Is Income-Based Student Loan Repayment Right For You? 8 Things You Need to Know

Doing some analysis can help you decide whether income-based student loan repayment is right for you.

Source: Flickr user imosaad.

Many people with student loan debt hear about the federal government’s income-based repayment program (IBR) for direct loans and think it may be too good to be true.

Who wouldn’t want to have their monthly payment capped at a fixed percent of their monthly income?

If you’ve just recently graduated and you’re working an entry-level position or are still trying to find a job in your desired career, you may not be earning very much. Coming up with the money to make the full monthly payment might be a struggle. So, reducing those payments to coincide with what you earn seems like a slam dunk–right?

Of course, it can be extremely beneficial for certain students. But there are some drawbacks and key considerations to take into account when deciding whether it’s the right choice for you.

After all, we wouldn’t want to make this student loan thing too easy, now would we?

1. These programs only apply to federal Direct student loans

If you have separate private student loans, this option won’t be able to help much with those. Instead, you’ll probably want to look into options for consolidation and refinance to help reduce your payment on these loans.

Federal Perkins loans also do not qualify for most income-based repayment plans.

2. Once you’ve chosen income-based repayment, you can’t change back

This may seem odd at first, but you can see why this must be true. If students were allowed to flip back and forth between income-based repayment and fixed-rate repayment, they would be able to simply use IBR while their salary is low, then when their salary increases in the future, simply switch back and never make up for the time spent making lower payments.

Remember that this system is not designed to get you “off the hook” for your loans. It’s meant to make the payments more gradual to coincide with the lifetime increase in earnings that most students will experience.

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3. There are multiple income-based repayment programs to choose from

There are a number of options for student loan repayment based on your income. While it may make the choice a bit more difficult, it does allow students to really choose a more customized repayment plan that works best for them.

Here’s a breakdown of the available options:

Repayment plan Details
Revised Pay As You Earn Repayment
  • 10% of discretionary income
  • Forgiveness after 20-25 years
Pay As You Earn Repayment
  • 10% of discretionary income
  • Forgiveness after 20-25 years
  • Only for eligible borrowers who became new borrowers on or after Oct. 1, 2007, and must have received a disbursement of a Direct Loan on or after Oct. 1, 2011
Income-Based Repayment
  • 10-15% of discretionary income
  • Must meet debt-to-income requirements
  • Monthly payment will never exceed 10-year standard repayment amount
  • Forgiveness after 20-25 years
Income-Contingent Repayment
  • Payments are the lesser of:
    • 20% of discretionary income
    • Fixed-payment 12-year loan
  • Forgiveness after 25 years
Income-Sensitive Repayment
  • Various formulas for determining payment based on income
  • Up to 15-year refinance (no forgiveness)

4. You’ll probably double the repayment period of your loans

Most federal direct loans are financed over a 10 year period. In most of the income-based repayment plans, you’ll be expected to pay at your designated income rate for 20 or 25 years (or until the loans are paid off). So, this means you’ll likely be paying for a longer period of time.

5. You’ll pay more over the life of your loan

Photograph of money. Is income-based student loan repayment for you?

Source: Flickr user Pictures of Money.

As noted above, you’ll be paying longer on your loans while they accrue interest at the same rate. This means that you’ll likely be paying more–in total–over the life of your loan, with more being paid to interest.

How much more you’ll pay will depend on your income over time and your repayment schedule. You could also save money if you end up having some of your loans forgiven, but this isn’t quite “free” money (see #6 below).

6. You may be eligible for partial loan forgiveness (eventually)

Many of the income-based repayment plans offer a 20 or 25-year repayment window, with any remaining balance after this time being forgiven.

This may seem like a sweet deal to have your loans forgiven, but keep in mind that you’ll be paying your loans well into your 40’s.

7. You’ll probably have to pay taxes on your loan forgiveness

Don’t get blindsided by this surprise. For tax and accounting purposes, any federal loan forgiveness is usually taxed as income. So, even though you may have a big chunk of your loans forgiven, you’ll have to pay a percentage of that in taxes that year.

So, be prepared to get a hefty tax bill if you qualify for forgiveness on your income-based student loan repayment plan.

8. Income-based repayment can be a good option if you’re planning to try for Public Service Loan Forgiveness

Most federal loans are eligible for Public Service Loan Forgiveness (PSLF) after 10 years if a student works full time for government or non-profit organization.

If this is your plan and you would like to minimize the amount that you have to repay within your 10-year window, you can opt for an income-based repayment program, which will reduce your student loan payments during that time, and then still be able to qualify for forgiveness when you become eligible.

All of these things should factor into your decision. Don’t just think short term about how the choice will affect your payments, but also consider the long-term implications of the terms of your loans.

You can also use the federal Repayment Calculator to get an estimate of how these different options will look for you, and which types of programs you’re eligible for.