IBR, PAYE and REPAYE: How to pick the best Income-Driven Repayment Plan

Michael Lux Basics, Blog, Strategy, Student Loans 0 Comments

There are four different income-driven federal repayment plans.  Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE), offer the lowest monthly payments.  However, plans like Income Based Repayment (IBR) and Income Contingent Repayment (ICR) may be the best choice due to eligibility requirements and tax considerations.

The Basics

Revised Pay As You Earn (REPAYE) – REPAYE is the newest repayment plan and for many it will be the best choice.  REPAYE caps monthly student loan payments at 10% of your discretionary income.  All federal borrowers and most federal loans are eligible for this repayment plan.

Pay As You Earn (PAYE) – PAYE was introduced just over 5 years ago.  Like REPAYE, PAYE caps monthly student loan payments at 10% of your discretionary income.  Unlike REPAYE, only federal borrowers who took out their first student loan after October 1, 2007, are eligible.

Income Based Repayment (IBR) – IBR requires monthly payments calculated at 15% of your monthly discretionary income.  All federal borrowers and most federal loans are eligible for this plan.

Income Contingent Repayment (ICR) – ICR is the original income-driven repayment plan.  Borrowers are required to pay 20% of their monthly discretionary income under this plan.  All federal borrowers and all federal loans can be eligible for this repayment plan.

Picking the best plan

Choosing which income-driven plan is best for you will depend upon a number of different circumstances.  In many cases the best repayment plan is the one with the lowest monthly payments.  Even if you can afford higher payments, getting lower payments allows you to direct any additional funds towards your highest interest debt.  However, there are a number of situations where it might be wise to choose a different plan.

If your spouse does not have student loans – Spousal income can have a huge impact on your student loan payments.  If your spouse does not have student loans, the plan you choose can impact whether or not their income is considered when calculating your monthly payment.  If you file your taxes separately, your spouses income is not counted on the PAYE, IBR, and ICR plans.  However, REPAYE will count spousal income regardless of how you file your taxes.

If your monthly payments are less than the monthly interest – Income-driven payments are based upon what you make, not what you owe.  If your loans generate $300 in interest per month but your payment is only $200 per month, your balance will be growing by $100 each month.  REPAYE, unlike the other income-driven plans, has a huge advantage.  The government will pay half of the excess interest that accrues each month.  In our example, instead of adding $100 per month in interest, REPAYE borrowers would only add $50 per month in interest.

If you have Parent PLUS loans – Parents who borrowed federal loans to pay for their child’s education has fewer options than other federal borrowers.  Parent PLUS loans are not eligible for any of the income-driven repayment plans.  However, a Parent PLUS loan can be consolidated through the federal government into a federal direct consolidation loan.  This new loan would be eligible for the ICR plan.  (Note: if you have both Parent PLUS loans and your own loans, be sure not to combine them… if they all get consolidated together the other loans loose eligibility for PAYE, REPAYE, and IBR)

Tips:

Consider the tax consequences – Filing separately can result in much lower payments using PAYE, IBR, and ICR.  Unfortunately, filing separately comes at a cost.  This tax move is usually much more expensive than filing jointly.  Be sure to consider your options at tax time.

Know how capitalized interest affects you – If your loan accrues more interest each month than what you pay, the balance is going up.  Fortunately, that additional interest is not immediately added to your balance.  Understand what events trigger interest capitalization and how to avoid them.  By avoiding interest capitalization, you avoid paying interest on interest.  For larger balances, this can save thousands in the long run.

Plan ahead for FFEL loans – FFEL loans, also called FFELP loans, were loans that were guaranteed by the federal government and are technically federal loans.  These loans were last issued in 2010.  If you have any of these loans they may not be eligible for certain repayment plans or programs like Public Service Student Loan Forgiveness.  However, if you consolidate these loans into a federal direct consolidation loan, the new loan becomes eligible.

Talk to your loan servicer – This often requires multiple phone calls.  Unfortunately, not all customer service representatives are accurate 100% of the time.  We suggest doing as much research as possible and then making your call.  Trust the loan servicers who prove to you that they know what they are talking about.

Think about student loan forgiveness – All of the income-driven repayment plans are eligible for Public Service Student Loan Forgiveness, which comes after 120 certified public service payments.  Under Public Service Loan Forgiveness, the debt is forgiven tax-free.  Even if you do not work in public service, your debt can be forgiven after 25 years of payments under an income-driven repayment plan (for all PAYE borrowers and REPAYE borrowers with only undergraduate debt, forgiveness comes after 20 years).  Unfortunately, the 20 and 25 year forgiveness is taxed as additional income for the year the loans are forgiven.

Don’t pay for assistance managing your federal loans – There are a number of companies that offer “services” to get you signed up for various federal programs.  Many of these companies are outright scams, and most cause more problems than do good.  Managing your federal loans may seem overwhelming at times, but it can be done by anyone.

Understand discretionary income – The term discretionary income refers to a specific calculation based upon your family size and Adjusted Gross Income from your tax return.  Many tax strategies that lower your yearly tax bill can also be used to lower your monthly payments on Income-Driven Repayment Plans.

Tools to Use:

Federal Repayment Estimator – This page will allow you to use your actual student loan information to calculate what your monthly payments would be on various student loan repayment plans.  This tool is helpful for estimating future payments as well as making sure your loan servicer has not made a mistake.

Department of Education Income-Driven FAQ – This extended document breaks down all of the details of each plan.  There are many pages on the Department of Education website that address income-driven repayment plans, but this document is among the most comprehensive and easiest to understand.