The term income-driven repayment plan is somewhat misleading. Many borrowers assume that they have to have a job with an income in order to make payments based upon how much money they earn. Fortunately, plans like Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Saving on A Valuable Education (SAVE), are open to the unemployed as well.
In fact, these plans are ideal for people without jobs.
What makes the income-driven plans an excellent option for borrowers is that monthly payments are based upon what you can afford to pay rather than what you owe. For borrowers without a job, that means $0 payments.
What happens once I get a job?
Income for the income-driven repayment plans is calculated yearly, using your most recent tax return. Each year you will have to re-certify your income to remain on the income-driven plan. When you get a job, your income will show up on your tax return. The future tax returns for your future employment will then increase your monthly payments accordingly.
This means that recent graduates who have not yet found a job do not need to estimate their income. Instead, they can apply for income-driven repayment without an income, and make $0 payments for a year.
The one thing to keep in mind is that even though the monthly payments are $0, interest will continue to accrue on unsubsidized accounts, and your balance will grow. In short, $0 may be the minimum payment, but it isn’t always the smartest payment.
Isn’t a $0 payment the same as a deferment or a forbearance?
A $0 payment on IBR, PAYE, or SAVE is much better than a deferment or a forbearance. For starters, deferments and forbearances usually are limited. With income-driven repayment, as long as you recertify your income each year, it is always an option.
The biggest benefit of enrolling in the income-driven repayment plans is that those $0 months still count towards student loan forgiveness. With IBR, PAYE, and SAVE, student loan forgiveness comes after 20-25 years. A lot of strategy goes into deciding whether or not chasing forgiveness is the best route, but for people with uncertain future income, counting those months towards forgiveness is an easy call. Time on forbearance or deferment counts towards nothing.
Additionally, borrowers that are considering pursuing Public Service Loan Forgiveness may be able to get some of their $0 payments to count towards PSLF if they start a job with an eligible employer.
What about the monthly interest?
Even though a $0 payment may seem like the perfect deal, there are still some concerns that borrowers should understand. The most critical concern is interest. All the while you pay $0 on your student loans, the balance will be growing. Your monthly statement may not show the interest that accrues each month, but your loan servicer has not forgotten about it.
Once you leave your income-driven plan, the interest that you didn’t pay is added back to the principal balance. In accounting, this is referred to as interest capitalization. When this happens, you start paying interest on the interest. Interest capitalization is one of the reasons that student loan balances can spiral out of control. Fortunately, interest capitalization can be avoided in many circumstances. It is critical for borrowers to understand what triggers interest capitalization and to take steps to avoid it.
One perk unique to the SAVE plan is the treatment of excess interest. Borrowers without a job should seriously consider SAVE as it prevents interest accumulation and balance growth.
Which repayment plan should I select?
Choosing the right income-driven repayment plan can be a bit tricky. Not all borrowers are eligible for all repayment plans, and some federal loans also have eligibility limitations.
The best repayment plan will depend upon your marital status, how you file your taxes and the loans that you have. This article on picking the best income-driven repayment plan should help you make your decision. A call to your student loan servicer is also a good way of making sure you are picking the best choice.
How do I sign up?
In the past, the signup procedure was somewhat complicated. Fortunately, the Department of Education has created a single application for all income-driven plan requests. It can be found on the Department of Education’s Student Aid website.
What if I have Parent PLUS loans that are not eligible for IBR, PAYE, or SAVE?
One of the downsides to Parent PLUS loans is that they are not eligible for IBR, PAYE, or SAVE. Sadly, a Parent PLUS loan is not eligible for any income-driven repayment plan.
However, there is a way around this issue. A Parent PLUS loan can be consolidated through federal direct consolidation. The new consolidated loan is then eligible for the Income-Contingent Repayment Plan (ICR). Unfortunately, the ICR plan calls for 20% of your discretionary income, while IBR, PAYE, and REPAYE only charge 10-15%. However, if you are unemployed, 20% of zero is still $0.
ICR is a rarely used repayment plan because the newer income-driven repayment plans are usually a better choice. In this case, ICR is the only income-driven option available, so it is the best option.
Before going through federal direct consolidation, it is essential to understand the consequences of the process before forming your strategy. If you are going to consolidate, be sure only to consolidate the Parent PLUS loans and not any other federal student loans. Combining loan types could result in some of your student loans losing eligibility for certain federal programs. Be sure to talk with your loan servicer about this process so that you do not make any mistakes in your effort to get $0 payments on your Parent PLUS loans.
Final Thought: Income-Driven Repayment could be ideal.
If you are unemployed or barely making enough to get by, income-driven repayment plans help borrowers lower their monthly student loan bills so that their student loans do not become delinquent or default. In many cases, this can mean $0 monthly payments.
