Do I need a divorce for lower student loan payments?

Michael Lux Blog, Lower Payments, Student Loans 1 Comment

For many borrowers, the best way to lower payments on federal student loans is to enroll in an income driven repayment plan.  These income driven plans, such as Income Based Repayment and Revised Pay As You Earn, require payments based upon salary rather than loan balance.  This results in a huge break for borrowers who have low income or large balances.

One thing that complicates these options is marriage.  In many circumstances, a married borrower could pay significantly more than a similarly situated single borrower on the very same income driven plan.  While there are ways to reduce the “marriage penalty”, it still does exist.

“Mixed” Couples vs. Double Borrowers

If you and your spouse both have federal student loans and enroll in an income driven plan, there is no marriage penalty.  Even though your incomes are combined for the calculation of your ability to pay, your debt is also combined when doing this math.

As an example, suppose you and your spouse were single and enrolled in IBR.  If you got married and both stayed on IBR, your combined payment would stay approximately the same.  It is possible that the payment for one spouse would increase, but there would be a drop for the other spouse.  The math gets a little complicated, but the bottom line is that the effective monthly payment towards student loans will stay the same.

Things get far more expensive for couples who have only one federal borrower…

IBR, PAYE, and Marriage

Two of the most popular repayment plans are IBR (Income Based Repayment) and PAYE (Pay As You Earn).  On these plans borrowers are required to pay 10 to 15 percent of their discretionary income towards student loans.

Most couples file their taxes jointly because it usually results in a number of tax breaks.  Couples that elect to file jointly must also use their combined income for purposes of calculating the IBR or PAYE payment.  If your spouse has a strong income, it means higher monthly payments.

The good news is that there is a way around this issue.  It is filing taxes separately.  By filing your taxes separately, your spouse’s income is no longer used for calculating student loan payments.  Unfortunately, this is not a perfect solution.  Not only do you lose the tax breaks associated with being married, filing separately also has different tax brackets than those for single people.  As a result, by filing separately, you may pay more in taxes than you would if you were single.  This added taxation is the “marriage penalty” for borrowers on IBR and PAYE.  The exact amount of this penalty will depend on a number of factors relating to your taxes and is something that should probably be discussed with an accountant.

REPAYE and Marriage

Things are much worse for married couples with one federal borrower who wants to enroll in the newly created REPAYE (Revised Pay As You Earn) Plan.  The advantage of REPAYE is that it lowers payments for borrowers who are not eligible for PAYE and must enroll in IBR.  Instead of paying the 15% required by IBR, REPAYE borrowers are only required to pay the 10% as required in PAYE.

The problem comes with how REPAYE treats spousal income an taxes.  Whether your file jointly or separately, spousal income is still used in your REPAYE calculation.  If your spouse has a large income, that means much bigger payments each month.  In this circumstance the “marriage penalty” is much larger.

The only way around this issue is to avoid REPAYE completely.  Borrowers should look into IBR or PAYE to evaluate different potential payments.

Should I get a divorce for lower payments?

Obviously this is a major decision that goes far beyond finances.  Even from a purely financial perspective, it is very complicated.  If you are considering going this route, be sure to have detailed conversations with your lender about different payments under various plans and various circumstances.  Talking with an accountant can also help you figure out the tax implications of your options and potential savings.

Another thing to keep in mind is that the “marriage penalty” really only refers to higher minimum monthly payments.  Student loans are loans that in most cases must be paid back.  Unless you are chasing Public Service Student Loan Forgiveness or another forgiveness program, a higher monthly payment that you can afford is not a bad thing.  The sooner the loan is paid off, the less interest you will spend in the long run and the more you will save.