Income-Driven Repayment

Income-Driven Repayment

Special Covid-19 Consideration

Since March 13, 2020 payments and interest on most Federal student loans have been suspended.  President Biden announced that his administration would continue to extend the suspension through September 30th, 2021.  This is great news for those who qualify, which are most borrowers with Federal student loan balances.  Check with your loan servicer if you have any questions on whether or not this applies to you.

Income-driven repayment-IDR is a very popular repayment option, and makes sense, at least initially, for many graduates entering their careers or going on to residency. 

IDR payments are capped at 10% of income and income must be recertified every 12 months.  Typically, graduates must have exhausted their six-month grace period before they are eligible to enroll in an IDR.  However, the six-month grace period, is simply another six months of full interest accrual.  By completing a federal loan consolidation application, you can elect to stop the six-month grace period early and immediately enroll in an IDR.  Many recent graduates with little or no income reported on their most recent federal tax return, may not even be required to make a payment in the first year after graduation! When you recertify your income every 12 months, if your income has gone up, your monthly payment for the next 12 months will also go up. The reverse is also true, as we saw in 2020, as a result of many borrowers being laid-off or furloughed during the Covid-19 pandemic. Those who recertified during Covid-19 pandemic, and reported less income versus the prior year, will see lower payments over the following 12 months.

Under current Department of Education rules, after completing 20 or 25 years of IDR payments, any remaining balance is forgiven.  However, that forgiveness is reported as taxable income in the year the forgiveness occurs.  Many graduates, however, have no interest in repaying their student loan balance over 20 or 25 years and for good reason.  Income-driven repayment is oftentimes the most expensive way to repay student loans over the long-term, especially if you are not participating in or qualify for the Public Student Loan Forgiveness program or another forgiveness program.  As such, we see many graduates enrolling in an IDR for 2-4 years as they enter residency or their careers, then once established in their careers and in a better shape financially, pivoting to a more aggressive repayment method, perhaps a private refinance or more traditional repayment plan.

Today, there are four different IDR plans: Revised Pay As You Earn-REPAYE, Pay As You Earn-PAYE, Income Contingent Repayment-ICR and Income Based Repayment-IBR.  For most graduates today, REPAYE and PAYE are the two repayment options to consider.  ICR is for parents who have taken out Parent Plus loans for their children and IBR is not used for current graduates, having been replaced by REPAYE or PAYE.  It is especially important to understand the nuances between REPAYE and PAYE. 

REPAYE can be a very cost-effective, initial repayment option for borrower’s exiting school or residency with little or no household income reported on their most recent federal tax return because REPAYE provides up to a 50% interest subsidy for many such borrowers. 

PAYE is most effectively used by married couples where spouse A has a relatively high income, and perhaps no or a low student loan balance and spouse B has a much lower income and a significant student loan balance. For the purposes of establishing an IDR, PAYE will only consider the income of spouse B, if the couple filed their taxes, married but separately.

Again, understanding the nuances between REPAYE and PAYE are critically important in deciding which IDR option to initially select and for how long it makes sense to remain on that particular IDR. 

For those graduates pursuing Public Service Loan Forgiveness-PSLF, they will be required to enroll in an IDR. Enrolling as soon as possible after graduation,

Depending on the balance of your loans, reported income and interest accrual, an income-driven payment might not even cover the interest accumulating on a monthly basis. 

Therefore, it is very important to understand what the total cost of the loan will be over the entire repayment period. If you work for a qualified nonprofit-employer, you will consider using PSLF and an income-based repayment method in concert with one another.
Depending on your household income, number of dependents and some other factors, you may be eligible for the Department of Education to forgive a portion of your interest accumulation each year for the first few years out of school or while in residency.  The interest savings can amount to several thousand dollars a year with proper planning.  It is very tempting to select an income-based payment because generally the payments are much lower, at least starting out, than other repayment methods.  But in our experience, most graduates don’t want to make payments for 20 or 25 years, opting to figure out a way to repay student loan debt much sooner.

Having a comprehensive plan at the beginning will provide the best opportunity to identify the appropriate repayment strategy that will allow you to pay off your student loans as quickly and as efficiently as possible, without ignoring the other important financial issues like budgeting, insurance and investment planning.

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