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Income-Based Student Loan Repayment: What Are Your Options?

Christopher Nagel, CFA


Student loans and the ways we go about repaying them remain in the news because, in one way or another, they affect so many of us. Whether in debt to their eyeballs or benefactor of a full ride to a college or university, millions of Americans with student loan debt are burdened by their payment obligations. One strategy for budgeting and planning repayments: income-based student loan repayment.

There are several plans that employ the income-based student loan repayment strategy, but the general idea is the same: lower the borrower’s monthly payments to a manageable number—that is, a percentage of their monthly income—and after a set period of time have the remaining balance forgiven. The main differences among the plans are the percentages of income to be paid monthly and the terms before the loans are forgiven.

Income-Based Repayment (IBR)
There are two types of IBR: Old and New. Old IBR refers to loans taken out before July 1, 2014. The repayment term is 25 years, the monthly payments come to about 15 percent of the borrower’s discretionary income, and the loans must be federal student loans. New IBR, which is slightly more advantageous to the borrower, applies to loans taken out on or after July 1, 2014. The repayment length is 20 years, the monthly payment amount is limited to 10 percent of the borrower’s discretionary income, and again, the loans must be federal student loans. For both types of plans the borrower must make monthly payments through the end of the repayment period. At that time the remaining balance will be forgiven. However, the balance of the forgiveness will be considered taxable income to the borrower in the year it is forgiven.

Those who are best suited for IBR meet the following criteria:
• They don’t expect their income to increase much over time.
• They may have graduate school debt.
• They are married, and their spouse also has income.
• They don’t qualify for a Pay As You Earn plan.

Pay As You Earn (PAYE)
A PAYE plan is similar to the IBRs, but with an additional benefit. Like New IBR, PAYE caps monthly payments at 10 percent of the borrower’s discretionary income and the payment term is 20 years. But it also limits capitalized interest to 10 percent of the outstanding balance. This benefit comes into play at forgiveness. If a borrower does not qualify for PAYE, the 10 percent cap does not apply and interest continues to grow on the borrower’s outstanding balance while the monthly payments are made, which means forgiveness will be for a larger amount. In a vacuum, the larger benefit seems good, but in the case of income-driven repayment it also means a bigger tax bill. PAYE is an improved version of IBR, but to qualify, loans must be taken out after October 1, 2007.

Revised Pay As You Earn (REPAYE)
Among income-driven options, REPAYE offers the most advantageous combination of low monthly payments and availability. The plan is best for single borrowers with no graduate school debt who do not qualify for other income-driven repayment plans, and who expect their income to increase substantially in the future. The repayment length is 20 or 25 years and payment amounts are 10 percent of the borrower’s discretionary income. The principal benefit is a more generous interest subsidy, which reduces the interest accrued on the loan but also the forgiveness benefit.

Public Service Loan Forgiveness (PSLF)
The PSLF plan is the most beneficial repayment plan for those who qualify, the coup de grace of loan forgiveness plans. The program is similar to other loan forgiveness programs, but after the borrower has made 120 qualifying monthly payments under a qualifying repayment plan while working full-time at a qualifying employer, the remaining balance is forgiven tax-free. The program is less well known than others, likely because so many borrowers either don’t qualify or incorrectly handle the process and nullify their eligibility at some point during the 10-year repayment term.

If you do not qualify for an income-based student loan repayment plan, you could opt to refinance your higher interest loans. Doing so will make you ineligible for any forgiveness programs, so consider all your options before proceeding with a refinance.

If you have questions about repayment options for your federal loans, please reach out to an HBKS financial advisor. Besides being able to talk through your options outside of forgiveness programs, we partner with firms that specialize in helping people with student loans choose the best option for them. The PSLF is an especially cumbersome process—the number of applicants that nullify their eligibility during the repayment term is high—and it helps to have guidance through the 10-year repayment term. The potential benefits of loan forgiveness are substantial, and getting it right is important to any borrower’s financial well-being.


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