Income based repayment

What is income-driven repayment?

Income-driven repayment is an umbrella term for four specific repayment plans that are available in the William D. Ford Federal Direct Loan Program and the Federal Family Education Loan Program. These four repayment plans are called Income-Based Repayment (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), and Income-Contingent Repayment (ICR).

Payments under the IBR Plan are 10% or 15% of discretionary income, but will never be more than the 10-year standard repayment amount. Whether a borrower pays 10% or 15% of discretionary income depends on when the borrower first started borrowing student loans.

Payments under the PAYE Plan are 10% of discretionary income, but will never be more than the 10-year standard repayment amount.

Payments under the REPAYE Plan are also 10% of discretionary income; however, unlike IBR and PAYE, payments for high-income borrowers may be higher than the 10-year standard repayment amount. Also, unlike IBR and PAYE, if required monthly payments do not cover the accruing interest, 50% of the unpaid interest is forgiven, thereby reducing negative amortization.

Payments under the ICR Plan are the lesser of 20% of discretionary income or a 12-year standard repayment amount adjusted based on the borrower's income.

What are the important benefits of an income-driven repayment plan?

The primary benefit provided by income-driven repayment plans is the lowering of the borrower's monthly payment to be less than what it would be under other repayment plans.

In addition, because payments are generally based on income, instead of loan debt, it is not certain whether or when a borrower will repay the loan in full. Therefore, the income-driven repayment plans provide for forgiveness after 20 or 25 years of qualifying repayment, depending on when the student borrowed and the plan the borrower chooses.

The income-driven repayment plans are also qualifying repayment plans for the Public Service Loan Forgiveness Program, which provides for forgives of certain federal student loans after 10 years of qualifying employment and payments.

The last benefit is that the government will pay the borrower's interest on subsidized loans for the first three years under the IBR, PAYE, and REPAYE Plans, if the repayment amount does not cover it.

Disadvantages of income-driven repayment

Since a borrower has a lower monthly payment to make, it will take longer to pay back the loans, therefore, more interest is paid. The borrower must file new documentation of earnings and family size every year.

For example, suppose a student graduates with $50,000 in student loans. The monthly payment will be $575.40 under the 10-year standard repayment plan at 6.8% interest. Under the 10-year standard repayment plan, and in the first year, interest payments will be $3,228, principal will be reduced by $3,616. At the end of the 10 years, interest payments will total $18,402. But if that student applies for the IBR plan and repays his or her student loans in full over 25 years, total interest payments increase from $18,402 to $51,770.

Qualifying for an income-driven repayment plan

Eligibility requirements for the income-driven repayment plans depends on which plan the borrower chooses and when the student borrowed.

The ICR Plan has the fewest number of eligibility requirements. A borrower is only required to have an eligible loan.

The IBR and Pay As You Earn Plans require that the borrower demonstrate a "need" to make income-driven payments and have eligible loans.

The Pay As You Earn Plan is limited to those who borrowed recently. Specifically, the borrower must be a "new borrower" as of October 1, 2007 and have received a disbursement of a Direct Loan on or after October 1, 2011. A borrower is a "new borrower" if, when receiving a federal student loan on or after October 1, 2007, the borrower did not have an outstanding balance on another federal student loan.

The Revised Pay As You Earn Plan is available to all Direct Loan borrowers regardless of when the money was borrowed. FFEL loans can be made eligible if they are consolidated into a Direct Consolidation Loan.

Eligible loans

Eligible loans for the ICR Plan are all loans made under the William D. Ford Federal Direct Loan Program except Parent PLUS Loans. However, if a Parent PLUS Loan is consolidated into a Direct Consolidation Loan, then the Direct Consolidation Loan may be repaid under the ICR Plan.

Eligible loans for the IBR Plan are all loans made under the William D. Ford Federal Direct Loan Program and Federal Family Education Loan Program except for Parent PLUS Loans. Unlike ICR, Parent PLUS Loans cannot be consolidated into a consolidation loan in order to qualify.

Eligible loans for the PAYE Plan are all loans made under the William D. Ford Federal Direct Loan Program except for Parent PLUS Loans. Unlike ICR, Parent PLUS Loans cannot be consolidated into a consolidation loan in order to qualify.

Borrowers with Federal Family Education Loan (FFEL) Program loans and Federal Perkins Loan Program loans may become eligible for the ICR, Pay As You Earn, and Revised Pay As You Earn plans by consolidating them into a Direct Consolidation Loan.

A "need" to make income-driven payments

The IBR and PAYE Plans require that borrowers demonstrate a "need" to make income-driven payments. This debt-to-income test checks to see whether the borrower would see a payment amount reduction under the IBR or PAYE Plan relative to the 10-year standard repayment plan.

Different terms and conditions under the IBR Plan

The IBR Plan has different terms and conditions depending on when the student borrowed. If the borrower is a "new borrower" on or after July 1, 2014, then the borrower will have payments that are generally 10% of discretionary income and forgiveness is provided for after 20 years of qualifying payment. If a borrower is not a new borrower on or after July 1, 2014, then payments will generally be 15% of discretionary income and forgiveness is provided for after 25 years of qualifying repayment.

Similar to the definition of "new borrower" for Pay As You Earn, a new borrower for the IBR Plan is one who, when receiving a federal student loan on or after July 1, 2014, the borrower did not have an outstanding balance on another federal student loan.

How to determine eligibility

Utilizing the repayment estimator online, a borrower can estimate his other monthly payments under all repayment plans, including IBR. However, the repayment estimator can only estimate eligibility. To receive an official determination of eligibility, a borrower must contact his or her loan servicer. The National Student Loan Data System (Nslds.ed.gov) can let a borrower know who is the servicer of his/her loan.

Public Service Loan Forgiveness Program

The Public Service Loan Forgiveness Program provides for the forgiveness of certain types of federal student loans after 10 years of qualifying employment and payments. The IBR plan is one of the qualifying repayment plans for the Public Service Loan Forgiveness Program. And, to receive Public Service Loan Forgiveness, borrower must have repaid their loans under one of the "income-driven repayment plans", including IBR.

Applying for an income-driven repayment plan

To apply for an income-driven repayment plan, the borrower needs to submit the Income-Driven Repayment Plan Request and provide information about family size and income. Income can take the form of tax information (adjusted gross income), or "alternative documentation of income", such as a pay stub.

Tax information, as well as the application, itself, and certification of family size, may be provided electronically through StudentLoans.gov. If completing the application electronically, a borrower may transfer tax information into the application directly from the Internal Revenue Service (IRS).

According to the application, borrowers may also self-certify that they currently have no income, thus avoiding needing to try and document that they have no income.

Because the eligibility criteria are complex, the application allows borrowers to indicate that they want their loan servicer to determine which of the income-driven plans the borrower is eligible for, and to place the borrower on the income-driven plan with the lowest monthly payment amount.

Which plan to choose

Most borrowers seeking an income-driven plan should choose Revised Pay As You Earn. The REPAYE plan provides benefits that the IBR, ICR, and PAYE plans do not, including a 50% interest subsidy if the required payment does not cover the accruing interest. However, there could be disadvantages to choosing the REPAYE plan which could result in higher amounts being paid over the life of the loan or very high monthly payments for borrowers with high incomes.

Recent announcements

On June 9, 2014, President Obama announced that the Department of Education would modify the PAYE Plan so that it is available to all borrowers, regardless of when they borrowed. The new repayment plan, Revised Pay As You Earn, launched on December 17, 2015.