Income Based Repayment (IBR) plans have been gaining popularity in recent years. They allow students more flexibility by reducing their payments and stretching out repayment plans over a longer period of time, promising forgiveness of any remaining debt at the end of that time period.
However, it may not be as simple as making a bunch of tiny payments and having your debt wiped clean. Here are a few considerations about IBR plans and how they help students:
How Payments are Calculated
There are currently several different income driven repayment options based on the when your child was in school and how they want to repay their loans. Depending on which option they choose, their payment will be capped between 10-20% of their discretionary income after graduation, and will never exceed what their regular payment would have been over the standard 10 year repayment period.
"Discretionary income" is a term used for a very specific calculation which equals the difference between their actual income and 150% of the poverty limit for their family unit. This doesn't take into account any other debt they may accumulate or other bills that they need to pay each month. As a result, this 10-20% may still be far greater than the actual amount of money they have available to make a payment.
By stretching out the repayment period of a loan, the amount of interest that accrues will end up being far greater than what your student would have paid under the original loan terms. Significantly less of their payment will be put toward paying down the principal each month, and depending on how small their payment is it may not even cover interest alone. This is why income-based repayment plans are usually combined with loan forgiveness.
Changes in Status
A lot can change in 20 years. As such, it's possible that your student will reach a point where they are no longer eligible for income based repayment and will have to go back to making their full original payment. Likewise, if they lose their job, they will have to re-qualify for the IBR plan, which will reduce their payments based on their new circumstances. This may provide a temporary reprieve for people who find themselves suddenly unable to make their regular payments, but it is not a good strategy for the long term.
If your student manages to make it through the full 20 years on an IBR plan with no late payments, and they are eligible for loan forgiveness, there are still taxes to contend with. Under current IRS rules, any forgiven debt will need to be counted as income during that year, and will be subject to income taxes. This can be an unexpected expense on top of the already increased interest that was paid.
Income Based Repayment plans serve a purpose as a short term way for students to stay current on their loans when they are just out of school and have entry level jobs, especially if their loan amount is very high. They can also act as a momentary solution during unexpected job loss. However, IBR plans cost more long-term and are not a good fit for someone who has the ability to pay off their loans according to the original payment plan.
Depending on your student's circumstance, a better option for them may be loan consolidation or refinancing. In order to get the best rates on refinancing compare offers from multiple lenders.
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