Choosing an income-driven repayment plan for your student loans

You’ve got student loan debt, but there are so many repayment options to choose from that it can seem overwhelming.

Income-driven repayment (IDR) plan is one of the most significant options.

IDR is different from your typical standard 10-year payment because your payment is based off, you guessed it, your income. The calculation also involves a few more items such as the federal poverty line and the percentage of discretionary income. The reason this can be helpful is it can base your student loan payments on a lower income and decrease your payments to a more manageable amount.

If you would like more info on what an IDR plan is or how they work, check out this article explaining each of the four types of IDRs.

If you know the basics, and you think an IDR plan would be good for you, how do you choose which plan is right for you? Let’s look at some situations that might apply to you and see which plan is the best fit.

You are aiming for Public Service Loan Forgiveness (PSLF)

The goal when targeting tax-free forgiveness with PSLF is to make as small a monthly payment as possible to increase future forgiveness.

For example, let’s assume you’re a physician going for PSLF. During residency, you make considerably less than when you become an attending and you have a spike in income. This jump in income could mean that your monthly payment calculated would be greater than the standard 10-year payment. PAYE and IBR are the only two IDR plans that have payment caps that limit your monthly payment to the standard 10-year payment plan amount even if income spikes.

The difference between PAYE and IBR at this point is the percentage of discretionary income you have to pay. Under PAYE, your percentage is set at 10%, while under IBR it is 10% if your loans were taken out after July 1, 2014, and 15% if before July 1, 2014.

If something were to change and you no longer pursue PSLF, PAYE has fewer restrictions on changing your payment plan compared to other IDR plans. However, if you no longer pursue PSLF, REPAYE has the best interest subsidies available and would result in less unpaid interest being capitalized when you go off the IDR plan. So if you are unsure whether you will be working at a nonprofit for the full 10 years required for forgiveness, REPAYE could be the best option to help lower the risk of unpaid interest being added to your principal balance if you change routes and leave the IDR plan in the future.

Loan forgiveness is an option, but PSLF isn’t

If you are not eligible for PSLF because you don’t work for a qualifying employer, but you want to aim for loan forgiveness, then your target program is income-driven repayment forgiveness (IDRF). This is taxable forgiveness, which means anything forgiven will be included in your income in the year forgiven. For this type of forgiveness, we look at the same three IDR plans as above in the PSLF section: PAYE, REPAYE and IBR.

Since the repayment term jumps from 10 years with PSLF to 20 or 25 years with IDRF, you should consider the repayment term of the IDR plan you choose. If you have any graduate school debt, it will take 25 years under REPAYE to have that forgiven, whereas PAYE or IBR would take 20 years of payments to reach forgiveness. This makes PAYE or IBR the better plan in terms of time frame; however, that doesn’t matter if you don’t qualify for IDRF in the first place. Your loans must be federal direct loans, and any FFEL loans must be consolidated or paid off. If not, those FFEL loans will not be forgiven.

Loan forgiveness doesn’t apply to you

If loan forgiveness is not an option for you, there are still a few options besides the standard 10-year. The best remaining options that you should consider are likely private refinancing or an IDR plan. Depending on the amount of your loans and interest rates available, you may get favorable rates from privately refinancing, which could save you on total interest paid.

If you aren’t able to get competitive rates for private refinancing or can’t currently afford the monthly payments if you privately refinance, you could benefit from using interest subsidies on an IDR plan first, before privately refinancing later on.

Interest subsidies are designed to benefit those who are making student loan payments, but the accrued interest is more than your payment, resulting in the loan balance increasing. To counteract this, interest subsidies were introduced to eliminate that extra interest that’s growing in your debt. However, there are restrictions based on your types of loans and specific IDR plan. REPAYE has the most lenient and longest lasting interest subsidies out of all four IDR plans. While on REPAYE, you can eliminate 100% of the unpaid interest for the first three years on subsidized loans and then 50% for years following the initial three years on subsidized loans. If your loans are unsubsidized, then the subsidy is 50% of accrued interest for all years while on REPAYE.

This is a beneficial strategy for those who can’t quite get a good interest rate for privately refinancing now but want to reconsider in a few years’ time. By going on REPAYE, you can pay down your loans or have a more manageable payment for a few years and allow yourself to get to a better income level before private refinancing. Note that once you go off an IDR plan, any unpaid interest not covered by interest subsidies will be capitalized (added to your loan principal balance).

You have Parent PLUS loans

If you have parent PLUS loans, the only IDR plan that is available to you is ICR. There is not a payment cap on this plan, so if your income spikes to a level where the payment is more than the standard 10-year repayment plan amount, your payment will not be capped at the standard 10-year amount. ICR does qualify for PSLF, but if the other qualifications are not met then you are limited to taxable loan forgiveness, which is a 20-year program.

You are married or could be in the future

It’s a surprising but potentially important consideration for an IDR plan. Payments on an IDR plan are based on your income, which includes any income from your spouse if you file a joint tax return. A potential solution to avoid spousal income may be filing your taxes as Married Filing Separate. All of the IDR plans, except for REPAYE, are eligible for this strategy. Click here for more information on this strategy. If this could benefit you, then REPAYE may not be the best IDR plan.

How to choose an income driven repayment plan: Wipfli Financial can help

Student loan planning offers many opportunities to be efficient with your payments and loan forgiveness opportunities. Talking with a professional regarding your student loans can help ensure you choose the right repayment plan. Contact Wipfli Financial Advisors to start the conversation.

CONTACT AN ADVISOR

Related content:

How Public Service Loan Forgiveness might solve your student loan problems
How marriage impacts your student loan planning
The top student loan forgiveness programs for medical professionals
The best student loan forgiveness programs for teachers

 

Choosing an income-driven repayment plan for your student loans

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Choosing an income-driven repayment plan for your student loans

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