Pros and Cons of Income-Driven Repayment Plans

The Education Department offers a dizzying number of repayment options, each with its own eligibility rules, terms, and tricky details. In many cases, borrowers who think they’ll struggle to repay the loans once payments resume next summer will probably want to switch to one of the four types of income-driven repayments.

IDR plans offer affordable monthly payments and wipe out whatever balance remains after you’ve made payments for 20-25 years. There are drawbacks, though. Below, find the pros and cons of income-driven repaymentIncome-Driven Repayment (IDR)A category of federal student loan repayment plans that calculate monthly payments based on income and family size rather than loan balance. Any remaining balance can be forgiven after 20–25 years of qualifying payments..

\* The Education Department is reviewing borrowers’ accounts to give them credit towards IDR Forgiveness and Public Service Loan ForgivenessPublic Service Loan Forgiveness (PSLF)A federal program that forgives the remaining balance on Direct Loans after 120 qualifying monthly payments made while working full-time for a government or qualifying nonprofit employer. for past repayment, deferment, and forbearance periods. The department is starting with borrowers’ who applied for the PSLF Waiver . It expects to finish this one-time account adjustment by July 1, 2023. Read more about the IDR Waiver .

Pro: Provides affordable monthly payments

The income-driven repayment options the Education Department offers are a lifeline to people experiencing financial hardship but still want to pay what they can. Nearly all federal student loan borrowers can use one of the IDR plans to get a payment amount that fits their budget. These payments can be as low as $0 per month, depending on your taxable income, family size, loan balance, and interest rate.

Related: Can’t Pay Parent Plus Loans? Try This

Pro: Qualifies for student loan forgiveness

Not only do income-driven plans give you a lower monthly payment to fit your financial situation, but they also come with a promise: loan forgiveness. As long as you pay what the Education Department thinks is reasonable — even if it’s just $5 a month on a $100 thousand loan balance — the department will erase whatever’s left after you’ve made your final student loan payment under the plan you chose.

Each payment plan is also a “qualifying paymentQualifying PaymentA monthly loan payment that counts toward federal forgiveness programs like PSLF or IDR forgiveness. Whether a payment qualifies depends on the loan type, the repayment plan, and the borrower's employment at the time of payment. plan” for the Public Service Loan Forgiveness Program. If you work full-time for a nonprofit organization or a local, state, or federal government agency, for example, you can use the Income-Based RepaymentIncome-Based Repayment (IBR)A federal income-driven repayment plan that caps monthly payments at 10% or 15% of discretionary income, depending on when the loans were taken out. Remaining debt is forgiven after 20 or 25 years of qualifying payments. Plan to pay as little as possible while waiting for PSLF to forgive your remaining balance after 10 years of service.

Related: Student Loan Forgiveness Age 65

Pro: Protects your credit score

Income-driven repayment plans won’t hurt your credit score — despite how low your monthly payment is. The credit bureaus don’t ding your score because your student loan balance is high, but your required payment is low. Their credit scoring models check whether the required payment is being made monthly. If it is, your score may even increase.

Related: How Do Student Loans Affect Credit Scores

Pro: Offers payment plan flexibility

You can move in and out of student loan repayment plans to find the payment option that fits your situation. For example, if you want to pay off your loans quickly, you can change to the 10-Year Repayment Plan. But if you need to lower your payments for a while so you can pay bills, save for a house, or pay off credit card debt, you can switch to one of the income-based payment plans and get a payment amount based on your discretionary income.

When your financial situation improves, you can stay in your current plan or return to a plan that shortens your repayment term, increases your payment, and pays the remaining balance faster.

Con: Adds interest to your loan balance

The price you must pay for getting a lower payment is having the unpaid interest added to your loan balance. If you have a low income and high balance, chances are your payments aren’t enough to cover the daily interest added to your loan balance. In that case, it’s possible you could make payments and watch your balance grow.

Worse still, if you change plans or fail to turn in your annual recertification paperwork on time, your servicer will add the unpaid interest to your loan balance through a process known as interest capitalizationInterest CapitalizationThe addition of unpaid interest to the principal balance of a loan. After capitalization, interest begins accruing on the new, larger principal, which increases the total cost of repayment..

This isn’t a problem if you stay in the income-based plan until your student loan debt’s forgiven. But if you don’t plan on waiting around that long to get rid of your debt, you may owe a lot more than you originally borrowed.

Thankfully, the Biden administration has sought to limit interest-capitalizing events. Under the new rules, the department will no longer add outstanding interest to your balance when you exit a forbearance, leave any IDR plan other than income-based repayment, and start repayment for the first time.

This relief is not retroactive, however. So you’re stuck with the interest already added to your balance.

“Interest on top of interest can result in borrowers owing more than they borrowed for college in the first place, even when they’re following the rules and making all the payments they owe,” said James Kvaal, the Education Department’s under secretary. “That’s not fair. That’s why we’re ending this practice, except in cases where Congress specifically requires it.”

Con: Complex eligibility requirements

Qualifying for income-driven repayment can be tough if you have a mix of different loan types. This is mostly for people who went to school before 2012 or borrowed loans for a child. If you have student loans made through the Federal Family Education Loan ProgramFederal Family Education Loan Program (FFELP)The federal program that guaranteed student loans made by private lenders through 2010. Loans issued under this program are commonly called FFELP loans and are still held by millions of borrowers. (FFEL) or Parent PLUS Loans, you’ll need to consolidate those loans into a Direct Consolidation Loan before applying for most income-driven plans.

Related: Best Student Loan Consolidation Companies

Con: Has annual paperwork requirements

Unlike other payment plans, you must fill out paperwork every year to stay in an income-driven repayment plan. If your annual income changes, your payments will change. Worse, if you miss the renewal deadline, your payments will be increased to the Standard Repayment PlanStandard Repayment PlanThe default federal repayment plan, which spreads loan payments evenly over 10 years — or up to 30 years for consolidation loans. It usually results in the lowest total interest paid among federal plans. amount until you share your updated income and family size information with your servicer.

Related: When to Recertify Income-Based Repayment

Due to the freeze on student loan payments, you won’t have to recertify until six months after the payment pause ends. If you need to report your information before then — say to get a lower monthly payment before the moratorium ends — you may be able to self-report your income, which means you don’t need to turn in a tax return or pay stub. This option also ends six months after payments start again.

Con: Includes your spouse’s income in your payment

Married borrowers have a tough choice to make when choosing income-driven repayment:

• Get a lower payment but a higher tax bill by filing taxes separately.
• Get a higher payment but lower tax bill by filing taxes jointly.

Each income-driven plan will use your spouse’s income — no matter when you met — if you file a joint tax return. But if you file married filing separatelyMarried Filing Separately (MFS)A federal tax filing status for married couples in which each spouse files an individual tax return. On most IDR plans, filing separately allows a borrower's payment to be based on their own income rather than household income., some of the plans will look at just your income. Read more about how married filing separately affects student loans.

Confusingly, your spouse will still need to sign the IDR form.

Related: Marrying Someone With Student Loan Debt

Con: Increases your tax bill

The IRS taxes the debt that’s forgiven after you’ve made your final student loan payment under your IDR plan. Depending on your loan balance and interest rate, you could end up owing tens of thousands of dollars in taxes for a debt you just escaped.

The federal government is working to change that outcome. Lawmakers started by passing the American Rescue Plan Act of 2021. That law made all student loan forgiveness and cancellation under any program — IDR Forgiveness, Borrower Defense to RepaymentBorrower Defense to RepaymentA federal process for discharging Direct Loans when the school misled the borrower or engaged in misconduct related to the loan or the educational services it promised., and so on — tax-free through 2025. The Biden administration is working on other fixes to remove the tax liability.

Are IDR plans a good idea?

Income-driven repayment plans are good for borrowers who need a longer-term repayment option due to unemployment or a drop in income rather than pausing payments temporarily with a deferment or forbearance. These plans tie your payment amount to your income, yielding monthly payments as low as $0. And after a couple of decades of payments, the Department of Education writes off the remaining loan balance.

You can stay in an IDR plan as long as you qualify

Your IDR plan will last as long as you meet the eligibility requirements and recertify your income and family size every year. You’ll be able to stay in that plan until you pay the balance or you make your final qualifying payment to get your loans forgiven. Read more about IDR ForgivenessIDR ForgivenessThe forgiveness of any remaining federal student loan balance after a borrower has completed 20 or 25 years of qualifying payments under an income-driven repayment plan, depending on the specific plan..

How to apply

If you’re married, you must provide proof of income for you and your spouse. You can use the adjusted gross incomeAdjusted Gross Income (AGI)A borrower's total taxable income minus specific deductions, as reported on a federal tax return. Federal income-driven repayment payments are generally calculated using AGI. (AGI) from your tax return, pay stub, and so on.

The advantage of applying online is that you can pull your AGI from your most recent federal income tax return using the IRS’s data retrieval tool. Otherwise, you must upload, fax, or mail the application and income information to your service provider.

Keep in mind that you’ll need to recertify your income and family size every year. Also, if you’re currently repaying your loans under a different repayment plan, your servicer may apply a forbearance to your account while it’s working on your request.

Plan

Monthly payment

New repayment period

Eligible loans

1. Income-Based Repayment Plan (IBR plan)

10% of your discretionary incomeDiscretionary IncomeFor federal income-driven repayment plans, a borrower's adjusted gross income minus a set percentage of the federal poverty guideline for their family size. Monthly IDR payments are calculated as a percentage of this amount. if you’re a new borrower on or after July 1, 2014, 15 percent of your discretionary income if you’re not a new borrower on or after July 1, 2014.

20 years if you’re a new borrower on or after July 1, 2014, 25 years if you’re not a new borrower on or after July 1, 2014.

FFEL Loans, Direct Loans, including Perkins Loans if consolidated. Parent PLUS Loans aren't eligible.

2. Income-Contingent RepaymentIncome-Contingent Repayment (ICR)The oldest federal income-driven repayment plan, with payments generally set at 20% of discretionary income or a fixed 12-year amount, whichever is lower. It is the only IDR plan available to Parent PLUS borrowers after consolidation. Plan (ICR plan)

The lesser of 20% of your discretionary income or the amount you would pay on a 12-year repayment plan with a fixed payment.

25 years.

3. Pay As You EarnPay As You Earn (PAYE)A federal income-driven repayment plan that caps monthly payments at 10% of discretionary income and forgives remaining debt after 20 years. It is only available to borrowers who took out their first federal loans on or after October 1, 2007. Plan (PAYE plan)

10% of your discretionary income.

20 years.

4. Revised Pay As You EarnRevised Pay As You Earn (REPAYE)A former federal income-driven repayment plan that capped payments at 10% of discretionary income, with forgiveness after 20 or 25 years. REPAYE was replaced by the SAVE Plan in 2023. Plan (REPAYE plan)

10% of your discretionary income.

20 years for undergraduate loans, 25 years for graduate and professional loans

Direct Loans; FFEL loans if consolidated; Perkins Loans if consolidated. Parent PLUS Loans aren't eligible.

Don’t think income-driven repayment is right for you?

If the income-driven repayment options don’t work for you, check out the Graduated and Extended Repayment Plans. Both plans lower your payments by stretching your repayment period over two to three decades, depending on your loan balance. You may pay more interest under these plans over the life of the loan, though.

Student loan refinancingRefinancingTaking out a new private loan to pay off one or more existing student loans, usually to lower the interest rate or change the repayment term. Refinancing federal loans into a private loan eliminates federal benefits like IDR and PSLF. is another option. If you have a good credit score and enough income to pay your bills and student loan debt, you might snag a better interest rate from a private lender. It makes sense to refinance if you’ll likely repay your loans before they’re forgiven. But refinancing federal student loans is risky. Private student loans don’t qualify for federal benefits like income-driven repayment and loan forgiveness. Make sure you’re okay with losing those options before refinancing.

Related: How to Refinance Federal Student Loans

Bottom Line

The freeze on federal student loan payments and interest will end in 2023. If you think you might have trouble making your payments, consider enrolling in an income-driven repayment plan. These plans will give you a payment that lets you pay less each month. At the end of the loan term, the government will forgive what you owe. give you a manageable payment but also lead to your debt being forgiven at the end of the loan term. This takes 20 years for undergraduate loans and 25 years for graduate school loans.

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