Picking your first student loan repayment plan can be an overwhelming and scary time.
The standard repayment plan may sound like a good starting point, but it often carries the highest monthly payments. Income-Driven Repayment (IDR) might sound good, but similar-sounding names like Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE) quickly make things confusing.
Is it a good idea to pick the plan with the lowest monthly payment? Which plans qualify for loan forgiveness? How do you avoid a mistake?
Sherpa Tip: This is an extensive article covering the various aspects of selecting a repayment plan and the strategies involved.
Feel free to skip through sections that don’t apply to your loan situation.
Also, if you want the easy answer for most borrowers: it’s an IDR plan. Pick the IDR plan with the lowest monthly payment. I will show my work below, but if you are in a hurry, opting for an income-driven repayment plan is usually the safest first student loan repayment plan.
Don’t Panic: Changing Repayment Plans is Easy
Every student loan decision can seem high stakes. Balances are often large and scary, and we have all heard student loan horror stories.
Picking your first student loan repayment plan is a low-stakes decision. You can always change repayment plans. If you pick a 25-year repayment plan, you are not committed to it for the next 25 years.
If anything, the one big mistake to avoid is losing eligibility for the various student loan forgiveness programs. The good news is that it is easy to confirm whether or not the plan you select will be eligible for all of the federal student loan forgiveness programs.
Income-Driven Repayment is the Best Option for Most Borrowers
Income-Driven Repayment, usually shortened to IDR, refers to a category of repayment plans.
Before jumping into the specifics of the various IDR plans, it is important to first cover the many similarities they share. These common features make IDR plans far superior to the other federal repayment plans — especially for borrowers starting repayment.
IDR Plans Keep the Door Open on Forgiveness
The path to a zero-dollar balance isn’t always obvious when starting student loan repayment. It might also change as life circumstances change.
Starting with an IDR plan is preferable because IDR plans count towards the various federal student loan forgiveness programs. Borrowers starting in repayment don’t necessarily need to understand the intricacies of each forgiveness option. They just need to know that IDR keeps that door open.
Borrowers Picking Their First Repayment Plan Often Qualify for $0 Per Month Payments
IDR payments are typically calculated based on your most recent tax return.
For recent graduates, this often means little or no income. Thus, it is common for people starting repayment to qualify for $0 per month payments on an IDR plan.
Borrowers can always pay extra without penalty, but qualifying for extremely low or $0 per month payments provides flexibility during a time of significant life changes.
The $0 per month payments will last for 12 months. Before the year ends, borrowers must submit new income documentation. At that point, payments get adjusted to match the newest tax return on file.
Signing Up for Your First Repayment Plan
Borrowers don’t actually have to sign up for a repayment plan. However, if they don’t pick a plan, one will be selected for them.
The problem with going this route is that the 10-year standard repayment plan is the default option. Of all the federal repayment plans, it is the one that usually results in the highest monthly payment.
Thus, the best move for most recent graduates and borrowers entering repayment is to sign up for an IDR plan before starting repayment.
How to Enroll in an IDR Plan
The Department of Education makes IDR enrollment pretty simple.
Studentaid.gov has a page dedicated to IDR enrollment and income verification. The built-in IDR data retrieval tool allows borrowers to document their income with little effort. Borrowers can complete an electronic application without having to print any documents or mail any paperwork.
The Department of Education estimates that the process takes less than 10 minutes.
For borrowers that wish to avoid an electronic application, a paper form is also available.
Picking the Right Income-Driven Repayment Plan
Selecting the best IDR plan isn’t always easy.
One helpful resource is the Student Loan Simulator. This tool, provided by the Department of Education, allows borrowers to see estimated payments on the various repayment plans.
This tool sometimes falls short in helping borrowers decide between the various IDR plans. For example, borrowers that qualify for $0 per month payments usually have multiple repayment plans with a $0 payment.
In this scenario — and for most recent graduates — the REPAYE plan is usually the best option. REPAYE comes with an interest subsidy that can cover a portion of the monthly interest accrued. If your monthly bill is lower than the interest your loan generates each month, REPAYE is an excellent option.
For borrowers that are married or have Parent PLUS loans, a deeper dive into the various IDR plan options is often necessary.
Sherpa Tip: New IDR plans may become available in the future that lower payments for all borrowers and allow a greater percentage of borrowers to qualify for $0 per month payments.
There is a new version of REPAYE currently in development.
Long-Term IDR Benefits
Thus far, we have only looked at IDR from the perspective of a borrower starting repayment.
It’s worth noting that the IDR benefits are long-lasting. Most borrowers will benefit from sticking with IDR for the duration of their loan repayment.
The obvious benefit is qualifying for forgiveness under a program like Public Service Loan Forgiveness. Repaying only a fraction of the debt and having the remainder forgiven is a great deal.
However, loan forgiveness isn’t the only benefit of IDR repayment. It is just the tip of the iceberg.
IDR Allows Borrowers to Focus on Other Risky Debts
Borrowers that use IDR to lower their monthly payments should have more cash available to attack credit card debt or high-interest student loans.
Given the many borrower protections associated with federal loans, focusing on eliminating private loans or credit card debt is a smart move. Borrowers can save money on interest and protect themselves if they lose their job or face a financial emergency.
Lower Payments During Financial Stress
When borrowers certify their income for an IDR plan, that certification is good for 12 months.
However, if the borrower faces a change in circumstances, they can immediately request a new payment calculation.
Borrowers that lose their job can submit a new income verification, certify that they don’t have any income, and lower their monthly bill to $0. This feature makes IDR plans well-suited to help borrowers navigate any period of unemployment.
Avoiding Deferments and Forbearances
Deferments and forbearances sound better in theory than how they actually behave in practice.
Pausing payments is great, but outside of a couple of exceptions, interest continues to accrue. By the time the deferment ends, the borrower is left with a larger balance.
Additionally, deferments and forbearances are limited resources. Once a borrower maxes out their hardship remedies, they must begin repayment.
By comparison, sticking with a plan like REPAYE is better. Borrowers can get affordable monthly payments, continue on REPAYE indefinitely, get help with the accruing interest, and make progress toward forgiveness.
For this reason, deferments and forbearances are usually a mistake.
Buying a House Could be Easier with IDR
The underwriting process for buying a house is notoriously tricky for student loan borrowers.
IDR can be the difference between buying a house and renting for student loan borrowers with large federal debt balances and more modest incomes.
The Risks and Concerns of IDR Repayment
Even if IDR is the best plan for most borrowers, it certainly isn’t the best repayment option for all borrowers.
There are a few potential issues with IDR that all borrowers should understand.
IDR Danger #1: Interest
Low monthly payments are great, but they can mean you rack up more interest.
Some borrowers may spend more money chasing forgiveness than what they would have paid if they tried to pay off the loan as quickly as possible.
IDR is best suited for borrowers struggling to manage their debt. The more money you make and the smaller your debt, the less benefit to IDR.
IDR Danger #2: Yearly certification
Sticking with IDR is a bit more high maintenance than other repayment plans.
Each year borrowers must certify their income. Failure to meet the deadline means the borrower gets put back on the standard 10-year repayment plan.
Income certification only takes a few minutes, but it is an essential step for all IDR borrowers.
IDR Danger #3: Increased Income
This “danger” of IDR should be pretty obvious.
The more money you earn each year, the more you have to pay on an IDR plan.
At a certain point, your income might become large enough that IDR no longer makes sense.
IDR Danger #4: Marriage
This last danger of IDR is probably the biggest one.
Getting married makes IDR payments more expensive. Some IDR plans allow borrowers to file taxes separately, but that usually means a larger tax bill. Make no mistake: there is a marriage penalty for IDR borrowers.
It is one of the aspects of IDR repayment that is incredibly unfair.
Digging Deeper: Advanced IDR Strategy
Now that we’ve covered most of the pros and cons of IDR, you might be ready to learn how to maximize the benefits.
Here are a few topics worth investigating:
- Using IDR to help maximize retirement savings
- Cleaning up student loan payments to prepare for a mortgage application
- Tax strategies to lower IDR payments
Dealing with IDR repayment isn’t always easy, but it is the best choice for most borrowers.
If you are starting your repayment journey, an IDR plan is often the best option.