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Beginners' Guide to Income-Driven Repayment Plans

So you've heard about these payment plans that will reduce your monthly student loan bill and you're wondering if  they're an urban legend. Let us assure you: these plans do, in fact, exist. 

But there are a few things you should understand before you sign up.


What is an income-driven repayment plan?

When you graduate from college and get that first student loan bill, your monthly loan payments are calculated based on the total amount of your loan balance.

So if you owe $10,000 on a 10-year term—ignoring interest—we'd divide your total balance ($10,000) by 120 (12 months x 10 years) to get your monthly payment amount of $83.

But under an income-driven repayment plan, your lender doesn't use your loan balance to calculate your monthly payment. Instead, they set your payment based on how much money you make. 

So how does that work? Glad you asked. 

How do income-driven repayment plans work? 

There are four income-driven repayment plans, but they all have the same purpose: to allow you to continue paying back your student loans without inhibiting your ability to afford basic things like food and rent. 

That means your lender (the U.S. Department of Education) needs to understand how much you spend on the non-negotiable things in their life so that they know how much you have left over (your "discretionary income").

The idea is that, while you absolutely have to pay the heat bill and the rent check, you could skip the new purse or the fancy vacation.

Of course, everyone on an income-driven repayment plan isn't submitting their monthly budget to the Department of Education. Instead, you provide documentation of your current annual income, and the government calculates your discretionary income using federal poverty guidelines for families of your size in your geographic location. 

See also: Discretionary Income: Why It Matters for Student Loans

Once they've calculated your discretionary income, they'll set your monthly payment at 10-20% of that number, depending on the specific plan you've chosen. 

Who can enroll in an income-driven repayment plan?

If you have federal student loans, you can enroll in an income-driven repayment plan. 

How do you know whether you have federal loans? It's not always obvious just by looking at your statements.

You can find out in two ways:

1.Visit the National Student Loan Data System. If you've never logged into the site before, you'll your Federal Student Aid ID, which you created when you applied for FAFSA (follow the prompts if you've forgotten yours). If you have a loan that's not listed there, it's probably a private loan. 

2. Ask your loan servicer. Give your loan servicer a call and ask them whether your loans are federal or private. 

If you just realized that your student loans are private and don't qualify for an income-driven repayment plan, don't despair. Refinancing your loans is another great way to lower your monthly payments. 

How do I enroll in an income-driven repayment plan? 

Great news: you can enroll in an income-driven repayment plan in less than 15 minutes. 

You'll need to gather some information, like your social security number, your federal student aid ID, proof of income, and similar information about your spouse (if you're married).

There are two ways to apply:

  1. Call your lender to apply, or 
  2. Complete the online form at the Federal Student Aid website. (We've laid out the entire process for how to enroll in an income-driven repayment plan so you can apply with no surprises.)

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When can I enroll in an income-driven repayment plan? 

You can enroll in an income-driven repayment plan at any time.

If you recently graduated from college, you were probably automatically placed on a standard repayment plan. Those plans have a 10-year term, with monthly payment amounts that are based on the total loan amount due.

If those payments are too high for you, you can enroll in an income-driven repayment plan right now.

What are the benefits of enrolling in an income-driven repayment plan? 

Choosing an income-driven repayment plan may be the right choice if your current monthly payments are unaffordable. Here's what to expect:

1. You may lower your monthly payments

For most young graduates, enrolling in an income-driven repayment plan reduces the amount owed on a monthly basis. Depending on the amount you owe and your income, your payment could be hundreds of dollars less each month. 

2. You will retain federal benefits

Changing the repayment plan on your federal loans does not change your eligibility for benefits like deferment or forgiveness.

You can still choose to defer your loans if you go back to school. You can still opt for forbearance if you're unable to make your payments.

3. Your remaining loan balance will be forgiven after 20 or 25 years, depending on the plan you choose

All income-driven repayment plans provide forgiveness of any remaining loan balance after 20 or 25 years. There is a catch, though (see below). 

4. You can change plans at any time

If your income changes or you think you'd benefit from a different plan, you're able to switch it up as long as you have federal loans. 

What are the drawbacks of income-driven repayment plans?

1. You may pay more over the life of the loan

One of the reasons an income-driven plan can reduce your payments is that they extend the term of your loans—from 10 years to 20 or 25 years.

That means a lower payment can be spread out over a longer time period, but you'll also be paying interest for those extra years. If you use the full repayment term, you could pay thousands more than if you'd stayed on the standard payment plan. 

2. Your monthly payment amounts may change 

As your income increases, so will your payments.

For some people, those increased payment changes can come as a shock, especially if they've already earmarked a recent raise for something else, like a new car payment or a bigger apartment.

3. You have to re-certify every year

Each year, you'll need to provide documentation (tax returns—or job offer letters if you're in a new position) to show your income.

The process isn't difficult, but you'll want to mark it on your calendar so you don't inadvertently find yourself removed from your chosen repayment program.

4. You may have to pay a hefty tax bill

Remember that loan forgiveness after 20 or 25 years that we mentioned above?

Well, the downside is that the government treats the forgiven balance like income you earned in that year, and you'll have to pay taxes on that amount. Twenty years may seem like a long time away, but an unexpected expense is rarely well-received—even for people in their forties. 

Reducing your monthly payment through an income-driven repayment plan is a great option for tons of federal borrowers.

But if the drawbacks outweigh the benefits for you—or if you have private loans—there are other ways to lower your monthly payments, like consolidation or refinancing

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