Income-Based Repayment Plans for Student Loans

How income-based repayment plans work

To qualify for IBR, you must fulfill several requirements. The first thing to note is that IBR is only available to federal student loan borrowers with either Direct or Federal Family Education Loans (FFEL). IBR covers most loans given to students, but not federal loans made to parents.

Additionally, applicants must have enough debt relative to their income to qualify for the plan. Generally, the amount that someone will have to pay is no more than 15% of their discretionary income, or 15% of what someone earns above 150% of the poverty level. This is often confusing, so the federal student aid website has a calculator to help you determine your repayment amount.

People who choose to enroll in the IBR and leave school after 2014 must make the minimum monthly payment on their loans for 25 years. After 25 years, the remainder of the loan balance is forgiven.

Income-based repayment plan example

Essentially, the repayment plans require that applicants demonstrate financial hardship to qualify for the IBR. For example, let’s say that you graduate in 2024, you are single and do not have kids, and struggle to find a job after graduation. Rather than default on your loans, which total $32,731 at 4.5% interest, you decide to apply for the income-based repayment plan. In your first year of IBR, your monthly payments would be $0.

To continue the example, let’s say in 2025 you get a job and are earning $35,000 per year. It’s still difficult to make ends meet, so you stay on the same repayment plan. The government adjusts your monthly payments each year, so this year, your monthly minimum payment is now $124.

If your income continues to increase by 2% each year and you pay for the whole 25-year term and your family size does not change, you will pay $310 a month at the end of the loan term and will have paid a total of $59,851 on the loan. Your monthly repayment will increase as your salary increases.

How to apply for an IBR plan

To apply for income-based repayment plans, you can log in to your federal student aid profile at studentaid.gov. Then, navigate to “manage loans” and apply via the federal student aid website. There is no application fee to complete an IBR request. If you are approved, you will need to rectify your income each year to continue making eligible payments.

Is income-based repayment right for you?

It can be nerve-racking to make a decision regarding your debt. To help you decide if an income-based repayment plan is the right choice for you, here are a few pros and cons of choosing this plan.

Advantages of IBR

If you do not earn a lot of money, the income-based repayment plan might be the plan for you. Here are a few reasons why:

• You won’t get overwhelmed: If you can’t find a job right out of school, or if you know that jobs in your field do not earn a high salary, then an income-based repayment plan will help you to keep your student loan payments manageable.

• Your payments remain low if you have a child: If you choose to start a family in the 25 years it will take you to repay an IBR plan, then this might be a helpful option. Dependents lower the amount you will be required to pay.

• Lower payments: Your payments will never be more than they would on the 10-year repayment plan. The formula used to determine your repayment amount keeps payments lower than they would be if you were to use the standard repayment plan and are capped at 15% of your discretionary income.

• Loan forgiveness: If you make eligible payments for 25 years, your loan balance will be forgiven after you make your final payment.

• Flexibility.You can change plans if you want to pay off your loan faster and can make additional payments if you choose. This plan is available for graduate student loans as well as undergraduates.

Disadvantages of IBR

Income-based repayment is not for everybody. There are a few disadvantages that come with this option. They are:

• You could spend a lot more money: If you make regular payments on a standard repayment plan on a $32,731 loan, you will pay about $45,600 on the loan and interest over 10 years. If you choose the IBR option, you will pay closer to $59,000 over time if you earn $35,000 per year and your income increases by 2% per year.

• Balance can increase: If you are earning very little money and are barely covering the interest payments, the balance of your loan can increase over time. This is called negative amortization.

• Long-term debt: If you choose to buy a home or want to take on another debt in the future, your student loan will be a part of your debt-to-income ratio, which will affect your eligibility.

• Payments increase: As your income increases, so will your payments. Just because you have a low payment now does not mean it will be this low forever.

Alternative options to IBR plans

Based on the pros and cons of IBR, you might be wondering what other options are available, especially if you’re a recent grad and do not have a job lined up. If you have federal student loans, there are a few other repayment plans available to you.

1. Other Federal Student Loan Programs

There are three other federal student aid repayment programs that might work for you depending on your income, profession, and situation. These are the Revised Pay as You Earn Repayment Plan (REPAYE), Pay as You Earn Plan (PAYE), and Income-Contingent Repayment Plan.

2. Deferment

Deferment is the ability to temporarily stop making your student loan payments or reduce the payments on your loans without falling behind on what you owe. You can push back the date at which you start paying on your loans in deferment.

If you are a recent graduate, your loans will go into an automatic six-month deferment. Additionally, federal student loan borrowers are automatically placed in an administrative forbearance, which means that payments are not due during the Coronavirus pandemic through Sept. 30, 2020.

If you need to defer your payments further, you can apply for forbearance through your loan servicer. Your loans will continue to accrue interest while in forbearance, but you will not be required to make payments.

3. Consolidation

If you have multiple student loans, you might be able to combine them into one loan with a fixed rate. The rate will be based on the average interest rate of all your loans that are being consolidated. This will help to create one monthly payment for you and simplify your repayment process.

4. Bankruptcy

If you declare Chapter 7 or Chapter 13 bankruptcy and demonstrate that repayment would impose undue hardship on your dependents, your federal student loans may be forgiven. However, this is not guaranteed and is decided on in bankruptcy court. Your creditors can challenge this request. Bankruptcy will negatively affect your credit score and financial situation over time and is not recommended unless it is a last resort.

Bottom line

IBR can be beneficial for people who are struggling to make their minimum student loan payments. IBR allows borrowers to decrease their monthly payments by spreading out the payments to up to 25 years. This option isn’t for everyone, and there are other options for people who want to decrease or defer their payments.

Ashley Kilroy is an experienced financial writer currently serving as an investment and insurance expert at SmartAsset. In addition to being a contributing writer at SmartAsset, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.

SmartAdvisor helps qualified financial advisors build meaningful relationships directly with mass-affluent consumers who are actively searching for financial advice. Learn more about how our platform can help grow your practice.

---

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent white papers.

More 529/College Planning Topics >