I’m a huge fan of Income-Driven Repayment plans like IBR, PAYE, and REPAYE.
These plans help ensure that borrowers can always afford their federal student loan debt. They also provide a path to student loan forgiveness for those overwhelmed with debt.
Each month, borrowers are expected to pay 10 to 20% of their discretionary income towards their student loans. Some borrowers even qualify for $0 per month payments. After 20 or 25 years of payments, the remaining debt is forgiven.
Unfortuantely, the IDR calculations have some flaws. More specifically, they seem to favor some borrowers over others.
IDR Payment Calculations are a Blunt Instrument
The fundamental issue with IDR calculations is that they are blunt instruments.
Calculating monthly payments on the various IDR plans is relatively simple. The Federal Loan Simulator can estimate monthly bills by asking borrowers just a few questions. This simplicity makes calculations easier for borrowers to understand and easier for servicers to process.
Generally speaking, simplicity is a good thing for student loan borrowers.
The downside to an efficient system is that it doesn’t handle unique circumstances particularly well. Most of the issues with IDR fairness are a direct result of the simplified nature of calculations.
Issue #1: Ignores Other Debts Like Private Student Loans
If the idea behind IDR is ensuring borrowers can afford their student loan bills, IDR misses badly for borrowers with large amounts of private student debt.
The IDR calculation is the same, whether you have to pay $1,000 per month on private loans or $0 per month.
Strict federal loan borrowing limits mean that many undergraduate students often resort to private loans.
It’s fair to argue that taxpayers shouldn’t take a backseat to private lenders when it comes to debt calculation. However, taking this position means that IDR calculations can’t factor in private debt. If you are a borrower with extensive private debt, your actual discretionary income looks different from someone without private loans.
Treating borrowers with massive private debt the same as borrowers with only federal loans is unfair. In an ideal system, the borrowers with private debt should qualify for more affordable monthly payments.
Sherpa Tip: If you have expensive private student loans, the best option to get them under control is usually to refinance the debt.
Unfortuantely the low interest rates offered by refinance lenders are usually only available to borrowers with a steady income and strong credit score. Those that need the most help often struggle to qualify.
Issue #2: IDR Calculations are Unfair for Non-Custodial Parents
If you are a parent with a dependent child, monthly IDR payments are lower than someone with the same income who doesn’t have children. This policy makes sense because caring for children takes up a considerable amount of a person’s discretionary income.
The problem with dependant calculations for parents is that the child must receive more than 50% of its support from the borrower parent. If you are a non-custodial parent who provides 40% support for your child, the IDR payment formula doesn’t consider this support at all.
If you are a parent, you almost certainly have some financial responsibility to your child, both from a moral and legal standpoint. Excluding parents who don’t contribute more than half of a child’s support isn’t necessary.
The IDR application should be amended to simply ask the borrower how many children they have.
Issue #3: Misses Badly on Regional Cost of Living
The discretionary income calculations factor in where you live… barely.
Discretionary income is defined as the money earned above 150% of the federal poverty level. Looking at the federal poverty level table, we see that poverty levels are a bit different for Alaska and Hawaii. Unfortuantely, the other 48 states are all treated the same.
If you earn $80,000 per year in Ohio, where I live, it is an excellent income. That same $80,000 per year in San Francisco or New York might be a struggle.
Housing expenses vary significantly from one location to the next. $300,000 buys a nice single-family residence throughout the midwest. In pricier real estate markets, it might only buy a small apartment.
If your job is in Seattle, living somewhere less expensive may not be an option.
Adding in other cost of living factors, it is clear that some locations are substantially more expensive than others. Sadly, for borrowers with a higher cost of living, incomes are treated equally across the 48 contiguous states.
Issue #4: Responds Slowly to Inflation
As inflation tightens budgets across the country, IDR calculations haven’t moved.
The federal government updates the poverty level guidelines once per year. This can hurt borrowers during times of inflation.
As the cost of living increases, actual discretionary income decreases. Making $18 per hour in January might go a lot further than the same $18 per hour in September.
Unless the government updates the federal poverty level guidelines more than once a year, inflation will hit IDR borrowers especially hard.
Issue #5: IDR Calculations Favor Homeowners Over Renters
The IDR formulas treat homeowners and renters the same.
For homeowners, this is an excellent deal. Locking in a fixed monthly payment mortgage looks better with each passing year.
For renters, housing expenses tend to grow with each passing year.
IDR calculations don’t consider housing costs. If you are a homeowner who bought before the real estate market went crazy, things look pretty good. If you are a renter, housing probably makes it harder to make student loan payments.
Issue #6: Discourages Saving for Retirement in a Roth IRA
Saving for retirement is a massive challenge for many student loan borrowers.
The good news on this front is that many retirement contributions can actually lower your IDR payments.
Unfortuantely, this isn’t the case for all retirement plans. Some retirement contributions, such as putting money in a Roth IRA, have no impact on monthly student loan payments.
Prioritizing some retirement accounts over others makes saving for the future even more complicated for student loan borrowers.
Issue #7: Higher Payments for Some Borrowers
The government doesn’t treat federal student debt equally.
If you borrowed your loans ten years ago, you can’t sign up for plans like Pay As You Earn (PAYE) or IBR for new borrowers. For many borrowers, this means a higher monthly bill.
Likewise, if you borrowed Parent PLUS loans, the only IDR plan available is Income-Contingent repayment (ICR). This is a problem for borrowers because ICR charges 20% of a borrower’s discretionary income when many other plans only charge 10%.
If the goal of IDR is to keep federal debt affordable, why limit access to IDR plans?
Fixing Income-Driven Repayment Calculation Fairness
Student loan repayment is already too complicated.
Each time we add an exception or a new rule, we create further complications. As a result, it is hard for the Department of Education to make IDR payment calculations fairer. Each issue addressed means another complication to an already complex system.
To address this issue, I’d like to see the government adopt a system similar to how we handle tax deductions. The current system of using the poverty level guidelines would be the equivalent of the standard deduction. In cases where the standard deduction isn’t fair, borrowers could “itemize” their expenses using a more complicated discretionary income formula.
Using this method, we keep the system simple for most borrowers but add complexity for those who need help.
Keeping Your PAYE, IBR, and REPAYE Payments Low
Even though the IDR payment formula is a blunt instrument, borrowers can use several different tactics to keep monthly payments manageable.
Because your “income” comes directly from your most recent tax return, tax season is a great time to find strategies for lower monthly payments.
Alternatively, if your income is unusually high for just one year, there are options to essentially exclude that money from IDR calculations.