For many students graduating from college, figuring out how to repay their student loans is easier said than done. Six in 10 students who graduated with a bachelor’s degree in 2015-2016 left school with student…
For many students graduating from college, figuring out how to repay their student loans is easier said than done.
Six in 10 students who graduated with a bachelor’s degree in 2015-2016 left school with student loans, according to the College Board, with an average debt of $28,400. According to a 2017 paper published by the District of Columbia-based think tank American Enterprise Institute, around 90 percent of student loans are taken out under the federal government’s direct loan program.
In response to many borrowers struggling to pay down their student debt, the government has increased the number of options for federal student loan repayments. Today, the Department of Education offers eight different repayment plans, ranging from income-driven to fixed- and graduated-repayment plans.
While some of these plans reduce monthly payments, experts say borrowers should consider one in which they can afford to pay the loan balance off faster. Here’s what borrowers should know about the different federal student loan repayment plans.
What Is the Best Federal Student Loan Repayment Option?
Experts say choosing the best student loan repayment plan is all about finding the right fit.
“The different repayment options are really suited for specific situations. It’s important to understand all the options, and then look to see which ones you qualify for,” says Ben Brown, founder of the Association of Young Americans, an organization whose work includes pushing for improved borrower protections.
Income-driven repayment plans are an option to help borrowers avoid delinquency or default if they’re having trouble making payments under a plan that isn’t based on annual income, experts say.
Leslie Tayne, a student loan expert and the managing director of Tayne Law Group, cautions borrowers: “Do your homework. Explore the long-term benefits and consequences. Be sure to not only think about short-term but the long-term effects.”
While income-driven repayments lower the monthly payment, these plans lengthen the term of the loan. Extending the life of the loan increases the interest amount a borrower pays.
“With that in mind, if you want pay off your student loan as cheaply as possible, it’s recommended that you follow standard repayment and, if possible, apply even more to your payments to bring down your principal even faster,” says Tim Stobierski, founder of StudentDebtWarriors.com, a website focused on paying off student loans.
What Are the Different Types of Income-Driven Repayment Plans?
According to a 2017 College Board report, 28 percent of federal student loan borrowers in repayment were enrolled in a plan to limit their payment to an affordable percentage of their incomes.
“The ideal plan will depend on when you borrowed your first loan, the types of loans borrowed and your marital status,” says Michael Lux, an Indiana attorney and founder of the Student Loan Sherpa blog.
Experts say there is no clear winner among the various repayment plans, since the right option is based on a borrower’s financial circumstances.
While the Trump administration has proposed altering the current federal student loan repayment options into a single income-driven repayment plan, no legislation has been introduced to reform the current structure.
There are four repayment plans classified as income-driven. Any remaining loan balance under an income-driven plan is forgiven if the federal student loans aren’t fully repaid at the end of the repayment period. But borrowers should be aware that under current IRS rules, a loan forgiven under one of these plans may be considered taxable income.
The following types of loans are eligible for these plans: direct, graduate PLUS and direct consolidation loans. Older loans, such as FFEL PLUS loans for graduate students, can qualify if consolidated into a direct consolidation loan.
— Income-Based Repayment: This plan, known as IBR, has two different terms based on when a borrower took out a direct loan. The Obama administration introduced an improved IBR plan to borrowers who took out a direct loan on or after July 1, 2014. The repayment plan for these borrowers is 10 percent of their discretionary income with a repayment period of up to 20 years.
The U.S. Department of Education counts discretionary income as the difference between a borrower’s annual income and 150 percent of the poverty guideline based on family size and state of residence; Alaska and Hawaii have separate guidelines compared with the other U.S. states and the District of Columbia.
A single person with an adjusted gross income of $40,000, for example, would have $18,210 subtracted from consideration, and $21,792 would be considered the annual discretionary income. Monthly discretionary income under this scenario would be about $1,816, so the borrower would pay around $182 per month under IBR.
For borrowers who took out a direct loan before July 1, 2014, the set payment amount and repayment period is different. These borrowers pay 15 percent of discretionary income over a repayment period of up to 25 years.
Under IBR, a spouse’s income is only considered if the couple files a joint tax return.
— Pay As You Earn: Often referred to as PAYE, this plan takes 10 percent of discretionary income and is capped at the amount a borrower would pay under the 10-year standard repayment plan, which divides the loan balance over 10 years.
A new borrower who is a single person with an adjusted gross income of $40,000 would pay the same initial payment of around $182 a month under PAYE. Similar to IBR, borrowers must qualify initially for partial financial hardship to enroll. A partial financial hardship exists when the annual amount due on a borrower’s eligible loans, as calculated under a 10-year repayment plan, exceeds 15 percent of discretionary income.
PAYE is only available to borrowers who received the loan on or after Oct. 1, 2011.
Spousal income is only considered if the couple files a joint tax return. “PAYE works like IBR for couples, but has the lower monthly payment, making it better for borrowers that qualify,” Lux says.
— Revised Pay As You Earn: This plan was introduced by the Obama administration in 2015 to broaden to the number of student loan borrowers who can qualify for an income-driven option. REPAYE was created for borrowers who don’t qualify for PAYE and is similar to its predecessor in a few ways: It requires 10 percent of discretionary income and extends the repayment term to up to 20 years if the borrower took out loans for undergraduate studies; the repayment term extends to 25 years if the borrower is paying back loans from a graduate or professional degree.
“Couples cannot file taxes separately in order to exclude spousal income,” says Lux, who adds that REPAYE does come with some perks related to interest. If a borrower’s monthly payment doesn’t cover the full amount of the interest on a subsidized loan, the government will pay the difference for the first three years. After that, the government will pay half of the difference in accruing interest.
— Income-Contingent Repayment: Monthly repayments under ICR are the lesser of 20 percent of discretionary income or the fixed amount needed to pay off the loan within 12 years, adjusted based on income. Spousal income is only considered if the couple files a joint tax return. Outstanding balances are forgiven after 25 years.
While Parent PLUS loans aren’t eligible for any income-driven repayment plans, a Parent PLUS loan consolidated into a direct consolidation loan qualifies for ICR.
Despite its name, the Income-Sensitive Repayment Plan isn’t considered an income-driven repayment plan. ISR is for loans that existed prior to the federal direct loan program, which the Obama administration introduced in 2010. The loans eligible for ISR include federal Stafford loans before the direct program, FFEL PLUS loans and FFEL consolidation loans.
Under the plan, monthly payments are based on a borrower’s annual income. According the Federal Student Aid website, “The formula for determining the monthly payment amount can vary from lender to lender.”
Although the program bases monthly charges on annual income, borrowers under this plan won’t be considered for Public Service Loan Forgiveness — a program for those working in the public or nonprofit sector. To be considered for PSLF, borrowers need to consolidate older loans, such as FFEL, under the federal direct program. After that, they need to enroll in an income-driven repayment plan.
What Are Basic Repayment Plans?
There are three repayment plans not tied to income and for which all types of federal student loans, such as direct, FFEL and PLUS, qualify.
— Standard: Repaying a student loan in 10 years is the typical term for a federal student loan. In fact, borrowers’ loans are enrolled automatically into this plan when their loans enter the repayment phase unless they select a different plan. This plan consists of 120 fixed payments over a 10-year period.
— Graduated: This plan starts with lower monthly payments that increase over time; payments usually increase every two years. Loans are to be paid off within 10 years.
— Extended: Under this plan, payments can be fixed or graduated, and the loans need to be paid off within 25 years. To qualify for this plan, a borrower must have more than $30,000 outstanding in either direct or FFEL loans.
Where Can You Find a Student Loan Repayment Plan Calculator?
While there are many tools available on lender and personal finance education websites to determine monthly payments, experts recommend using the Education Department’s online repayment calculator for federal student loans.
“There are some amazing tools on the Department of Education’s website that take into account how much money you’re making, your tax status as well as some basic loan information and tells you if you’re eligible for different loan repayment plans,” Brown says. “There are great tools all over the place, but the Department of Education tool is the standard.”
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