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Why Income Based Repayment Is The Right Choice For you

March 21, 2020

Here’s the thing, if you’re reading this post, you likely need a lower monthly payment on your student loan debt. Good news. With federal student loans, it’s pretty easy to do that: enroll in one of the US Department of Education’s loan repayment on your income.

woman sitting at desk

Private loans on the other hand? They typically don’t offer loan repayment plans based on your income. So typically, you’re stuck with paying what they want, making interest-only payments, or, if possible, seeking a private student loan settlement or discharge in bankruptcy.

For now, let’s set your private student loans aside. (Of course, if you want some help, feel free to contact me.)

Instead, let’s focus on your federal student loans. In particular, let’s talk about the income-based repayment plan.

Let’s start with…

What is the Income-Based Repayment Plan

Simply put, the IBR plan is a student loan repayment plan offered by the Department of Education to help borrowers get affordable student loan payments. The IBR plan is one of four income-driven repayment plans, the others being:

  • The Revised Pay As You Earn plan;
  • The Pay As You Earn plan; and
  • The Income-Contingent Repayment plan

Each of these IDR plans offers an alternative to the 10-year Standard Repayment Plan.

Later, we’ll discuss how the IBR plan calculates your monthly payment. But for now, let me give this brief explanation: your monthly payment is made up of three things:

  1. Your adjusted gross income from your most recent tax return within the last 2 years;
  2. Your family size; and
  3. Your loan balance.

In exchange for getting an affordable monthly payment, you’ll be extending your repayment term from 10 years under the Standard Repayment plan to 20 or 25 years under the IBR plan.

That’s a whole lot more in interest that will accrue.?

We’ll deal with that later.

For now, let’s turn our attention to…

The Eligibility Guidelines for IBR

Of the 4 Income-Driven Repayment plans, the IBR plan is one of the more flexible in terms of its eligibility requirements.

It has two requirements. First, your monthly student loan payments under the IBR plan can’t equal or exceed what your payments would be under the 10-year Standard Repayment Plan. Second, your federal student loans must be either:

  • Direct Loans (Subsidized and Unsubsidized);
  • Direct Graduate Plus Loans;
  • Direct Consolidation Loans;
  • Federal Family Education Loans (FFEL loans); or
  • FFEL Consolidation Loans.

If you have federal loans other than these (Parent Plus loans and consolidation loans that include Parent Plus loans) you’ll need to look into the income-contingent repayment plan for a lower payment.

Which IDR plan is best

Now that we know what the IBR plan is, let’s compare it to the other income-driven repayment plans.

Women sitting at table with laptop

IBR vs REPAYE

Here are 5 differences between IBR and REPAYE:

  1. REPAYE will give you a lower monthly payment. The REPAYE plan uses 10% of your discretionary income. The IBR plan uses 15%.
  2. Only your Direct Loans are eligible for REPAYE. If you have FFEL loans, you’ll have to pay those loans under the IBR plan unless you change them into a Direct Consolidation Loan.
  3. There’s no cap on your monthly payment under the REPAYE plan. The IBR plan caps your monthly payment at no more than you would pay under the Standard Repayment plan. The REPAYE plan has no cap. So if you’re a high-earner, your monthly payment under the REPAYE plan could be more than it would be under the 10-year plan.
  4. REPAYE counts your spouse’s income no matter how you file taxes. For married borrowers, your monthly payment may end up being higher than it would be if you filed taxes separately and repaid your loans under the IBR plan.
  5. You’ll be removed from the REPAYE plan if you fail to timely submit your recertification application. If that happens under the IBR plan, you’ll remain on IBR but your payment will increase. A lot.

»Recommendation: Consider IBR if you have FFEL loans and don’t want to consolidate.

IBR vs PAYE

The PAYE plan has 2 more eligibility requirements that the IBR plan. First, your monthly payments must be less than what your payments would be under the Standard plan. Second, you must not have borrowed a federal student loan before October 1, 2007, prove you need help paying your loans, and got a Direct Loan disbursement after October 1, 2011.

Another big difference is that the PAYE plan offers income-driven based forgiveness after 20 years of qualifying payments.

Finally, for married borrowers who filed their last tax return separately, PAYE is a huge boon. Unlike REPAYE, the PAYE plan excludes your spouse’s income if you filed your tax return married filing separately. This exclusion results in you getting the 10% discretionary income formula under PAYE vs the 15% discretionary income formula you get under the IBR plan.

»Recommendation: For my money, the PAYE plan is the best repayment plan. It gets you the lowest payment and offers the quickest path to income-driven forgiveness.

IBR vs ICR

Let’s start with this:

The Income-Contingent Repayment plan is the worst of all the IDR plans.

Seriously.

The worst.

Here’s why.

The ICR gives you a higher monthly payment than the IBR plan. It does so for two reasons. First, it uses 20% of your discretionary income rather than the 15% the IBR uses. Second, on top of that, it defines discretionary income differently than the other IDR plans. Instead of using 150% of the poverty guidelines for your family size, the ICR plan uses 100%. That means your discretionary income amount will be a lot more than under the other plans.

Even though the ICR plan is trash, it does have one benefit: it allows borrowers with Parent Plus loans to access an income-driven repayment plan. The ICR plan is the only IDR plan you can use to repay a Parent Plus Loan. To do that, you have to consolidate your Parent Plus Loan into a Direct Parent Plus Consolidation Loan.

Further Reading: Here are 2 Options for Parent Plus Loan Forgiveness

Income-Driven Repayment Plan Chart

Okay, so that was a lot of information about the various repayment plans. Let’s try and recap it with 2 charts.

Payment & Forgiveness Compared

income driven repayment comparison

Choose an IDR Plan

Courtesy of NerdWallet, here’s a chart helping you choose the right IDR plan:

income driven repayment options

In my experience, choosing the IBR plan comes down to your marital status and the type of loans you have.

For married borrowers, here’s how that works. If you’re married, still with your spouse, file taxes separately, and your spouse doesn’t have federal student loans, then the IBR plan will likely lead to a better outcome than the REPAYE or PAYE plan.

For those with loans made under the FFEL loan program, you should stick with the IBR plan only if you don’t want to get a loan consolidation. The truth is, if you’re single and have FFEL loans, you’ll get a lower monthly payment amount under the REPAYE plan.

How is Income-Based Repayment Calculated

As I mentioned above, your IBR monthly payment amount is calculated using 3 things:

  • Your AGI;
  • Your family size; and
  • Your loan balance.

You can find your AGI by looking on the first page of your most recent federal tax return.

Once you have that, you’ll tally your family size. According to the US Department of Education, your family size includes children that you provide more than half the support for and any adult that lives with you and that you provide more than half the support for. Support includes rent, food, insurance, clothes, tuition, etc.

After tallying your family size, you’ll reference the federal poverty guidelines.

ibr federal poverty guidelines

Find the poverty guideline for your family size, multiply it by 150%. For example, if your family size is 4, 150% of that is $37,650.

From there, you’ll subtract that number from your AGI. The resulting number is your discretionary income. Multiply that by 15% and you’ll have your annual payments. Finally, you just need to divide that amount by 12 to get your monthly payment amount.

Okay. So that’s a lot of math.

Let’s skip that.

Instead, let’s use the Department of Education’s Repayment Estimator at studentaid.gov.

How to Apply for Income-Based Repayment

You have a couple options for applying for the income-based repayment plan. You can submit an electronic application using studentloans.gov. You can also submit a paper application to your servicer.

In another post, I walk through How to Complete the Income-Driven Repayment Form. So I’ll direct you to that post for further instruction.

» Download:

IBR Forgiveness Options

There are 2 main options for forgiveness when you used the IBR plan:

  • Forgiveness at the end of the Income-Based Repayment Plan; and
  • Public Service Loan Forgiveness.

The first type of forgiveness takes until the end of your loan repayment term, 25+ years. After you make 300 qualifying payments (i.e., on-time), the Department of Education will forgive your remaining loan balance.

The second type occurs much quicker. Under the PSLF program, your loan balance will be forgiven after you make 120 qualifying payments.

To qualify for the program, you need to work for the government or a qualifying nonprofit. You also need to have loans made under the Direct Loan Program. PSLF doesn’t offer loan forgiveness for FFEL loans.

Don’t worry if you have FFEL loans. You can get them to qualify for PSLF by consolidating them. Loan consolidation has the added benefit of allowing you to choose your loan servicer. So now you can leave FedLoan or AES for Great Lakes.

Visit studentloans.gov to submit your loan consolidation application electronically. You can also submit a paper application to your loan servicer.

Income Based Repayment Disadvantages

To this point, we’ve talked a lot about the IBR plan’s advantages. But there are a few disadvantages. Let’s go over those quickly.

1. Leaving IBR or Switching Repayment Plans

When you leave IBR, your unpaid interest will capitalize. That is, the unpaid interest will be added to your principal balance, thereby increasing your student loan debt. You’ll also be automatically placed into the 10-year Standard Repayment plan for 1 payment. Obviously, this will cause your payment to jump dramatically. You can avoid having to make this payment, however, by requesting a one-month forbearance payment of at least $5.

If you want to come back to the plan, you have to prove you have a “partial financial hardship”. For IBR, you have a partial financial hardship when “the annual amount due on your eligible loans, as calculated under a 10-year Standard Repayment Plan, exceeds 15 percent of the difference between your adjusted gross income (AGI) and 150 percent of the poverty line for your family size in the state where you live.”

2. Tax Implications

After you made your 300th payment under the IBR plan, your loan balance will be forgiven. Hooray.

But watch out.

Under the current rules, the amount that was forgiven will be treated as taxable income. This can lead you to owe a hefty tax bill.

Having said that, there may be a way to avoid this tax liability. You’ll need to speak with a qualified tax professional for more help.

3. What if You Can’t Afford IBR Payments

Not surprisingly, this happens. The IBR plan doesn’t account for your credit card payments, medical expenses, and tuition payments for your children.

When you can’t afford your payment under the IBR, you can look into switching to the REPAYE plan. But that that has its drawbacks as I explain above.

Another option is to contact your loan servicer to request a deferment or forbearance.

Other Questions About IBR

1. Does IBR Include Spouse Income

Yes. But only if: (a) you filed your last tax return jointly, and (b) you can still reasonably access your spouse’s income (i.e. have access to the return and are still together).

2. How Long Does it Take to Get Approved for Income-Based Repayment

In my experience, FedLoan and Navient take the longest to approve IBR payments. I’ve seen them routinely take 3 to 5 weeks to approve applications. Great Lakes and Nelnet, on the other hand, get payments approved in 2 to 3 weeks.

3. How Long is My Monthly Payment Under an IBR Plan

Your monthly payment is good for 12 months at a time. Towards the end of your loan repayment term, you’ll need to renew your monthly payment amount by submitting a recertification application. The IBR recertification form is the same one you used to apply for the IBR plan in the first place, the Income-Driven Repayment Form.

4. Does an Income-Based Repayment Affect Credit Scores

No.

5. Can You Get a Mortgage with IBR Payments

Yes. I’ve had many clients buy a home while being on the IBR plan.

The one difficulty they have comes down to what type of mortgage you’re applying. Fannie Mae, Freddie Mac, and the VA have different rules for how they use your student loan payment to calculate your debt-to-income differently.

You can read more about buying a home with a mortgage by reading:

High Student Loan Debt and Buying a House: Guidelines for FHA, Fannie Mae, Freddie Mac, and VA Mortgages

Final Thoughts

Choosing the right repayment plan for your student loans can be complicated. There’s a lot of factors that go into making that choice.

Let’s talk if you want help. Shoot me an email or:

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