[UPDATE] This post was updated in Aug 2023 to reflect the changes to the REPAYE plan (now SAVE)
Now that the federal student loan pause has an official end date, millions of Americans across the US are preparing to resume payments on their federal student loans in the fall.
If you’re one of the majority of borrowers who are not feeling financially stable enough to resume your minimum monthly payments, how can you make your student debt payments more manageable? Well, one option that might be available to you is an Income-Driven Repayment (IDR) plan.
IDR plans are special payment plans designed to help make your federal student loan debt more manageable by setting up a monthly payment structure that takes your income and family size into account. In some cases, they can even reduce your minimum monthly payment to $0.
It’s important to note that income-driven repayment plans are only available for federal student loans; borrowers with private student loans are not eligible for IDR and may want to look at other options like refinancing or employer student loan assistance benefits instead. Likewise, defaulted federal loans are not eligible for IDR.
The department of education currently offers four types of IDR plans for federal student loans:
Borrowers with Direct Loans are eligible for all IDR plans as long as they meet eligibility requirements. Borrowers with other types of federal loans may qualify for IDR if they consolidate their loans into a Direct Consolidation Loan. Parent PLUS loans are only eligible for one plan, the Income Contingent Repayment plan, after consolidation.
(What’s consolidation? If you have one or more federal student loans, you can combine them into a single Direct Consolidation loan for free through loan consolidation. You can get the process started through the government’s student aid portal).
All of the plans offer the ability to make minimum payments that are a percentage of your discretionary income and, if you still have a loan balance outstanding at the end of your new repayment term, each of the IDR plans offers forgiveness.
Here’s a breakdown of the differences between the different payment plans:
In early 2023, the Biden administration proposed regulation that would change the terms of REPAYE to reduce the burden of federal student loans. The proposed changes would lower the minimum payment on undergraduate loans under REPAYE to 5% of a borrower’s discretionary income, stop unpaid interest accumulation, and shorten the required payback period based on the original principal amount borrowed (among other things). These changes are expected to be finalized by the end of 2023.
More changes are expected to go into effect summer 2024.
The key benefits of all income-driven repayment plans are:
The first major benefit of an IDR plan is that it could lower your monthly minimum payment–in some situations, you may not have to make monthly payments at all.
For all IDR plans, your new minimum monthly payment is determined by your income and family information and will generally be 10-20% of your discretionary income (but usually not more than the minimum amount required by your standard repayment plan). When applying for an IDR, your loan servicer will typically either use your adjusted gross income (based on your two most recent tax returns) or ask for alternative documentation of income to calculate your new minimum monthly payments.
You’ll need to certify your income and family information during the application process and recertify this information every year by re-submitting an IDR plan application with your loan servicer. If your income and family situation changes, you may see your minimum monthly payment for the year change as well.
Here’s a comparison of your typical monthly payments under the different plans:
A second benefit of IDR is the possibility for loan forgiveness at the end of the repayment plan. Currently, under all IDR plans, any loan balance remaining at the end of the repayment term will be forgiven.
Any periods in which you were required to pay $0 each month, in which your loan payments were deferred due to economic hardship, or in which you were repaying the loan under other payment plans will count towards your total repayment period.
Some potential drawbacks of income-driven repayment plans are:
While IDR plans will generally reduce your minimum monthly payments, they will also extend the repayment period on your federal student loan. On a standard repayment plan, the repayment term is usually around 10 years; with an income-driven repayment plan, the repayment term is typically about 20-25 years.
This means that if you decide to repay your loan with an income-driven repayment plan, you’ll likely be in debt for twice as long as you would have been if you had repaid your loan on the standard plan. For some, a lower monthly minimum payment could be worth this tradeoff, but if you’d prefer to be free of your student debt sooner, you might want to consider sticking to your original repayment plan.
Here’s a comparison of typical repayment periods under the different plans:
A second drawback of IDR is that you may end up paying more total interest on your loan in the long run because of the extended repayment period. More time to repay your loan means more time for interest to accumulate on your outstanding loan balance.
If you think about the total interest on your loan as the cost of borrowing money for your education, this means that despite lower minimum monthly payments, an IDR plan may actually make taking out a loan for your education more expensive in the long run.
The final drawback of IDR is that repaying your loan on an IDR plan could leave you with a tax bill at the end of your repayment period.
Prior to the COVID pandemic, any federal student loan forgiveness a borrower received was typically treated as taxable income so you’d have to pay taxes on it based on your income tax bracket (with some exceptions). Currently, under the American Rescue Plan Act, any student loan balances that are forgiven through the end of 2025 are exempt from federal taxes, but this is only a temporary exemption and doesn’t necessarily apply to state taxes. If you live in a state that doesn’t fully conform to or follow the IRC’s treatment of student loans, you might find that you have to pay taxes on any student loan forgiveness you receive. Those states might include Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina, Wisconsin.
Proposed policy changes including the Student Tax Relief Act are trying to permanently exempt student loan forgiveness from federal income taxes, but until this legislation is passed, be aware that you might need to pay taxes on any forgiven loan balance depending on when your loans are forgiven and where you reside.
If you believe IDR is right for you, you can apply for a repayment plan for free with your loan servicer. Log in to your FAFSA portal and apply here.
Note that if you have multiple servicers for any loans that you’d like to repay under an income-driven repayment plan, you’ll need to submit a separate IDR request to each servicer.
If you have private student loans or have federal student loans but don’t believe an income-driven repayment plan is for you, what other options do you have to make your student debt burden more manageable?
Regardless of what type of loans you have or whether you’re on a repayment plan, an employer student loan repayments benefit is an effective benefit that can help you save money and pay off your loans more quickly.
Highway Benefits removes all the hassle of launching and managing an employer student loan repayments benefit. With Highway, your employer can get a student loan repayment benefit up and running faster than you can apply and get approved for an income-driven repayment plan.
Talk to your employer about offering an employer student loan repayments benefit today.
Disclaimer: This article is purely information and is not intended as financial advice. If you have federal student loans and want to know how income-driven repayment will affect your particular situation, visit StudentAid.gov or speak with a financial and/or tax advisor.