Student loan payments can put a lot of pressure on a borrower's budget, especially when they're right out of college and money is scarce. Luckily, if you have federal student loans, you can sign up for a program that can significantly reduce your monthly payments -- and may even lead to loan forgiveness.
Income-based repayment plans
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The Department of Education offers several income-based repayment plans for federal student loan borrowers. Instead of basing your student loan payment on the amount you borrowed and the term of the loan, these plans base your payment on how much "discretionary income" you have. You can make very small payments when your income is low, and then increase the payments once you're making more money. And if you get stuck with low-wage jobs for a long time, you'll at least get one nice benefit from it: After a certain period of time on an income-based repayment plan, any remaining loan balance is automatically forgiven (you'll have to pay income taxes on the forgiven loan balance, though).
"Discretionary income," according to the rules of the income-based repayment plans, is the difference between your income and 150% of the federal poverty guideline for your state and the size of your family. So if you have a big family and/or a really low income, your student loan payments could be as low as $0 under these plans. You're required to recertify your income and family size annually in order to stay on an income-based plan.
The basic IBR plan
The core income-based repayment plan, called the IBR plan by the Department of Education, requires you to pay a flat 15% of your discretionary income on your student loans each month (someone who is a new borrower on or after July 1, 2014 need only pay 10%). However high your income gets, your payment requirement can never exceed the standard 10-year payment plan amount. After 25 years of payments, the remaining balance is forgiven (or after 20 years if you're a new borrower on or after July 1, 2014).
To qualify for the IBR plan, you must be a new borrower as of Oct. 1, 2007, and you must have received a loan disbursement on or after Oct. 1, 2011. Your loan payments under this plan must also be smaller than they would be on the 10-year standard repayment plan.
Income contingent repayment plan (ICR)
The ICR plan doesn't have any eligibility requirements aside from being a federal student loan borrower. This is the only income-based plan that parents with PLUS loans can sign up for. With the ICR plan, you pay 20% of your discretionary income, with payments not to exceed the amount you'd pay on a 12-year fixed repayment plan.
After 25 years on the ICR plan, any remaining balance on the loans will be automatically forgiven. Unlike the IBR plan, there's no cap on the payment size -- so if you start making real money, your payments could become higher than they would on any of the standard repayment plans (of course, you can always switch repayment plans at that point).
PAYE and REPAYE plans
The Pay As You Earn Repayment Plan and Revised Pay As You Earn Repayment Plan (PAYE and REPAYE) are similar to the other income-based repayment plans, but they have a lower payment requirement -- just 10% of your discretionary income. The REPAYE plan has no special eligibility requirements; the PAYE plan has the same requirements as the IBR.
For the PAYE plan, loan balances remaining after 20 years are forgiven. For the REPAYE plan, undergraduate loans are forgiven after 20 years, and graduate loans are forgiven after 25 years. PAYE loan payments are capped at the amount you'd pay on the standard 10-year repayment plan; REPAYE loan payments are not, so if your income goes up significantly, you may want to switch plans.
Picking the right repayment plan
The Department of Education's student loan website has a repayment calculator you can use to see what your monthly payments would be under the various plans. Most low-income borrowers will want to stick with the plan that results in the lowest payments, assuming they qualify for that plan. If it looks like you'll be stuck with a relatively low income for a while, selecting one of the plans with a shorter repayment term might also be a good idea so that you're more likely to have part of your loans forgiven. Once you've identified the best plan for you, you can apply for the income-based repayment plans on the Department of Education's student loan website.
After you switch to a lower payment plan, it's important to think about what you'll do with that extra money. Rather than spending it on nonessentials, consider directing at least some of it to important financial goals such as paying off high-interest debt and saving for retirement. Doing so will yield ample rewards down the line.
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