Income driven repayment plan

What Is Income Driven Repayment Plan?

An income driven repayment plan (IDR) is a federal student loan repayment option that bases a borrower's monthly payment amount on their income and family size rather than the loan balance. This approach falls under the broader category of student loan management, aiming to make loan payments affordable for borrowers experiencing financial hardship or low earnings relative to their debt. IDR plans are designed to prevent loan default and provide a safety net, potentially leading to loan forgiveness after a specified period.

History and Origin

The concept of income-driven repayment for federal student loans emerged in the early 1990s as a response to the growing challenge many borrowers faced in affording their monthly payments under traditional repayment structures. The first federal income-driven repayment plan, Income-Contingent Repayment (ICR), was made available in 1995. This initial plan allowed for payments based on income and family size, with any remaining loan balance forgiven after 25 years. Subsequent plans, such as Income-Based Repayment (IBR) in 2009, Pay As You Earn (PAYE) in 2012, Revised Pay As You Earn (REPAYE) in 2015, and most recently, the Saving on a Valuable Education (SAVE) Plan, expanded and refined the options available, often reducing the percentage of discretionary income required for payments and shortening the repayment period for forgiveness for some borrowers. The introduction of these plans aimed to protect student borrowers from economic challenges by ensuring their education debt did not lead to overwhelming financial burdens.⁷

Key Takeaways

• Income driven repayment plans calculate monthly payments based on a borrower's income and family size, not the total loan amount.
• These plans can significantly reduce monthly payments, sometimes to as low as $0, for borrowers with low incomes.
• After a certain number of qualifying payments (typically 20 or 25 years), any remaining loan balance is forgiven, though this forgiven amount may be considered taxable income.
• IDR plans serve as a crucial safeguard against loan default for federal student loan borrowers.
• Borrowers must recertify their income and family size annually to remain on an income driven repayment plan.

Formula and Calculation

The calculation for an income driven repayment plan generally involves a percentage of your discretionary income, which is your adjusted gross income (AGI) minus a certain percentage of the federal poverty line for your family size.

The general approach is:

$\text{Monthly Payment} = \frac{(\text{Adjusted Gross Income} - (\text{Poverty Line} \times \text{Factor})) \times \text{Payment Percentage}}{12}$

• Adjusted Gross Income (AGI): Your AGI is typically derived from your federal income tax return.
• Poverty Line: The relevant federal poverty guideline for your family size, published annually by the U.S. Department of Health and Human Services (HHS). For instance, discretionary income is often defined as the amount by which your AGI exceeds 150% of the poverty guideline for your family size.⁶,⁵
• Factor: This factor varies by IDR plan (e.g., 150% or 225% of the poverty line).
• Payment Percentage: This percentage of discretionary income also varies by plan (e.g., 10%, 15%, or 20%).

For example, the Saving on a Valuable Education (SAVE) Plan generally sets payments at 10% of discretionary income for undergraduate loans, where discretionary income is defined as AGI minus 225% of the poverty line. Other plans, like IBR, might use 15% of discretionary income (for older borrowers) where discretionary income is AGI minus 150% of the poverty line.

Interpreting the Income Driven Repayment Plan

Interpreting an income driven repayment plan involves understanding how it aims to provide affordability and eventual loan forgiveness. A lower monthly payment indicates a greater reliance on income-based adjustments, suggesting that the borrower's income is relatively low compared to their student loan debt. Conversely, a higher payment under an IDR plan implies that the borrower's income allows for larger contributions.

It is important to note that while IDR plans can significantly lower monthly payments, they may also extend the repayment period, potentially leading to more interest rates accruing over the life of the loan. In some cases, if payments are not enough to cover the accrued interest, the loan balance may increase due to capitalized interest. This means that even with a low or $0 payment, the total amount owed can grow before potential forgiveness.

Hypothetical Example

Consider Sarah, a recent college graduate with $40,000 in federal student loans. Her current adjusted gross income is $30,000, and she is a single individual (family size of 1). Let's assume the federal poverty guideline for a one-person household is $14,580.

If Sarah enrolls in a hypothetical income driven repayment plan that calculates payments based on 10% of her discretionary income, where discretionary income is AGI minus 225% of the poverty line:

1. Calculate 225% of the poverty line: ( $14,580 \times 2.25 = $32,805 )
2. Calculate discretionary income: ( $30,000 - $32,805 = -$2,805 )

Since Sarah's adjusted gross income is less than 225% of the poverty line, her discretionary income is negative. In this scenario, her monthly payment under this income driven repayment plan would be $0. She would still be making qualifying payments towards eventual forgiveness, and her loans would not be considered delinquent or in default, even with a zero-dollar payment. This demonstrates how IDR plans provide flexibility during periods of low income.

Practical Applications

Income driven repayment plans are primarily applied to federal student loans to help borrowers manage their debt burdens. They are particularly useful for:

• Recent Graduates: Those entering fields with lower starting salaries or who are still seeking employment, allowing them to keep their payments manageable while they establish their careers.
• Borrowers with fluctuating incomes: Freelancers, gig workers, or individuals in careers with variable pay can benefit from payments that adjust to their current earnings.
• Individuals pursuing Public Service: Borrowers working for government agencies or qualifying non-profits may combine IDR plans with Public Service Loan Forgiveness (PSLF) to achieve forgiveness in a shorter timeframe (typically 10 years of qualifying payments).
• Long-Term Debt Management: For those with high debt-to-income ratios, IDR plans offer a path to eventual forgiveness, even if they never earn enough to fully pay off their loans under a standard plan.

Applying for an income driven repayment plan typically involves submitting an application and providing proof of income to the loan servicer, often by granting access to federal tax information.⁴,³

Limitations and Criticisms

Despite their benefits, income driven repayment plans have faced several limitations and criticisms:

• Complexity: The existence of multiple IDR plans (e.g., IBR, PAYE, REPAYE, SAVE) with varying terms, eligibility requirements, and calculation methods can be confusing for borrowers to navigate. This complexity can lead to borrowers not choosing the optimal plan for their situation or facing challenges understanding their options.
• Administrative Issues: There have been historical issues with the administration of IDR plans by loan servicers, including miscounting qualifying payments, delays in processing applications, and inadequate communication with borrowers, potentially hindering progress toward loan forgiveness.²,¹
• Growing Loan Balances: For borrowers with low incomes, monthly payments under an IDR plan may not be enough to cover the accrued interest, leading to the loan balance growing over time due to capitalized interest. This can be discouraging and make the overall debt seem insurmountable, even if eventual forgiveness is expected.
• Tax Bomb on Forgiveness: Currently, any loan balance forgiven under an IDR plan (outside of PSLF) may be considered taxable income by the IRS, potentially leading to a significant tax liability at the time of forgiveness.

Income Driven Repayment Plan vs. Standard Repayment Plan

The fundamental difference between an income driven repayment plan and a standard repayment plan lies in how the monthly payment is determined and the total repayment timeline.

While a standard repayment plan aims to pay off the loan quickly and efficiently over a fixed period, an income driven repayment plan prioritizes affordability and provides a safety net for borrowers facing income constraints, albeit potentially with a longer repayment period and higher overall interest paid before any forgiveness.

FAQs

Q: Who is eligible for an income driven repayment plan?
A: Generally, federal student loan borrowers with eligible loan types (primarily Direct Loans and some FFEL Program loans) are eligible. Eligibility for specific IDR plans and the payment amount depend on your adjusted gross income and family size.

Q: How often do I need to reapply for an income driven repayment plan?
A: Borrowers on an income driven repayment plan must "recertify" their income and family size annually. Failing to recertify can lead to your monthly payment increasing and any unpaid interest capitalizing.

Q: Can my monthly payment be $0 on an income driven repayment plan?
A: Yes, if your discretionary income is below a certain threshold (typically if your income is less than 150% or 225% of the federal poverty line for your family size), your calculated monthly payment can be $0. These $0 payments still count towards loan forgiveness.

Q: Do all income driven repayment plans lead to loan forgiveness?
A: Yes, all federal income driven repayment plans offer loan forgiveness of any remaining balance after 20 or 25 years of qualifying payments, depending on the specific plan and whether the loans are for undergraduate or graduate study. However, this forgiven amount may be subject to federal income tax.

Q: Can I switch between different income driven repayment plans?
A: In many cases, yes, borrowers can switch between different income driven repayment plans, though specific rules and impacts on capitalized interest or qualifying payment counts may vary. Using the Federal Student Aid's Loan Simulator tool can help borrowers determine the best plan for their situation.