What is income-driven repayment?

Income-driven repayment plans are an option for federal student loans that use your income and family size to determine your monthly payment. Because the monthly payments depend on your income, payments often become much more affordable during lean financial times.

What is income-driven repayment?

One of the primary benefits of federal student loans is that they offer income-driven repayment plans. These plans have historically set monthly loan payments at a percentage of your discretionary income to make the payments more affordable. Income-driven repayment plans also benefit from forgiving any remaining loan balance at the end of the repayment term.

With the introduction of the Biden Administration’s Saving on a Valuable Education (SAVE) income-driven repayment plan, which includes a new formula for determining discretionary income, these types of payment plans are becoming even more affordable for borrowers with millions even qualifying for $0 payments.

How do income-driven repayment plans work?

So, what is income-driven repayment, and how does it work? These plans calculate your monthly loan payment as a percentage of your discretionary income. Discretionary income is the difference between your annual income and 100 to 225 percent of the federal poverty guidelines, depending on your repayment plan, family size and location.

The exact percentage depends on the specific plan but often ranges from 10 to 20 percent.

Some income-driven repayment plans, like Revised Pay As You Earn (REPAYE), have what’s often referred to as a marriage penalty; this is where the loan payments are based on the joint income of married borrowers, resulting in a higher monthly bill. To avoid this, you’ll have to sign up for a plan like Pay As You Earn (PAYE), which will use only your income as long as you and your spouse file separate federal income tax returns.

Types of income-driven repayment plans

There are four types of income-driven repayment plans you can apply for:

Which income-driven repayment plan is best?

The best income-driven repayment plan depends on your financial situation and loan type. For instance, if you have FFEL loans, your best option to avoid consolidation is to go for the Income-Based Repayment Plan. If you’re a parent who took out a loan for your child’s education, your only option is the Income-Contingent Repayment Plan.

If you have Direct Loans, the choice is trickier because more options are available. Because there’s no right answer for everyone, use the U.S. Department of Education’s loan simulator to see which repayment plan makes sense for you. When you input your loan amount, income and family size into the calculator, you’ll see which plan results in the lowest monthly payment.

How much you’ll pay on income-driven repayment

Loan servicers will set payments based on your discretionary income. All loan servicers use a standard formula to determine this amount, so it’s easy to calculate yours with some basic information.

To determine your discretionary income, look for the difference between your adjusted gross income (AGI) and either 100 or 150 percent of the federal poverty level for your family size and where you live. Most income-driven repayment plans use the 150 percent limit, though Income-Contingent Repayment uses 100 percent and the new SAVE plan uses 225 percent of the federal poverty level.

Here’s an example based on 150 percent of the federal poverty level.

Imagine your adjusted gross income is $45,000 and you live in Indianapolis, Indiana. In 2022, 150 percent of the poverty guideline is $20,385 for a family of one in Indianapolis. The difference between your AGI and this amount is $24,615. That’s your discretionary income.

If you paid 10 percent of this amount under an income-driven repayment plan, you would pay $2,461.50 for the year and $205.13 monthly.

Let’s see how that math changes if you have three kids. If you’re a family of four, 150 percent of the 2022 poverty guideline is $41,625. The difference between this amount and your AGI is only $3,375. If you owed 10 percent of this amount on an income-driven repayment plan, you would only pay $337.50 on your student loans for the year. That’s only $28.13 per month.

Is income-driven repayment a good idea?

Income-driven repayment can be good for those with high loan balances and low incomes. It’s also a smart strategy for borrowers who are struggling with their payments and don’t want to refinance their student loans and those who want to avoid entering deferment or forbearance.

Consider your main goal if you’re considering signing up for an income-driven repayment plan. If you want to pay off your loans quickly or near the end of your repayment period, an income-driven repayment plan may be a bad choice. You would likely be extending the life of your loan by making reduced payments. This also means you will pay more in interest over the life of the loan.

However, if you need relief from your monthly payments and don’t mind a longer repayment period, an income-driven repayment plan may make more sense than a standard repayment plan.

You may want to consider an income-driven repayment plan if:

• You just graduated college and haven’t been able to find a good-paying job.
• You can’t afford your monthly federal student loan payment over the long term.
• You’ve recently become unemployed or have reduced income.
• You want to temporarily reduce your payments without consolidating or refinancing your student loans.

How to apply for income-driven repayment

If you’ve decided to pursue income-driven repayment, you’ll have to request the change with your loan servicer:

1. Determine your options: Reach out to your loan servicer and find out what options may be available. Your options will depend on your federal loan type and when you borrowed the money. You can decide which plan is right for you using the U.S. Department of Education’s loan simulator or by asking your loan servicer to identify the most appropriate income-driven plan (or plans) for your situation.
2. Submit a request: Once you’ve decided what kind of income-driven repayment plan you want, the next step is submitting an Income-Driven Repayment Plan Request. This application can be submitted online or via hard copy. Paper copies of the application can be obtained from your loan servicer. When applying, you’ll need to provide income information.
3. Repeat with all loan servicers: If you hold loans with multiple servicers, you must repeat this process with each.
4. Keep making payments: It generally takes a few weeks for your servicer to decide on your income-driven repayment application. In the meantime, keep making regular payments to avoid defaulting.

It’s also worth noting that you’ll have to do this process each year to remain eligible for income-driven repayment. Otherwise, your servicer will automatically put you in the standard repayment plan, increasing your payments.

Alternatives to income-driven repayment

If an income-driven repayment plan does not work for you or you’re not eligible, other options exist to reduce your monthly loan payments:

• Graduated repayment plan: Under this plan, loan payments start low and increase every two years. Payments are made for up to 10 years on most loans (up to 30 years on consolidation loans).
• Extended repayment plan: This approach involves a longer repayment term, which reduces the monthly payment but ultimately increases the total interest paid over the life of the loan. Payments are made for up to 25 years.
• Student loan refinancing: While refinancing your federal student loans with a private lender will eliminate federal benefits like income-driven repayment plans and loan forgiveness programs, lowering your monthly payment by getting a lower interest rate or extending your loan term is possible.

The bottom line

Income-driven repayment plans can provide substantial financial relief and make your loan payments more affordable. The introduction of the SAVE plan has expanded the relief offered by these types of repayment plans to millions of additional borrowers. If you’re interested in pursuing income-driven repayment or learning more about what an income-driven repayment plan is, contact your loan servicer or visit the Federal Student Aid website to learn more about the options and the application process.

FAQ about income-driven repayment

• Does income-driven repayment include spousal income?

  Whether or not your spouse’s income affects your income-driven repayment plan depends on your chosen plan.
  
  ICR, IBR and PAYE use only the borrower’s income as long as the borrower files taxes separately. REPAYE, on the other hand, bases the loan payment on joint income, regardless of whether the borrower and their spouse filed separate or joint tax returns.

• What is the maximum income for income-driven repayment?

  There’s no explicit income cutoff when it comes to qualifying for income-driven repayment plans. The loan payments will simply increase as your income increases. However, if your income increases enough, your income-driven repayment may be greater than what you would pay with the standard 10-year plan.

• How are income-driven repayment plans changing?

  President Biden’s administration has been exploring a few changes to income-driven repayment plans. The biggest change to the plans is that between 2021 and 2025, borrowers who have their balance forgiven on an income-driven repayment plan will not owe taxes on the forgiven amount. Previously, borrowers could be met with a large tax bill at the end of their repayment period.
  
  The Department of Education is also considering a new income-driven repayment plan, currently called Expanded Income-Contingent Repayment (EICR). EICR would cover only undergraduate loans, but it would introduce a marginal approach to payment calculations. With the new plan, any discretionary income that falls below 200 percent of the federal poverty line would not be charged.
  
  Discretionary income between 200 and 300 percent of the federal poverty line would be charged 5 percent, and discretionary income above 300 percent of the federal poverty line would be charged 10 percent. Borrowers would make these payments for 20 years.