Student loans are one of the most significant debt burdens Americans face, outpacing both credit card and car loan debt. And for many Americans, that debt has become unmanageable. According to CNBC, more than 1 million borrowers default on their student loans every year. And the nonprofit public-policy research organization Brookings expects up to 40% of all borrowers to go into default before 2023.
Unfortunately, defaulting on student loans can have dire consequences. Your credit score takes a drastic plunge, making it difficult or even impossible to get a mortgage, buy a car, or even lease an apartment. And if you owe money in federal student loans, the government can garnish your wages, capture your tax refunds, and even keep your Social Security payments — all without ever having to sue you.
If you default on private student loans, the consequences can be equally dire. But private financial organizations have to sue you before they can garnish your wages.
When it comes to private student loan debt, there are only a few available options for managing and reducing payments, like refinancing your student loans through a company like Credible. But there is hope for federal student loan borrowers. Federal loans come with a variety of payback options, including deferment and forbearance, student loan consolidation, and income-driven repayment (IDR) plans.
If your federal student loan payments exceed your monthly income or are so high it’s difficult to afford basic necessities like food and housing, lowering your monthly student loan payment by taking advantage of one of the various IDR plans can help.
Pro tip: When you refinance your student loans through Credible, you could receive up to a $750 bonus, exclusive to Money Crashers readers. Learn more about refinancing through Credible.
How Income-Driven Repayment Plans Work
The default repayment schedule for federal student loans is 10 years. But if you have a high debt balance, low income, or both, the standard 10-year repayment schedule probably isn’t affordable for you. However, if your payments are more than 10% of your calculated discretionary income, you qualify for the federal definition of “partial financial hardship,” which makes you eligible to have your monthly payments reduced.
That’s where IDR plans come in. Instead of setting payments according to your student loan balance and repayment term length, IDR plans set them according to your income and family size. Even better, if you have a balance remaining after completing your set number of payments, your debt may be forgiven.
These plans are especially helpful for graduates right out of school who are not yet employed, are underemployed, or are working in a low-salary field. For these graduates, their paychecks often aren’t enough to cover their monthly student loan payments, and IDR means the difference between managing their student loan debt and facing default.
How IDR Plans Calculate Your Discretionary Income
IDR plans calculate your payment as a percentage of your “discretionary income.” The calculation is different for every plan, but your discretionary income is the difference between your adjusted gross income (AGI) and a certain percentage of the poverty level for your family size and state of residence. Your AGI is your pretax income minus certain deductions, like student loan interest, alimony payments, or retirement fund contributions. To find the federal poverty threshold for your family size, visit the U.S. Department of Health and Human Services.
Using these guidelines, some borrowers even qualify for a $0 repayment on an IDR plan. That’s hugely beneficial for people dealing with unemployment or low wages. It allows them to stay on their IDR plan rather than opt for deferment or forbearance.
And there are two good reasons to take that option. Unless it’s an economic hardship deferment, time spent in forbearance or deferment doesn’t count toward your forgiveness clock. However, any $0 repayments do count toward the total number of payments required for forgiveness.
Additionally, unless it’s an economic hardship deferment, any interest that accrues on your loans during a period of deferment or forbearance gets capitalized once the deferment or forbearance ends. Capitalization means that interest is added to the principal balance. When that happens, you pay interest on the new higher balance — in other words, interest on top of interest.
But with IDR, if you’re making $0 payments — or payments that are lower than the amount of interest that accrues on your loans every month — most plans won’t capitalize any accrued interest unless you leave the program or hit an income cap.
Student Loan Forgiveness
Any of your student loans enrolled in an IDR program are eligible for student loan forgiveness. Forgiveness essentially means that if you make the required number of payments for your IDR plan and you have any balance remaining at the end of your term, the government wipes out the debt, and you don’t have to repay it. For example, let’s say your plan requires you to make 240 payments. After doing so, you still have $30,000 left on your loan. If you’re eligible for forgiveness, you don’t have to repay that last $30,000.
There are two types of forgiveness available to those in an IDR program: the basic forgiveness available to any borrower enrolled in IDR and public service loan forgiveness (PSLF).
Public Service Loan Forgiveness
The PSLF program forgives the remaining balance of borrowers who’ve made as few as 120 qualifying payments while enrolled in IDR. To qualify, borrowers must make payments while working full-time for a public service agency or nonprofit. Public service includes doctors working in public health, lawyers working in public law, and teachers working in public education, in addition to almost any other type of government organization at any level — local, state, and federal. Nonprofits include any organizations that are tax-exempt under Section 501(c)(3) of the Internal Revenue Code. They do not include labor unions, partisan political organizations, or government contractors working for profit.
PSLF can potentially be of great benefit to those required to have extensive education but work in low-income fields, like teachers. Unfortunately, it’s notoriously difficult to get. The American Teachers Federation has filed a lawsuit against the Department of Education (ED) for its failure to grant PSLF to qualifying teachers, as reported by USA Today.
For the best chance at receiving PSLF, the ED recommends you fill out an employment certification form annually and every time you change jobs. Additionally, once you reach 120 qualifying payments, you must complete a PSLF application to receive the forgiveness.
IDR Loan Forgiveness
For all other IDR borrowers, each program requires them to make a set number of payments — from 240 to 300 — before they qualify to have their loan balances forgiven. At this time, because the program isn’t yet 20 years old and no borrowers have qualified, there is no specific application process for student loan forgiveness.
According to the ED, your loan servicer tracks your number of qualifying payments and notifies you when you get close to the forgiveness date. No one yet knows if there will be a standard application form or if it will be automatic. Hopefully, as the program reaches the age when borrowers can start using the benefit, the process will become standardized.
Drawbacks to Forgiveness
Forgiveness is one of the biggest advantages of IDR, especially for borrowers with high balances relative to their income. But there are pros and cons of student loan forgiveness. First, while forgiveness sounds like it could be a significant financial benefit, the reality is the average borrower doesn’t have any balance remaining to forgive after making the required number of IDR payments.
And if the government does forgive your balance, the IRS counts that as income, which means you have to pay income taxes on the amount forgiven. If you have a high balance remaining and can’t pay your taxes in full, that means making multiple additional payments — this time to the IRS — just when you thought you were finally done with your student loans.
What Loans Are Eligible for IDR?
You can only repay federal direct loans under most IDR plans. However, if you have an older federal family education loan (FFEL) (which includes Stafford loans) or federal Perkins loan — two now-discontinued loan types — you can qualify for these IDR plans by consolidating your student loans with a federal direct consolidation loan.
Note, however, that consolidation is not the right choice for all borrowers. If you consolidate a federal Perkins loan with a direct consolidation loan, for example, you lose access to any of the Perkins loan forgiveness or discharge programs. Further, if you consolidate a parent plus loan with any other student loans, the new consolidation loan becomes ineligible for most IDR plans.
Private financial institutions may have their own programs for repayment. But they aren’t eligible for any federal repayment program.
4 Types of Income-Driven Repayment Plans
There are four IDR plans for managing federal student loan debt. They all let you make a monthly payment based on your income and family size. But each differs according to who’s eligible, how your loan servicer calculates your payments, and how many payments you have to make before you qualify for forgiveness.
If you’re married, also note that some calculations can be dependent on your spouse’s income, depending on whether you file jointly or separately. Because you can lose some tax benefits if you file separately, consult with a tax professional to see whether married filing jointly or married filing separately is more advantageous for your situation.
Regardless of your marital status, each IDR plan works differently. Your loan servicer can help you choose the plan that’s best for you. But it’s essential you understand the features, pros, and cons of each IDR type.
1. Income-Based Repayment Plan
Income-based repayment plans (IBRs) are likely the most well-known of all the IDR plans, but they’re also the most complicated. Depending on when you took out your loans, your monthly payment could be a more substantial chunk of your discretionary income than for newer borrowers, and you could have a longer repayment term. On the other hand, unlike some of the other IDR plans, this one has a favorable payment cap.
- Payment Amount: You must pay 10% of your discretionary income if you took out all of your loans after July 1, 2014, or you have no outstanding balance remaining on any federal student loan taken out before July 1, 2014. You must pay 15% of your discretionary income if you took out any of your federal loans before July 1, 2014, and you still owe on any of them after July 1, 2014. If the amount you’re required to pay is $5 or less, your payment is $0. If the repayment amount is more than $5 but less than $10, your payment is $10. If you’re married and your spouse owes any student loan debt, your payment amount is adjusted proportionally, depending on the share of debt you both owe in total.
- Discretionary Income Calculations: For IBR, discretionary income is the difference between your AGI and 150% of the poverty level for your family’s size and state of residence. Your loan servicer includes spousal income in this calculation if you’re married filing jointly. They don’t include it if you’re married filing separately.
- Payment Cap: As long as you remain enrolled in IBR, your payment will never be more than you’d be required to pay on the standard 10-year repayment schedule, regardless of how large your income grows.
- Federal Loan Interest Subsidy: If your monthly payments are less than the interest that accrues on your loans, the government pays all the interest on your subsidized loans — including the subsidized portion of a direct consolidation loan — for up to three years. It doesn’t cover any interest on unsubsidized loans.
- Interest Capitalization: If your monthly payments are no longer tied to your income — meaning your income has grown so large you’ve hit the payment cap — your servicer capitalizes your interest.
- Repayment Term: If you borrowed any of your student loans before July 1, 2014, you must make 300 payments over 25 years. If you borrowed after July 1, 2014, you must make 240 payments over 20 years.
- Eligibility: To qualify, you must meet IBR’s criteria for partial economic hardship: The annual amount you must repay on a 10-year repayment schedule must exceed 15% of your discretionary income. If you’re married and filing jointly and your spouse owes any student loan debt, your loan servicer includes this debt in the calculation. Almost any federal loans are eligible for IBR. That includes both FFEL and direct loans, but not parent plus loans or any direct consolidation loan that included parent plus loans.
- Forgiveness: Your remaining loan balance is eligible for forgiveness after you make 20 or 25 years of payments, depending on whether you borrowed before or after July 1, 2014.
2. Pay-as-You-Earn Repayment Plan
The pay-as-you-earn (PAYE) plan is possibly the best choice for repaying your student loans — if you qualify for it. It comes with some benefits over IBR, including a potentially smaller monthly payment and repayment term, depending on when you took out your loans. It also has a unique interest benefit that limits any capitalized interest to no more than 10% of your original loan balance when you entered the program.
- Payment Amount: You must pay 10% of your discretionary income, but never more than you would be required to repay on the standard 10-year repayment schedule. As with IBR, if the amount you must pay is $5 or less, your payment is $0. If the repayment amount is more than $5 but less than $10, you pay $10. If you’re married and your spouse owes any student loan debt, your payment amount is adjusted proportionally, depending on the share of debt you both owe in total.
- Discretionary Income Calculations: For PAYE, your servicer calculates discretionary income as the difference between your AGI and 150% of the poverty line for your state of residence. If you’re married and file jointly, they include your spouse’s income in the calculation. They don’t include it if you file separately.
- Payment Cap: As with IBR, as long as you remain enrolled, payments can never exceed what you’d be required to repay on a standard 10-year repayment schedule, regardless of how large your income grows.
- Federal Loan Interest Subsidy: If your monthly payments are less than the interest that accrues on your loans, the government pays all the interest on your subsidized loans for up to three years. It doesn’t cover any interest on unsubsidized loans.
- Interest Capitalization: If your income has grown so large you’ve hit the payment cap, your servicer capitalizes your interest. But no capitalized interest can exceed 10% of your original loan balance.
- Repayment Term: You must make 240 payments over 20 years.
- Eligibility: To qualify, you must meet the plan’s criteria for partial financial hardship. For PAYE, this means the annual amount due on your loans is greater than 10% of your discretionary income. If you’re married and filing jointly and your spouse owes any student loan debt, this debt is included in the calculation. Additionally, you can’t have any outstanding balance remaining on a direct loan or FFEL taken out before Sept. 30, 2007. You must also have taken out at least one loan after Sept. 30, 2011. All federal direct loans are eligible for PAYE except for parent plus loans.
- Forgiveness: As long as you stay enrolled, you remain eligible for forgiveness of your loan balance after 20 years of payments if any balance remains.
3. Revised Pay-as-You-Earn Repayment Plan
If you don’t meet the qualifications of partial financial hardship under PAYE or IBR, you can still qualify for an IDR plan. The revised pay-as-you-earn (REPAYE) plan is open to any direct federal loan borrower, regardless of income. Further, your payment amount and repayment terms aren’t contingent on when you borrowed. The most significant benefits of REPAYE are the federal loan interest subsidy and lack of any interest capitalization.
However, there are some definite drawbacks to REPAYE. First, there are no caps on payments. How much you must pay each month is tied to your income, even if that means you have to make payments higher than you would have on a standard 10-year repayment schedule.
Second, those who borrowed for graduate school must repay over a longer term before they become eligible for forgiveness. That’s a huge drawback when you consider those who need the most help tend to be graduate borrowers. According to the Pew Research Center, the vast majority of those with six-figure student loan debt borrowed it for graduate school.
- Payment Amount: You must pay 10% of your discretionary income. As with IBR and PAYE, if the amount you must pay is $5 or less, your payment is $0. And if the repayment amount is more than $5 but less than $10, your payment is $10. If you’re married and your spouse owes any student loan debt, your payment amount is adjusted proportionally, depending on the share of debt you both owe in total.
- Discretionary Income Calculations: For REPAYE, your servicer calculates discretionary income as the difference between your AGI and 150% of the poverty line for your state of residence. If you’re married, they include both your and your spouse’s income in the calculation, regardless of whether you file jointly or separately. However, if you’re separated or otherwise unable to rely on your spouse’s income, your servicer doesn’t consider it.
- Payment Cap: There is no cap on payments. The loan service always calculates your monthly payment as 10% of your discretionary income.
- Federal Loan Interest Subsidy: If your monthly payment is so low it doesn’t cover the accruing interest, the federal government pays any excess interest on subsidized federal loans for up to three years. After that, they cover 50% of the interest. They also cover 50% of the interest on unsubsidized loans for the entire term.
- Interest Capitalization: As long as you remain enrolled in REPAYE, your loan servicer never capitalizes any accrued interest.
- Repayment Term: You must make 240 payments over 20 years if you borrowed loans for undergraduate studies. If you’re repaying graduate school debt or a consolidation loan that includes any direct loans that paid for graduate school or any grad plus loans, you must make 300 payments over 25 years.
- Eligibility: Any borrower with direct loans, including grad plus loans, can make payments under this plan, regardless of income. If you have older loans from the discontinued FFEL program, they are only eligible if consolidated into a new direct consolidation loan. Parent plus loans are ineligible for REPAYE.
- Forgiveness: As long as you remain enrolled, your loans are eligible for forgiveness after 20 years of payments.
4. Income-Contingent Repayment Plan
The income-contingent repayment plan (ICR) is the oldest of the income-driven plans and also the least beneficial. Your monthly payments are higher under ICR than any other plan, and you must make those payments over a longer term. Additionally, although they limit the amount of capitalized interest, it’s automatically capitalized annually whether you remain in the program or not.
There is one major plus: It’s the only plan parent plus loans are eligible for. But you must still consolidate them into a federal direct consolidation loan to qualify.
- Payment Amount: You must pay the lesser of 20% of your discretionary income or what you would pay over 12 years on a fixed-payment repayment plan. If you’re married and your spouse also has eligible loans, you can repay your loans jointly under the ICR plan. If you go this route, your servicer calculates a separate payment for each of you that’s proportionate to the amount you each owe.
- Discretionary Income Calculations: For ICR, your servicer calculates discretionary income as the difference between your AGI and 100% of the federal poverty line for your family size in your state of residence. If you’re married filing jointly, your servicer uses both your and your spouse’s income to calculate the payment size. If you’re married filing separately, they only use your income.
- Payment Cap: There is no cap on payment size.
- Federal Loan Interest Subsidy: The government doesn’t subsidize any interest.
- Interest Capitalization: Your servicer capitalizes interest annually. However, it can’t be more than 10% of the original debt balance when you started repayment.
- Repayment Term: You must make 300 payments over 25 years.
- Eligibility: Any borrower with federal student loans, including both direct loans and FFEL loans, is eligible for ICR. For parent plus loans to qualify, you must consolidate them into a federal direct consolidation loan.
- Forgiveness: As long as you remain enrolled, your loans are eligible for forgiveness after 25 years of payments.
How to Apply for Income-Driven Repayment Plans
To enroll in an IDR plan, contact your student loan servicer. Your servicer is the financial company that manages your student loans and sends your monthly bill. They can walk you through the process of applying for IDR and recommend the most beneficial plan for your unique situation. You must complete an income-driven payment plan request, which you can fill out online or using a paper form your servicer can send you.
Because your servicer ties payments on any IDR plan to your income, they require proof of income after you complete your application. Proof of income is usually in the form of your most recent tax return. Have this handy when applying over the phone. They also need your AGI, which you can find on your tax return. You must also mail or fax a copy of your return before your application is complete.
It generally takes about a month to process an IDR application. If you need them to, your loan servicer can place your loans into forbearance while they process your application. You aren’t required to make a payment while your loans are in forbearance. But interest continues to accrue, which results in a larger balance.
You can change your student loan repayment program or have your monthly payments recalculated at any time. If an IDR plan is no longer advantageous to you, you lose your job, you switch jobs, or there’s a change in your family size, contact your student loan servicer to either switch your repayment plan or have your monthly payments recalculated.
You aren’t obligated to do so if the change would result in higher monthly payments. However, you are required to recertify each year.
You must recertify your income and family size annually by providing your student loan servicer with a copy of your annual tax return. You must recertify even if there are no changes in your family size or income.
Loan servicers send reminder notices when it’s time to recertify. If you don’t submit your annual recertification by the deadline, your loan servicer disenrolls you, and your monthly payment reverts to what it would be on the standard 10-year repayment schedule.
You can always reenroll if you miss your recertification deadline. But there are a couple of reasons not to be lax about recertification.
First, if your income increases to the point at which your monthly payment would be higher than it would be on the standard 10-year repayment schedule, you can’t requalify for either the PAYE or IBR plans. But if you stay in the program, your payments are capped no matter how much your income increases.
Second, if you’re automatically disenrolled from your IDR plan because of a failure to recertify, any interest that accrues during the time it takes to get reenrolled is capitalized. That means your servicer adds interest to the balance owed. Even after you reenroll in your IDR plan, you begin earning interest on the new capitalized balance, thereby increasing the amount owed. And that’s true even if you place your loans into a temporary deferment or forbearance.
How to Choose an IDR Plan
The easiest way to choose the best IDR plan is to discuss it with your loan servicer. They can run your numbers and tell you which plans you qualify for and quote you monthly payments under each plan.
Don’t just choose the plan with the lowest monthly bill unless you can’t afford a higher payment. Instead, balance your current needs with the long-term costs of any plan. For example, one plan might offer a lower monthly payment but a longer repayment term. Further, although your interest rate remains fixed on all the IDR plans, some offer benefits, like interest subsidies, that can reduce the overall amount you must repay.
Even if you think you’ll qualify for PSLF, which could get you total loan forgiveness in as little as 10 years, it’s still worth it to weigh your options. Currently, too few borrowers qualify for PSLF, so it might not work out to pin your hopes on it until the program becomes more streamlined.
Note that IDR plans aren’t right for everyone. Before enrolling in any IDR plan, plug your income, family size, and loan information into the federal government’s repayment estimator. The tool gives you a picture of your potential monthly payments, overall amount to repay, and any balance eligible for forgiveness.
If you’re struggling to repay your student loans or facing the possibility of default, an IDR plan probably makes sense for you. But they aren’t without their drawbacks. It pays to research all your options, including the possibility of picking up a side gig to get those student loans paid off faster.
Student loan debt can be a tremendous burden, preventing borrowers from doing everything from saving for a home to saving for retirement. The faster you can get rid of the debt, the better.
Are you, like millions of other student loan borrowers, struggling to make your monthly payments? Does an IDR plan sound like a good fit for you?