I’m a big fan of the income-driven repayment plans. Borrowers in over their head have a light at the end of the tunnel. Savvy borrowers looking for an edge have a useful tool for a number of different strategies. Plans like IBR, PAYE, and REPAYE are one of the great perks about having federal student loans.
Despite my love for income-driven repayment plans, I must admit that there is a small group of borrowers who should avoid these plans. Today we will discuss the limited circumstances in which IBR, PAYE, and REPAYE are mistakes.
Minimum Payments When You Can Afford More
This trap is easy to fall into and can be very expensive. With federal interest rates routinely in the 7-8% range, the interest on the loans can be quite as expensive. I’ve argued that paying the minimum on these loans is the ideal approach… but that strategy hinges on aggressively paying down your highest interest loan. If you pay as little as possible for as long as possible, it maximizes interest spending.
Some borrowers will only pay the minimum. If you are someone who pays what is required on the monthly bill and nothing more, an income-driven repayment plan could be a mistake. Payments on the standard repayment plan may cost more each month, but they will eliminate the debt faster and spend less on interest.
A common example of the dangers of minimum payments can be seen with borrowers chasing student loan forgiveness. For some, loan forgiveness is a great deal, for others it actually costs more money due to interest and tax consequences. This forgiveness example demonstrates how getting student loans forgiven might be the expensive route.
Borrowers who are certain they will be able to pay off their loan in full can benefit from refinancing with a private lender. This process means giving up the perks associated with federal loans, but by locking in interest rates at around 2%, the potential savings can be significant.
If Deadlines Will Be Missed
The key requirement to participating in plans like IBR, PAYE, and REPAYE is that you have to submit income verification each year. Missing this deadline reverts back to the standard repayment plan. It can also cause “administrative forbearances” which means you won’t have a bill for a month or two, but that interest on your account will continue to accrue.
These deadline related issues can cause headaches and extra interest spending.
Signing Up for the Wrong Income-Driven Repayment Plan
Speak to some borrowers and they will tell you that the income-driven repayment plan is the best. Others will say that it is the Revised Pay As You Earn Plan. The truth is that it really depends upon your individual circumstances. The important thing to take away is that there are major differences. The resources below will help your sort out those differences.
When you apply for an income-driven repayment plan, the application form actually recommends select an option that enrolls them in the plan that results in the lowest monthly payments. This is a mistake. Plan selection should account for your tax strategy, spouse’s finances, and your overall debt level. The analysis isn’t especially complicated, but it shouldn’t be overlooked.
Resources to Review:
- Department of Education’s Income-Driven Plan FAQ – This pages is really helpful for reviewing some of the fine print and determining eligibility.
- Student Loan Sherpa Article on Picking the Best Income-Driven Plan – This article was written to help people decide between the three most popular plans. It explains how things like debt level and marital status can influence your plan selection.
- Studentloans.gov Federal Repayment Estimator – This tool was made by the Department of Education and can pull your actual student loan information to provide estimates of monthly payments on various plans.