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How Income-Driven Repayment Plans Work

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Student loan payments based on income seem like the answer for students worried about taking on too much student loan debt. However, they aren’t guaranteed to exist upon graduation and the income-driven repayment amounts don’t take into account the cost of living in expensive cities like New York, Los Angeles, and San Francisco.


Here’s what your family needs to know about income-driven repayment plans before the first dollar is borrowed for student or parent loans:


Why income-driven plans exist


Income-driven repayment plans exist so that if you’re unemployed or in a lower paying job, you can still afford your student loans. Most federal student loans qualify. For many, it allowed them to consider public service employment that may pay less. 


Private student loans aren’t included.


If you have private student loans beyond federal student loans, these aren’t included in income-driven payment plans. Thus, when you borrow them, you have to consider the payment amount stated for each private student loan as what you’ll pay. Then, federal student loan payments are an additional amount.


Always consider the 10-year payment, or at least a 30-year consolidated payment, as the maximum amount you’ll pay for federal student loans. This way you’re always prepared no matter how much your income-driven payment rises.


There are many types of income-driven repayment plan options, but one that is the most important.


You may see a big list of types of income-driven repayment plans, but the main option for new students is Pay As You Earn.  This plan takes 10% of discretionary income. While discretionary income is hard to calculate, you can estimate what the payment could be using the Repayment Estimator calculator.


Payments start as low as $0.


While payments can be as low as $0 with no income or income relatively close to the poverty line, payments can rise quickly as a graduate’s income does. For instance, in a students first year or two after college with internships and entry level jobs, they may qualify for a $0 payment or a payment that is less than $100. As their income grows, they may not qualify at all.


This is when it’s important to calculate extended repayment plans of up to when deciding a maximum amount to borrow. An extended payment can be half the amount of the payment on a 10 year plan. You can switch payment repayment plans. Just don’t switch if you have any inkling you could qualify for Public Service Loan Forgiveness.


The Repayment Estimator can estimate payments for a variety of federal student loans.


Payments are recalculated on an annual basis.


Probably the most important part of staying on an income-driven repayment plan is submitting annual income verification. You’ll have to verify income every year. Otherwise, you’ll be put on a standard 10-year repayment plan that get quite pricey. The standard payment on $50,000 with a 4% interest rate is over $500. 


Parent income-driven repayment is more complicated.


Parents can qualify for a income-driven repayment plan called income-contingent. The payment is a bit higher than the one commonly used for students, and parents have to consolidate student loans to one direct lending loan.


The cap on the payment amount is the same as the 10-year repayment amount.


These plans are essentially required for Public Service Loan Forgiveness


If you or your student is striving for Public Service Loan Forgiveness, the remaining balance is forgiven after 10 years of on-time payments in either the standard 10-year repayment or income-driven options. If paying the standard payment for 10 years, there would be nothing to forgive.


Note: These are the most important facts you need to know before starting income-driven repayment. There are other important facts for repayment. But if you learn what’s in this primer, you’ll have a good information base for deciding how much to borrow.


5 Takeaways

  • Income-driven federal student loan repayment plans are helpful for students who can’t afford higher student loan payments. Payments may be as low as $0.
  • Private students loans don’t qualify.
  • Parents qualify, too, for Parent PLUS and their own their own loans. However, they have to choose the income contingent plan.
  • You have to be on income-driven option to have a chance at qualifying for Public Service Loan Forgiveness.
  • Income-driven repayment options aren’t always the lowest payment option.

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