3 Income-Based Repayment Plans: The Pros and Cons

Thousands of recent college graduates are struggling to pay large student loans at a time in their life when earnings are relatively low. But fortunately there is some relief, at least in regard to government-sponsored student loans. Of course, there are pros and cons involved with each that you need to be aware of before using one of these plans. Here three income-based repayment plans that may help.

3 Income-Based Student Loan Repayment Plans (crop)

Income-Based Repayment (IBR)

The IBR is probably best known of the income-based repayment plans. The program started in 2009 and helps borrowers with repayment by keeping monthly payments relatively low. Percentage rates that are based upon your income. Under certain circumstances, you may not even have to make monthly payments at all. For example if you earn less than 150% of the federal poverty level based on your income and family size, no loan payment will be required. And, if you earn more than 150% of the poverty level, your payment will be capped at 15% of the amount of the excess earnings (not your total income).

In addition, under an IBR, your remaining debt will be forgiven after you’ve made 25 years of on-time payments.

Monthly payments under an IBR are capped at the following percentages of income, based on family income and household size:

Family Income$20,000$40,000$60,000$100,000
Household Size: 1 Person1.8%8.4%10.6%12.4%
Household Size: 2 People0% (no payment)6.0%9.0%11.4%
Household Size: 4 People0%1.4%5.9%9.5%
Household Size: 6 People0%0%2.8%7.7%

Pros. Since an IBR is entirely income based, your monthly payment will be calculated at an amount that should fit comfortably within your budget. The zero payments will obviously work even better. And, after 25 years, the loan balance is forgiven. In theory, it would be possible for a twenty-something coming out of college to be student loan-free before turning 50, even without making any monthly payments.

Cons. The program only covers federally insured student loans. So, if you have private loans an IBR won’t help. In addition, IBRs don’t extend to student loans made to parents.

There is also a significant potential negative in regard to low or zero payments. In the event that your payment does not cover the interest on your student loans, the government will pay the interest for you. However, they will only cover the first three years, and that’s only on subsidized Stafford loans. After three years, the unpaid interest will be added to your principal balance, increasing the total amount that you owe. (The same is true for other types of loans.) However, since the loan will be forgiven after 25 years, the accumulated interest won’t be much of a factor.

Pay As You Earn (PAYE)

3 Income-Based Student Loan Repayment PlansThe PAYE plan is similar to the IBR in most respects, but the monthly payment cap percentages are generally lower than on the IBR. This results in lower monthly payments. The program was rolled out in 2012 and targets both current students and recent graduates.

The plan is available for most types of Federal Direct Student Loans (William D. Ford Federal Direct Loan Program). Qualification requirements state that you must have taken out your first federal student loan after September 30, 2007, but took out at least one after September 30, 2011.

In order to qualify, your current student loan payment must take eat up more than 10% of your earnings above 150% of the poverty level. If so, you can pay off your loans in a 10-year repayment plan. And like the IBR, if you earn less than 150% of the federal poverty level for your household size, no monthly payment will be required. If you earn above that threshold, the payment will be capped at 10% of your earnings above 150% of the federal poverty level.

The PAYE plan also offers debt forgiveness and cuts that term from 25 years on the IBR to 20 years for PAYE.

Monthly payments under a PAYE plan are capped at the following percentages of income, based on family income and household size:

Family Income$20,000$40,000$60,000$100,000
Household Size: 1 Person1.2%5.6%7.1%8.2%
Household Size: 2 People0% (no payment)4.0%6.0%7.6%
Household Size: 4 People0%0.9%3.9%6.4%
Household Size: 6 People0%0%1.8%5.1%

Pros. Just as is the case with the IBR, your monthly payment will be adjusted downward to fit comfortably within your budget. You may even end up making no monthly payment all. If you do have to make monthly payments, they are likely to be lower than what it would be under the IBR plan. Further, the period of debt forgiveness is just 20 years, which is shorter than the IBR by a full five years.

Cons. Once again, the program only covers federally insured student loans. So, if you have private loans, a PAYE plan won’t help. And, just like the IBR, the PAYE plan doesn’t apply to student loans made to parents.

Interest is handled the same for the PAYE plan as it is for an IBR. If your payment does not cover the interest on your student loans, the government will pay the interest for you – but only for the first three years and only on subsidized Stafford Loans. For other loan types, and after three years, the unpaid interest will be added to your principal balance – increasing the amount that you owe.

You do have the same interest rate advantage with the PAYE plan as you do with the IBR, except that the loan will be forgiven after just 20 years, not 25. So, the interest added to your principal balance will simply go away when that happens.

Public Service Loan Forgiveness (PSLF)

The main feature of the PSLF program is that it offers borrowers carrying outstanding federal student loans an opportunity to have their debt forgiven after 10 years of employment in public service jobs. This includes government jobs and jobs with 501(c)(3) organizations.

Government jobs include employment by federal, state and local governments, as well as tribal governments. This includes jobs with the military, public schools, public hospitals and public colleges. The employment requirement can also be met through a full-time position with AmeriCorps or the Peace Corps.

Even if your employment does not fit within those guidelines, you may still be eligible to participate in the PSLF plan. This is only the case if your employer is a non-profit, not a labor union, not political, and non-religious AND it provides certain public services. (For a full discussion of qualified employment situations, please refer to DEPARTMENT OF EDUCATION 34 CFR Parts 674, 682, and 685.)

The 10-year repayment period applies to payments made after October 1, 2007. You must use the Employment Certification for Public Service Loan Forgiveness form in order to enroll in the program, and it will need to be partially completed by your employer.

Pros. The PSLF plan can be used in conjunction with an IBR plan, so you can have the benefit of lower monthly payments, as well as complete debt forgiveness after just 10 years.

Cons. The program only applies to Stafford, Grad PLUS or consolidation loans that were made as part of the Direct Loan program. Again, it does not apply to private source student loans. If you have a Federal Family Educational Loan (FFEL loan) or a Perkins Loan, you must consolidate them through a Federal Direct Loan. Participation in the program does not extend to employment situations beyond those narrowly defined within the program guidelines. So, if you are employed in a for-profit business, you will not be eligible.

Wrapping Up

There you have it; three programs that can provide you with assistance in paying your student loan debts, at least if your student loans are government sponsored.

(Sources: What is Public Service Loan Forgiveness? and IBR Info.)

Topics: debtEducation

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