In this post, you’ll learn how to choose the best repayment plan for student loans. You’ll do that by answering 5 simple questions:
- When did you borrow your first student loans?
- Are all your federal student loans Direct Loans?
- Did you borrow federal loans for graduate school?
- Did you file your taxes married filing jointly?
- Do you earn more than $75 thousand?
…before we answer those questions, we’ll first discuss:
- The types of student loan repayment plans
- How long are student loan terms
- Income based repayment, forgiveness, and taxes
Now that you have the roadmap, let’s get to it.
Or, if you want, skip past the background material and get right to the questions.
The types of student loan repayment plans
You have four options if you want to pay your student loans based on your income:1
Here are the basics of those four plans:
With those basics in mind, let’s go a little deeper.
Revised Pay As You Earn: This is the newest income based repayment option. The REPAYE plan came about after President Obama directed Arne Duncan, the then Department of Education Secretary, to cap payments at 10% of discretionary income for all borrowers with Direct Loans.
Three things make the REPAYE plan awesome
First, you don’t need a partial financial hardship to stay in the plan. (We’ll talk more about that hardship later.) So long as you have Direct Loans, you can stay in the plan.
Second, your undergraduate loans will be forgiven after 20 years of repayment. The Direct Loans you took out for grad school will be forgiven 5 years later.
Finally, unlike the PAYE plan and the IBR plan for new borrowers, your eligiblity for the REPAYE plan doesn’t depend on when you borrowed the loan. The only thing that matters is you have Direct Loans.
The REPAYE plan does have a drawback:
The REPAYE plan counts your spouse’s income as part of your discretionary income. And because it counts your spouse’s income, it’s possible your payment under the REPAYE plan would be higher than it would be under other plans.
Both the IBR and ICR plans will only count your income if you’re married and file taxes separately.
The REPAYE plan is good for you if: You’re not married and your federal loans are all Direct Loans.
Pay As You Earn
Before there was REPAYE, there was PAYE.
The benefits of the PAYE plan, which was initiated back in 2012, are pretty much the same as the REPAYE plan. It caps your loan payment at 10% of your income and it offers student loan forgiveness.
There are three major differences, however.
First, under the PAYE plan, your entire Direct Loan balance — both undergraduate and graduate — may be forgiven after 20 years of repayment.
Second, if you’re married and file your taxes separately, only your income is counted as part of your discretionary income. That means your payment as a married borrower is likely lower under the PAYE plan than it would be under the REPAYE plan.
Finally, you must have a partial financial hardship. If you don’t, you can’t stay in the PAYE plan.
The PAYE plan is good for you if: You’re married and file you taxes separately and you’re considered a new borrower.2
Income Based Repayment
There are two IBR plans.
One for “new borrowers”.
And another for all other borrowers.
For new borrowers — that is, you got your first loan after 30 June 2014 — monthly payments are capped at 10% of discretionary income. Older borrowers payments are capped at 15%.
Other than the cap difference, new and old borrowers are treated the same.
For instance, if you’re married, your spouse’s income counts towards your payment only if you file your taxes jointly. And if you stay in the IBR plan for 25 years, your Direct Loans and FFEL loans will be forgiven.
The IBR plan is good for you if: You’re married, file taxes separately, have FFEL loans, and don’t qualify for PAYE.
Income Contingent Repayment
The ICR plan is the oldest income based repayment plan. President Clinton introduced the ICR plan back in the mid-1990’s.
The ICR plan caps your payment at 20% of your discretionary income. Yikes! And like the other IDR plans, it offers forgiveness. You just have to wait 25 years.
The ICR plan is good for you if:You borrowed a Parent PLUS Loan. The ICR plan is the only plan that will let your repay a Parent Plus loan based on your income. To do that, you have to consolidate the Parent Plus Loan into a Direct Consolidation Loan
How long are student loan terms
Let’s be quick here.
Your federal student loans last forever or until you pay them off or get them forgiven, whichever occurs first.
Unlike credit card debt or private student loans, federal student loans don’t have a statute of limitations. That means you can owe your federal loans until you die.
But let’s say you want to pay your loans before you die, how long will it take you to get rid of them.
Here’s a chart breaking that down.
Of course, if you pay more towards your student loans, you get rid of them faster.
But if you can’t do that right now, then choose the plan that fits your situation and gets rid of your loans the fastest.
For a lot of unmarried borrowers, the plan that fits is the REPAYE plan.
For married borrowers, the IBR plan is likely best.
A word on income based repayment plans, forgiveness & taxes
Each income driven repayment plan qualifies you for two types of forgiveness:
- income based forgiveness and
- Public Service Loan Forgiveness
As you already know, repaying under one of the IDR plans qualifies you for income based forgiveness after you’ve made at least 20 years of payments.
But did you know this: Depending on who you work for, you may also qualify you for the PSLF program.
And if you can qualify for that program, I got two words for you:
The PSLF cuts your forgiveness in half. You go from getting your loans forgiven in 20 to 25 years, down to 1o years. And you do that just because you work for the government or a qualifying nonprofit.
And there’s one more awesome thing you should know about the PSLF program.
Can you guess? It has to do with taxes.
That’s cool. Most people don’t know this. Or even think about it for that matter. But that’s okay. You’ll be one step ahead of the game.
The other awesome thing about getting your loans forgiven under the PSLF program is what happens to your taxes.
Under the PSLF program, nothing happens to your taxes when your loans are forgiven. That’s because the IRS doesn’t consider loans forgiven under the PSLF program as taxable income.
Yep. That means if you get $10 thousand or $200 thousand forgiven, you won’t have to pay taxes on the amount forgiven.
Amounts forgiven under an income based forgiven program, on the other hand…
…are considered taxable income.
So if you get $150 thousand in loans forgiven, you may have to pay taxes on it.
There’s a chance you can escape that terrible outcome, however.
You won’t have to pay taxes on the forgiven amount if you’re considered insolvent. When the time comes, you’ll use IRS Form 982 — or whatever form replaces it — to apply for the insolvency exception. If approved, you can won’t have to pay taxes on the forgiven amount.
Now that we’ve got all that out the way, let’s get to the part you’ve been waiting for:
Choosing the best student loan options
I tried to make things easier by drawing an infographic. But as I was drawing it, I realized just how fact specific choosing a right repayment plan is. Any flow chart that I would design would have arrows going all over the place.
Choosing the best repayment plan for student loans truly has everything to do with you.
So I scrapped the infographic. I’ll leave that task for someone better than me.
Instead, let’s concentrate on answering these 5 questions. I believe your answers will do a better job of identifying the best repayment plan than any chart could.
1. When did you borrow your first student loans?
You’re eligible for the PAYE and IBR plans only if you’re a new borrower. So if you took out your first loan before 1 October 2007, say goodbye to the PAYE plan. And say goodbye to the IBR plan for new borrowers if you took out your first loan before 1 July 2014.
That leaves you with the REPAYE plan, the IBR plan for old borrowers, and the ICR plan.
But if you took out your first loan after 30 June 2014, you’re eligible for all four IDR plans.
2. Are all your federal student loans Direct Loans?
But if all your loans are Direct Loans, you’re likely3 eligible for all the IDR plans.
3. Did you borrow federal loans for graduate school?
This question isn’t about what plan you’re eligible for. Rather, it’s about deciding which plan offers the best forgiveness given your level of education.
For example, if you borrowed loans for graduate school, you’d probably choose the PAYE plan over the REPAYE plan if that’s an option for you.
Simple. Under the PAYE plan, all your Direct Loans — both undergraduate and graduate — will be forgiven after 20 years. With the REPAYE plan, you’ll have to wait 5 more years for forgiveness.
4. Did you file your taxes married filing jointly?
How you filed your taxes are a big deal for income based repayment of student loans.
That one decision has the biggest impact on your monthly payment. Remember, if you file jointly, your spouse’s income will be used to increase your monthly payment. And that’s true even if your spouse doesn’t have federal student loans.
Try telling your spouse they can’t buy something because they need to help you repay your student loans:
All kidding aside, if you want the lowest payment and the greatest flexibility, consider filing your taxes separately.
But if you filed separately and you want the lowest payment, choose between the PAYE or IBR plans. Forget the ICR plan. It’s almost never a good option.
5. Do you earn more than $75 thousand?
Okay. So this question isn’t about what plan you’re eligible for.
And it’s not for everyone.
It’s aimed at married borrowers.
It’s all about whether it makes sense to file taxes separately or jointly.
Here’s my rule of thumb:
If you and your spouse’s combined income is less than $75 thousand, you likely gain no benefit from filing jointly. So you should probably file separately. At least that’s what I got from reading The Collision of Student Loan Debt and Joint Marital Taxation by Professor Victoria Hanneman.
Here’s what to do next
As I see it, you have three options when it comes to deciding which loan repayment plan is best for you.
First, you decide for yourself. Use the information. Do some more research. Run your taxes both separately and jointly. Compare the numbers. Choose the best plan.
Second, you could call your servicer and ask them to choose the right repayment plan for you. But if you do that, you have to wonder if they’ll really choose the right plan for you. They may just choose the one with the lowest monthly payment. Who knows if they’ll consider your marriage status or forgiveness options.
Finally, you can hire me. We can meet in my St Louis office or we can meet over the phone. It doesn’t matter. Either way, you’re going to end up with the best student loan debt repayment plan for you.
You’re a new borrower if two things are true. First,you got your first federal student loan after 30 September 2007. Second, you got a federal loan after 30 September 2011.↩
I say likely because any Direct Loan that repaid a Parent Plus loan isn’t eligible for the REPAYE, PAYE, or IBR plans.↩