College graduates who are struggling to repay their federal student loans have a new repayment option, Income-Based Repayment (IBR), which becomes available on July 1, 2009. This repayment plan caps the monthly payments based on a percentage of discretionary income, not the amount owed. Borrowers do not have to consolidate their loans to get access to this plan.
Payments Based on Income, Not Debt
Income-based repayment is similar to income-contingent repayment, but with some key differences. Both plans cap monthly payments based on a percentage of discretionary income, but income-based repayment uses a smaller percentage of discretionary income and a smaller definition of discretionary income. Also, income-contingent repayment is only available to borrowers in the direct loan program, while income-based repayment is available in both the federally-guaranteed student loan program and the direct loan program.
The new repayment plan caps the monthly payments at 15% of the amount by which adjusted gross income exceeds 150% of the poverty line for the family size. For example, suppose a single borrower has $40,000 in federal education loans and an AGI of $30,000 a year. The 2009 poverty line in the continental US is $10,830, and 150% of that is $16,245. The IBR cap on monthly payments is then 15% of ($30,000 - $16,245) divided by 12, or $171.94. This is considerably lower than the $460.32 a month which would be required under standard 10-year repayment or the $277.63 a month which would be required under extended 25-year repayment.
The monthly payment will be adjusted annually, based on the prior year's federal income tax returns. A borrower who is married to a spouse with high income can file as married filing separate in order to have the monthly payments based on only the borrower's income instead of the combined income.
Best for Borrowers with High Debt, Low Income
Income-based repayment is best for borrowers who have high debt relative to their income. Borrowers with a debt-to-income ratio of 1.0 or higher will be most likely to benefit from income-based repayment, but even borrowers with a lower debt-to-income ratio may benefit, depending on their income and family size.
The income-based repayment plan can provide significant repayment relief to borrowers who are struggling to repay their student loans. Most borrowers will have a monthly payment under income-based repayment that is less than 10% of gross income. This includes single borrowers who have less than $50,000 in income and married borrowers with two children who have less than $100,000 in income. Borrowers with lower income will have to devote even less of their salary to repaying debt.
The income-based repayment plan compares favorably with other options for borrowers in financial difficulty, such as the economic hardship deferment and forbearances. The economic hardship deferment and forbearances suspend monthly payments for up to three years each. A borrower whose income is less than or equal to 150% of the poverty line will have a zero monthly payment under income-based repayment without a three-year limit. However, a borrower earning more than 150% of the poverty line will have a monthly payment under income-based repayment. But this helps avoid a key problem with using deferments and forbearances for more long-term financial problems, where the suspension of payments just digs the borrower into a deeper hole.
Monthly payments can be less than the interest that accrues. During the first three years of income-based repayment the federal government will pay any unpaid interest on subsidized loans, including the part of a consolidation loan that repaid subsidized Stafford loans. Any other unpaid interest is defered and will be capitalized when the borrower no longer qualifies for income-based repayment (i.e., when the income-based repayment cap is higher than the payment under standard 10-year repayment). This compares with the economic hardship deferment, where the federal government will pay all the interest, not just the unpaid interest, on subsidized loans for up to three years. (In contrast, during a forbearance the borrower is responsible for the interest that accrues on all loans, not just the unsubsidized loans.)
Remaining Debt May be Forgiven
An added benefit of income-based repayment is that any remaining debt is forgiven after 25 years. Unfortunately, this forgiveness will be taxable under current law. However, the forgiveness period drops to 10 years for borrowers who are employed full-time in public service careers, and that forgiveness is tax-free according to a U.S. Treasury ruling last year. (To be eligible for public service loan forgiveness a borrower must repay her loans in the direct loan program. Borrowers who have loans in the federally-guaranteed student loan program can transfer their loans to the direct loan program by consolidating them at loanconsolidation.ed.gov even if they've previously consolidated their loans.)
For example, consider an attorney who accumulated $120,000 in law school debt, but wants to pursue a job as a public defender earning $40,000 a year. That's a debt-to-income ratio of 3 to 1, yielding monthly payments that are 41.4% of gross income under standard 10-year repayment and 23.5% of gross income under extended 30-year repayment. Under income-based repayment the monthly payments would be 8.9% of gross income -- much more affordable. After working as a public defender for 10 years, all the remaining debt would be forgiven, including the original $120,000 loan balance and more than $30,000 in accrued but unpaid interest. This makes it possible for public-spirited students to pursue lifelong careers in public service despite the high debt and low salaries.
Private and Parent PLUS Loans Not Eligible
Unfortunately, non-federal loans are not eligible for income-based repayment. Income-based repayment is only available for Stafford, Grad PLUS and consolidation loans. It is not available for Parent PLUS loans or for consolidation loans that include Parent PLUS loans. Income-based repayment can be used with Perkins loans, but only if those loans are included in a consolidation loan. It is also not available to students who have defaulted on their loans unless they have rehabilitated those loans.
Additional Resources
Additional information about income-based repayment is available from FinAid.org. FinAid also provides information about public service loan forgiveness and a flexible income-based repayment calculator for evaluating monthly payments and loan forgiveness under this repayment plan. Another source of information is ibrinfo.org from the Project on Student Debt.
Mark Kantrowitz is publisher of FinAid.org and FastWeb.com. He is a national expert on student financial aid, scholarships and student loans.
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Thank God!! There's a new repayment option that will help the college students in there studies. Having a college degree us very important because of lesser opportunity of jobs if you don have any college degree. With this kind of economy. people are trying anything just to survive everyday. Since having a college degree is a high price, they try student loan or credit card which is by the way not cheap. If every they try any a href="http://personalmoneystore.com/moneyblog/2009/05/15/student-loans-credit-cards/">student loans, they end up, having a bigger debt. So I hope that it will really lessen the burden of college student who wishes to have a good life.
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hi,
in your article you mention, "An added benefit of income-based repayment is that any remaining debt is forgiven after 25 years." Do they do an inventory of your assets before they forgive the loan? what if a person all of a sudden inherits a house and some money from parents?
d.a.
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Nobody has yet reached the 25-year forgiveness for income-based repayment (or the similar 25-year forgiveness for income-contingent repayment, which has been around longer). So it remains to be seen what procedures they will use. The forms, for example, won't be submitted for OMB approval for many years.
However, the monthly IBR payments are based on Adjusted Gross Income (AGI) from federal income tax returns, adjusted once a year (or within a year in cases involving a change of financial circumstances, such as mid-year job loss). In all likelihood that will be sufficient. The IBR forgiveness is not based on assets, just income. If the income shows up on your income tax return, it will affect IBR. (If it should show up but you don't report it, that's tax evasion, and when discovered you'd not only have to pay taxes and penalties, but they might go after you for fraud. The penalties for fraud involving federal student aid include prison time and/or up to $20,000 in fines.)
If you win a jackpot or other windfall that increases your AGI one year, but then return to low income the next year, the 25-year clock would continue from where it left off.
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this info is extremely helpful, and i'll be counting the days to july 1st
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How would someone become eligible for this repayment plan? Is this offered to students that are in repayment?
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It is available to students who are in repayment, starting July 1, 2009. It is available for all federal student loans, including those who are already in repayment. It is a very good option if you are having trouble repaying your debt. You can switch into it by calling your lender; they may want to see last year's federal income tax returns as filed with the IRS.
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Mr. Kantrowitz, thank you for all your thorough and helpful information.
Are forbearances and deferments available in the income-based repayment plan? Meaning, if my income is above 150% of the poverty line, can I still take out a limited number of deferments and forbearances?
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Forbearances and deferments are available in the income-based repayment plan, subject to the same restrictions as in other repayment plans. For example, there is a three-year limit on the economic hardship deferment.
If your income is less than or equal to 150% of the poverty line, your monthly payment under income-based repayment is zero. If your income is greater than 150% of the poverty line, your payment will typically be less than 10% of AGI, but if even this is too high for you, you can seek an economic hardship deferment or a forbearance from your lender. I do not expect that many people on income-based repayment will do this, since most of the circumstances that lead people to seek an economic hardship deferment (e.g., family and medical leave, unemployment) will result in a zero payment under income-based repayment. But borrowers with a significant amount of subsidized Stafford loans might seek to stack the economic hardship deferment with income-based repayment in order to take advantage of the subsidized interest benefit if they are experiencing financial difficulty for an extended period of time.
Note that deferments and forbearances do not count toward the 120 payment (10 year) requirement for public service loan forgiveness or the 25-year forgiveness for income-based repayment.
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Is there any benefit to the income-contingent repayment plan over the income-based repayment plan? It seems like income-based repayment is better all around.
Also, is income-based repayment an option that you think will be available for the foreseeable future? Or might signing up for the plan become unavailable after several years?
Thank you.
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Income-based repayment always results in a lower monthly payment than income-contingent repayment. Borrowers who are pursuing public service loan forgiveness should use income-based repayment.
There is one technical difference that may make income-contingent repayment attractive to higher income borrowers. Income-based repayment functions as a cap on the monthly payments, and as soon as the borrower's payments under standard ten-year repayment fall under the cap, the borrower no longer qualifies for income-based repayment. Income-contingent repayment, on the other hand, is not implemented as a cap but rather as an alternate payment amount and so can be used even when the payment amount exceeds the standard ten-year repayment amount. This can be attractive to some high income borrowers, such as doctors and lawyers, because it can lead to repaying the debt faster (e.g., in 7 years instead of 10).
I expect income-based repayment to be available permanently. There is no time limit in the authorizing legislation.
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