing if income falls.

Loan Forgiveness and Interest Implications

Income-Driven Repayment plans offer loan forgiveness after a specified period of qualifying payments. Depending on the specific IDR plan, any remaining federal student loan balance is forgiven after 20 or 25 years of payments. This forgiveness is contingent on the borrower having made all required payments on time.

Borrowers must understand the tax implications of loan forgiveness. Under current Internal Revenue Service (IRS) regulations, debt forgiven under an IDR plan is considered taxable income in the year forgiveness occurs. This is often called a “tax bomb,” as it can result in a significant tax liability. Forgiven amounts are reported to the IRS on Form 1099-C, Cancellation of Debt.

The American Rescue Plan Act of 2021 made federal student loan forgiveness tax-free at the federal level from December 31, 2020, through January 1, 2026. After this period, the forgiven amount will likely be taxable. Some states may still tax forgiven student loan amounts, regardless of the federal tax-free period. Forgiveness under Public Service Loan Forgiveness (PSLF) is not considered taxable income by the IRS.

Interest accrual and capitalization are factors in IDR plans. Interest continues to accrue on the loan balance, even if monthly payments are too low to cover the full interest. Interest capitalization occurs when unpaid accrued interest is added to the principal balance. This can happen if a borrower exits an IDR plan, fails to recertify income on time, or if their income becomes too high.

Some IDR plans offer interest subsidies. For instance, the SAVE Plan prevents the loan balance from growing due to unpaid interest by having the government cover any interest not covered by the borrower’s monthly payment. This means the principal balance will not increase as long as payments are made. For other plans like IBR and PAYE, an interest subsidy may apply to subsidized loans for the first three years if the monthly payment does not cover the accruing interest.

Applying for and Maintaining Your Plan

Enrolling in an Income-Driven Repayment plan requires borrowers to provide financial information to their loan servicer. To begin, borrowers need to gather documentation verifying their income and family size, such as recent federal tax returns or pay stubs. Details about household members are also needed to determine family size.

The official application for an IDR plan can be completed online through the Federal Student Aid (FSA) website, StudentAid.gov, using a borrower’s FSA ID. Borrowers can also download a paper form from StudentAid.gov and submit it directly to their loan servicer via mail or by uploading it to the servicer’s website. The application allows borrowers to select a specific IDR plan or request placement on the plan with the lowest monthly payment.

After submission, borrowers should expect their loan servicer to review the application and communicate the approved monthly payment. Processing times can vary, often taking several weeks, and loan servicers may apply a temporary administrative forbearance while the request is processed. Borrowers should save confirmation emails and contact their loan servicer or the Federal Student Aid Ombudsman Group if they do not receive a response within 60 days.

Maintaining enrollment in an IDR plan requires an annual recertification of income and family size. This annual process ensures the monthly payment continues to reflect the borrower’s current financial situation. Loan servicers send reminders to borrowers about 90 days before their recertification due date.

Failing to recertify income and family size on time has consequences. For most IDR plans (PAYE, IBR, ICR), if a borrower does not recertify, their monthly payment will revert to the Standard Repayment Plan amount, and any unpaid accrued interest will capitalize, increasing the loan principal. For the SAVE Plan, failure to recertify results in placement on an alternative repayment plan with a payment not based on income. Borrowers can consent to the Department of Education automatically accessing their tax information from the IRS for seamless annual recertification.

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Citations:
https://studentaid.gov/manage-loans/repayment/plans/paye
https://studentaid.gov/announcements-events/save-plan
https://studentaid.gov/understand-aid/types/loans/plus/parent
https://studentaid.gov/manage-loans/repayment/plans/ibr
https://studentaid.gov/manage-loans/repayment/plans/icr
https://studentaid.gov/help-center/answers/article/how-is-discretionary-income-calculated
https://aspe.hhs.gov/topics/poverty-economic-mobility/poverty-guidelines
https://studentaid.gov/help-center/answers/article/what-do-i-do-if-my-income-has-changed-and-i-need-to-update-my-income-driven-repayment-plan
https://studentaid.gov/manage-loans/repayment/plans/income-driven/questions
https://studentaid.gov/manage-loans/forgiveness-cancellation/public-service
https://www.irs.gov/taxtopics/tc431
https://studentaid.gov/help-center/answers/article/interest-capitalization
https://studentaid.gov/help-center/answers/article/what-happens-if-i-dont-recertify-my-income-driven-repayment-plan
https://studentaid.gov/help-center/answers/article/documents-needed-to-apply-for-income-driven-repayment-plan
https://studentaid.gov/app/ibrInstructions.action