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The Downside to Income-Driven Repayment Plans Like IBR, PAYE and REPAYE

IDR plans have a ton of borrower-friendly features, including student loan forgiveness. However, they have some flaws that all borrowers should understand.

Written By: Michael P. Lux, Esq.

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The Income-Driven Repayment plans were created to ensure that borrowers could afford their monthly student loan bills no matter how large their balance.

Many experts — myself included — argue that IDR plans like IBR, PAYE, and REPAYE make federal loans the best student loan option available.

However, IDR plans are not perfect. In some cases, IDR might not be the best choice for every borrower.

You might pay more over time.

Typically, low monthly payments are a perk — not a downside. However, spending less each month on your student loan payments prolongs the time it takes to repay the debt.

For some borrowers, paying off the debt quickly is the best approach. The faster your balance drops, the less you spend on interest. If your federal loan has a high interest rate, quickly eliminating the debt can result in significant savings.

IDR is best suited for borrowers with large balances who cannot afford any other repayment plans. For these borrowers, IDR presents a path to debt freedom in 20 to 25 years.

If your entire loan balance will be repaid, or mostly repaid by the time you reach forgiveness, consider an aggressive strategy. By prolonging payments on IDR, you spend more on interest. For many, chasing forgiveness could be the more expensive route.

You have to certify your income yearly.

IDR repayment is not a set it and forget it option.

Once a year, borrowers must submit income verification documents to the Department of Education. This information is used to calculate monthly payments for the following year.

If you miss an income certification deadline, it could be an expensive mistake. When borrowers fail to certify their income, they get placed back on the standard repayment plan. Crucially, the change in repayment plans causes interest capitalization.

Submitting your yearly IDR certification takes very little time. However, this tedious yearly task cannot be avoided.

If your debt is forgiven, it might be taxed.

Borrowers call the big tax bill for IDR forgiveness the “Tax Bomb.”

The basic rule is that if debt gets forgiven, the IRS treats it as income the year it gets forgiven. If you have $60,000 of student loan debt forgiven on an IDR plan, it could mean the IRS taxes you as though you earned an extra $60,000 that year.

The good news for borrowers is that this particular tax has been eliminated until 2026. However, your forgiven debt could be taxed if you won’t reach IDR forgiveness until a later date.

Sherpa Thought: I think the IDR tax bomb will be permanently eliminated at some point. It is bad public policy and terrible for borrowers.

However, the possibility of that large tax bill in the future exists. Due to this financial threat, it is a good idea to have a backup plan in place.

IDR payments are higher for married people.

One of the biggest flaws with IDR repayment is that it is more expensive for married borrowers.

There are ways to minimize the damage. For example, some borrowers on PAYE and IBR file their taxes separately. However, borrowers on REPAYE don’t have this option.

No matter how you file your taxes, there is still a marriage penalty. Either you pay more in taxes, or you have higher IDR bills.

Ending the marriage penalty should be an easy decision for the government, but this issue rarely gets much attention.

IDR enrollment makes filing taxes more complicated.

Even if you are single, tax season greatly impacts IDR payments.

The Department of Education usually calculates IDR payments based on your most recent tax return. Specifically, they look at your Adjusted Gross Income (AGI). As your AGI goes up or down, your monthly IDR payment changes.

For borrowers, this means that the deductions you claim, the retirement accounts you use, and the timing of filing your taxes are important details.

In short, tax time is a critical time for student loan borrowers.

IDR is still the best choice for most borrowers.

Now that we have aired the dirty laundry, I think it’s important to point out one fact: IDR, though flawed, is a tremendous resource for many borrowers.

If you are struggling financially or out of a job, $0 per month payments are possible.

Additionally, IDR enables borrowers with massive student debt to save for retirement or focus on other important financial goals like buying a house.

We should try to tweak IDR to improve the flaws of the current system. However, with warts and all, IDR is still the best option for a large percentage of federal borrowers.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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