If you have federal student loans the two best repayment plans are Income-Based Repayment (IBR) and Pay As You Earn (PAYE). The reason these plans are the best is because your student loan payment is based upon what you can afford rather than how much you owe. For most borrowers this results in a big reduction in minimum monthly payments.
Under IBR, the Department of Education expects you to pay 15% of your discretionary income towards your student loans. The PAYE plan reduces that number to 10%. Which plan you qualify for depends upon when you took out your first student loan. The bad news for those of us who took our a federal loan before October of 2007 is that we are stuck with IBR. The good news is that when REPAYE goes into effect, we may get to join the 10% crowd.
But what exactly is discretionary income for student loans?
Before you have to pay anything under IBR or PAYE, the government lets you keep 100% of your salary up to a certain point. That number is set at 150% of the poverty level. According to the Department of Education, this is the portion of your income that is non-discretionary. The federal poverty level changes each year and is based upon your family size. For 2015, the numbers look like this:
|Household Size||150% of Poverty Level|
For the purposes of your student loan payments, your discretionary income is every dollar (pre-tax) that you make above the numbers listed on the table. Suppose your housed size is 3 and you make $42,135 per year. In this example, your discretionary income would be $12,000 per year. We get this number by subtracting the $30,135 for a family of three from the $42,135 yearly salary.
Calculating your payments
Once you determine your discretionary income, divide that number by 12. The new number is your monthly discretionary income. In our example it would be $1,000. That means that if you were on IBR, your monthly payment would be $150, and if you were on PAYE, your monthly payment would be $100.
Note: the exact calculation will vary depending on how you verify your income with your lender. Some people use there two most recent pay stubs while others use last year’s taxes. If you use your most recent tax form, it will be based upon your AGI.
What isn’t factored into your discretionary income?
How much you can truly afford to pay depends upon a whole lot more than just the size of your family. Unfortunately, these factors are not considered. If you have medical bills, owe child support, or have other private student loans; your discretionary income does not change.
However, as noted earlier, for most people income is based upon their AGI. If you plan ahead, you can lower your AGI and set extra money aside for retirement. Be sure to check out our tricks for lowering your AGI. Going this route will reduce your discretionary income and it will result in lower PAYE and IBR payments.