By my estimation, approximately 10 million federal student loan borrowers are enrolled in the wrong repayment plan.
The math is pretty simple: almost all borrowers should sign up for an IDR plan. According to the latest government statistics, only about 38% of borrowers enroll in IDR plans like IBR, PAYE, and REPAYE.
Some people claim they make too much to benefit from IDR. Others want to repay their loans quickly, so they pick another repayment plan. Even if you have a high income or an aggressive repayment mindset, IDR is still the best option in most cases.
Repayment Plan Stats: It is possible that IDR enrollment will increase after the federal student loan payment and interest freeze. However, the IDR enrollment statistics of 2019 similarly show less than 40% enrollment.
IDR has the Lowest Monthly Payment for Millions of Borrowers
One of the great features of IDR is that borrowers can make payments based on what they can afford rather than what they owe. For many borrowers, this means $0 per month payments.
With college prices continuing to grow and wages remaining stagnant, the number of borrowers who benefit from IDR increases each year.
It’s also worth noting that there are no prepayment penalties with federal student loans. Borrowers are permitted to pay extra whenever they like. A lower IDR payment means the borrower has a lower minimum monthly payment. If you want to pay your loan off in ten years, there is no harm in making payments according to a 10-year repayment schedule while staying enrolled in an IDR plan.
This approach may sound silly, but it has major advantages.
The big advantage for all borrowers is flexibility. If you have car trouble or need to make repairs to your house, the low minimum payment makes weathering the storm easier. Once the temporary financial hardship passes, you can resume making larger payments.
Another advantage to enrolling in an IDR plan — even if you don’t need the reduced payments — is the progress towards loan forgiveness. If you have to retire early or face a permanent pay cut, the time on IDR counts towards forgiveness. If there is even a chance that you might seek forgiveness one day, it makes sense to get started on IDR whenever possible.
Picking the Lowest Monthly Payment is Usually the Smart Move
A low minimum monthly payment allows borrowers to focus on bigger financial priorities.
There is a long list of items that are arguably more important than paying down your federal loans:
- Credit Card Debt – Living with student loans is tough, but credit card debt is often worse. Credit card interest rates are usually above 20%. This debt should get paid off before your student loans. If you can lower your student loan payment, you can make bigger payments towards your credit cards.
- Emergency Fund – Do you have money set aside for a rainy day? Are you living paycheck to paycheck? An emergency fund should be a high-priority goal for all student loan borrowers.
- Private Loans – If you have a private student loan, it often makes sense to pay off this debt first. A lower federal student loan payment frees up more cash to attack your private loans.
- Buying a House – Saving up for a down payment is a considerable challenge. If you spend less on student loans, you move closer to home ownership.
- Saving for Retirement – Retirement may seem like a far-off goal, but saving now will make the future much easier. If you can get employer matching at work, it’s almost always a good idea to max that out. IDR payments and saving for retirement work really nicely together.
Eliminating student debt is an important goal, but it’s not the only thing. Planning a student loan strategy requires thinking about your other obligations and goals. In many cases, opting for a low minimum payment can make a big difference.
Even if IDR isn’t the Lowest Payment, it may be the Best Choice
Some Borrowers will find that IDR doesn’t result in the lowest monthly payment. They may discover that graduated and extended repayment options generate the lowest monthly bill.
In this situation, paying a little extra to enroll in an IDR plan could make sense.
Student loan forgiveness may not be on your radar now, but it could be in the future. Spending a little extra to sign up for an IDR plan might provide valuable months towards student loan forgiveness. Your income might change, or the federal rules might change.
If monthly payments are relatively close, picking IDR keeps more doors open for future opportunities.
Sherpa Tip: If you are curious about your various repayment options, check out the Department of Education’s Loan Simulator.
The Loan Simulator will estimate monthly payments based on your actual loan information and the income information you provide.
IDR Can Work Well for Borrowers with Larger Incomes and Smaller Balances
IDR is still a better choice, even if you can easily afford monthly payments on the 10-year standard repayment plan.
Even though monthly payments on the various IDR plans increase as your income increases, the ICR plan has a special provision for borrowers in this circumstance.
Income-Contingent Repayment (ICR) typically charges 20% of a borrower’s monthly discretionary income. However, ICR only charges this amount after first looking at what a borrower would pay on a 12-year repayment plan. If the 12-year analysis gives a lower monthly payment, the borrower’s ICR payment may be significantly less than 20% of their discretionary income.
The exact ICR calculation is fairly complicated, so let’s look at an example with actual numbers…
ICR Magic for High Income, Low Balance Borrowers
Suppose a borrower has an adjusted gross income is $80,000 and only owes $10,000 on their federal student loans, which charge a very reasonable 4% interest. On paper, this is someone who should be able to quickly repay their federal loans without the help of an income-driven repayment plan.
The standard 10-year plan would result in a monthly bill of $101, which should be very affordable to a borrower with an $80k per year salary. However, by enrolling in ICR, the borrower would pay $93 per month.
In this situation, the selling point isn’t saving $8 per month. The value is enrollment in an IDR plan. If the borrower works in a PSLF-eligible job, they may get some of their debt forgiven. If the borrower gets their pay cut significantly or has to retire early, the time on ICR could be valuable progress towards IDR forgiveness.
Admittedly, this is a pretty extreme example. Our 80k per year borrower probably doesn’t need any forgiveness to manage their 10k debt. However, even if it is a long shot, the possibility remains. ICR enrollment costs this hypothetical borrower nothing and keeps the door of forgiveness cracked open.
Even with smaller debts and higher incomes, IDR enrollment can still work.
When Isn’t IDR the Best Choice?
There is a reason for putting the big asterisk in the title. IDR isn’t always the best choice for all borrowers.
If you live in a high cost of living area, the IDR payment calculations might be unfairly high. If the IDR calculation causes a monthly payment higher than what you can realistically afford, a plan like the graduated or extended repayment plan might be the best option.
Another problem exists for people who have impulse control issues. While there is a long list of ways to take advantage of low minimum payments, it’s also possible to waste the opportunity. If you need high minimum payments to force yourself to pay extra, it could make sense to avoid IDR.
Finally, sometimes the best choice is a private loan refinance.
When Does Private Loan Refinancing Enter the Equation?
IDR is great because it opens doors. It allows borrowers to focus on other financial goals, and it makes federal student loan forgiveness a possibility.
What happens if you don’t need any of the IDR perks?
Suppose you are confident you can pay off your debt in full. You conclude that forgiveness will never happen and want to knock out your student loans.
In that scenario, the detail that really matters is your interest rate. The higher the interest rate, the more you spend knocking out your federal loans.
In this limited situation, refinancing with a private lender could make sense. If you get charged 6.8% interest on your federal loans, and you can refinance your debt at 2-3%, the savings could be considerable.
As of December, 2022, the following lenders offer the lowest student loan refinance rates:
|Rank||Lender||Lowest Rate||Sherpa Review|
|T-1||2.50%||Splash Financial Review|
|T-1||2.50%||Laurel Road Review|
Enrollment and Picking the Best Income-Driven Repayment Plan
Even though IDR plans have many advantages, they also have drawbacks.
The enrollment process intimidates many borrowers new to IDR.
A significant area of confusion is IDR plan selection. Borrowers can choose Income-Contingent Repayment (ICR), Income-Based Repayment (IBR), Pay As You Earn (PAYE), or Revised Pay As You Earn (REPAYE). The best option will depend upon many different factors, including your marital status and when you went to school. The Federal Loan Simulator can help estimate payments on the various plans, and there are many different articles written that help borrowers identify the best plan for their circumstances.
Even if you pick the “wrong” IDR plan, it is often only a minor mistake. For many borrowers, a less than ideal IDR plan is still better than most of the other federal repayment plans.
If you want to get signed up for an IDR plan, the Department of Education processes applications online. The entire process typically takes less than 10 minutes.