The Income-Based Repayment (IBR) is best for borrowers who are experiencing financial difficulty, have low income compared with their debt, or who are pursuing a career in public service.
Income-based repayment is intended as an alternative to income sensitive repayment (ISR) and income contingent repayment (ICR). It is designed to make repaying education loans easier for students who intend to pursue jobs with lower salaries, such as careers in public service. It does this by capping the monthly payments at a percentage of the borrower’s discretionary income.
Income-based repayment is only available for federal student loans, such as the Stafford, Grad PLUS and consolidation loans. It is not available for Parent PLUS loans or for consolidation loans that include Parent PLUS loans. IBR is not available for Perkins loans, but it is available for consolidation loans that include Perkins loans. It is also not available for private student loans.
Capped at Percentage of Discretionary Income
Income-based repayment is similar to income-contingent repayment. Both cap the monthly payments at a percentage of your discretionary income, albeit with different percentages and different definitions of discretionary income. Income-based repayment caps monthly payments at 15% of your monthly discretionary income, where discretionary income is the difference between adjusted gross income (AGI) and 150% of the federal poverty line that corresponds to your family size and the state in which you reside. There is no minimum monthly payment. Unlike income-contingent repayment, which is available only in the Direct Loan program, income-based repayment is available in both the Direct Loan program and the federally-guaranteed student loan program, and loan consolidation is not required.
Income-based repayment is based on the adjusted gross income during the prior tax year. In some cases the prior year’s income figures may not be reflective of your financial circumstances. For example, your income may be lower this year due to job loss or a salary reduction. In such a circumstance you can file an alternative documentation of income form to get an adjustment to your monthly payment.
The maximum repayment period is 25 years. After 25 years, any remaining debt will be discharged (forgiven). Under current law, the amount of debt discharged is treated as taxable income, so you will have to pay income taxes 25 years from now on the amount discharged that year. But the savings can be significant for students who wish to pursue careers in public service. And because you will be paying the tax so long from now, the net present value of the tax you will have to pay is small.
A new public service loan forgiveness program will discharge the remaining debt after 10 years of full-time employment in public service. Unlike the 25-year forgiveness, the 10-year forgiveness is tax-free due to a 2008 IRS ruling. The borrower must have made 120 payments as part of the Direct Loan program in order to obtain this benefit.
In addition to discharging the remaining balance at the end of 25 years (10 years for public service), the IBR program also includes a limited subsidized interest benefit. If your payments don’t cover the interest that accrues, the government pays or waives the unpaid interest (the difference between your monthly payment and the interest that accrued) on subsidized Stafford loans for the first three years of income-based repayment.
Who Will Benefit from IBR?
The IBR program is best for students who will be pursuing public service careers and borrowers with high debt and low income. Having a large household size also helps. Borrowers who have only a short-term temporary income shortfall may be better off seeking an economic hardship deferment.
If the borrower’s income is near or below 150% of the poverty line, the monthly payment under IBR will be $0. In effect, IBR will then function like the economic hardship deferment for the first three years and like a forbearance thereafter.
Students who are not pursuing careers in public service may be intimidated by the thought of a 25-year repayment term. However, it is worth careful consideration, especially by students who might be considering using an extended or graduated repayment plan. IBR will likely provide the lowest monthly payment for many low income borrowers and certainly is a reasonable alternative to defaulting on the loans.
Calculating the Benefit of IBR
Since the monthly payment and financial benefits depend on the borrower’s family size and income trajectory, it is best to use a specialized calculator to evaluate the benefits on a personalized level.
Calculating the cost of a loan in the IBR program can be somewhat complex, in part due to the need to make assumptions about future income and inflation increases. Finaid provides a powerful Income-Based Repayment Calculator that lets you compare the IBR program with standard and extended repayment. You can compare the costs under a variety of scenarios, including the possibility of starting off with a lower income and later switching to job with a higher salary.
Can Switch Repayment Plans
An important feature of the government’s IBR program is that although you must initially sign up for 25-year income-based or income-contingent repayment, you are not locked into this payment plan. If your circumstances change or if you just decide that you want to pay off your loan more rapidly, you may do so. (Borrowers who switch into Direct Lending in order to obtain public service loan forgiveness are limited to the IBR, ICR and standard repayment plans.)
New Version of IBR Starts in Fall 2012
The Health Care and Education Reconciliation Act of 2010 cuts the monthly payment under IBR by a third, from 15% of discretionary income to 10% of discretionary income, and accelerates the loan forgiveness from 25 years to 20 years. However, it is only effective for new borrowers of new loans on or after July 1, 2014. Borrowers who have federal loans before that date are not eligible for the improved income-based repayment plan. Public service loan forgiveness remains available in the new IBR plan.
A separate 10% version of the income-based repayment plan calculator is available for borrowers who qualify for the improved income-based repayment plan.
Borrowers who don’t qualify for income-based repayment may wish to review Finaid’s section on Trouble Repaying Debt. For example, such borrowers may wish to consider the economic hardship deferment, forbearances or extended repayment for their federal loans. Options for repayment relief on private student loans are more limited.