Do income based repayment plans work for you?
So there you are fresh out of college or maybe not so fresh, as yours truly, but you have student loans still. Last week, I discussed the need the need to develop saving habits while paying down your student debt.
Considering that there are a couple of different options for student laons do you have the right repayment plan or do you know that you have options?
For simplicity sake, even though nothing in finance is simple, there are two basic repayment plans to repay your loans.
Let’s look at an example:
Steven has $40,000 worth of student debt with the average interest rate of 6%. He makes roughly $35,000 working and is considered single for tax purposes.
Steven has two options:
Pay using the standard 10 year repayment schedule or pay based on using the income based repayment plan (IBR). To qualify for the IBR your income must be low enough to make your calculated payments lower than the standard repayment plan. Taken into consideration is also your family size along with the type of loans.
By choosing the IBR plan Steven’s payments are restricted to 10% of his discretionary income that is above the poverty line, which would be AGI of $35,000 – $17,655 (*150% over the poverty line) = $17,345 of which 15% is the max payment is $2,601 or about $216 monthly. This means over 20 years he would pay roughly $51,840 or if there was still a balance left after 20 years then the loan would be forgiven.
Under the standard 10 year repayment plan the monthly payment would be about $444 monthly. Or about $53,280 over 10 years.
Take another example of a married couple Brad & Stephanie who together make a combined, $70,000 but have $65,000 worth of student loan debt.
Based on the IBR plan there payments would be $60,000 – $23,895 = $36,105 of which 15% is the max payment $5,415 or about $451 monthly. Or $108,250 over the 20 year repayment cycle.
On the standard repayment plan their payment would be $665 monthly or about $79,800 over 10 years.
You may think that IBR looks attractive in certain cases and it is. However, it has some drawbacks to be aware of. One drawback is that the amount of loan that is forgiven is counted as taxble income in the year you have the loan forgiven. Depending on the size of your loan this may be a large amount.
Another drawback is the amount of time you hold the debt. A 20 year repayment schedule is a long time. If your income is drastically increasing then your payment might level out at the 10 year repayment level due to higher income.
Each situation is unique. Don’t base your decision solely on these examples. Instead, learn how they might work in relation to your situation.
Have you heard of income based repayment? What would be the best plan for you?
*calculations were based on the 2015 poverty line tables here