Income driven repayment

In short

If you are holding federal student loans and the monthly bill feels too big, there is a plan built for your situation. Income driven repayment ties what you pay to what you earn, not to what you owe. A friend of mine once said the bill felt like a stone in her shoe, and this is one way to take the stone out. You apply through the official site, StudentAid.gov, and you can do it for free. You will need your latest tax return or proof of income, and you will need to update it every year. Payments can be as low as zero dollars if your income is low enough. Any balance left after the plan's set number of years may be forgiven, and the official page at StudentAid.gov explains how that forgiven amount is treated for taxes.

The whole of it

What it is

I once watched a neighbor open a loan statement at his kitchen table and go quiet. He was doing everything right, and the number still did not fit his life. If that sounds familiar, you are in good company, and the folks who wrote this program had you in mind.

Income driven repayment is a group of plans for federal student loans. Each plan sets your monthly payment as a share of your discretionary income, which is the part of your income left after a basic living allowance. The allowance is tied to the federal poverty guideline for your family size. The plans go by names such as Income Based Repayment, Pay As You Earn, and Income Contingent Repayment, and the Department of Education has also created newer plans over the years. Some plans have been closed to new people or changed by law and by court action. So the exact menu you can choose from may look different this year than it did last year.

Private loans are not part of this. Only federal loans qualify, and some types need a step called consolidation first. Small word, big detail.

How it works

A friend of mine who teaches middle school told me she thought a lower payment meant she was cheating the system. She was not. The plan is written into law, and using it is no different from using any other part of the tax code or the loan rules.

Here is the basic path. You apply on StudentAid.gov and pick a plan, or you ask your loan servicer to place you on whichever plan gives the lowest payment. You report your income, usually through your tax return or by linking to the IRS on the application. Your servicer then sets a monthly payment. Once a year you recertify, which means you send in fresh income and family size so the payment can be reset. If you miss that step, your payment can jump to a higher amount, so mark the date on the calendar by the phone.

The payment formula is a percentage of your discretionary income. That percentage is set by the plan you are on, and it is a figure written into law and rule, so look for it on the official page. The rule for the plan you choose is the current figure, which the official source publishes each year. The length of time before any leftover balance is forgiven also depends on the plan. That is the current figure, which the official source publishes each year.

If your payment is smaller than the interest that builds each month, the difference does not always vanish. Some plans cover part of that gap, and some do not. Read the fine print on the plan you pick. It matters.

The numbers, and where to find yours

You have probably wondered which numbers are yours and which belong to everybody. Fair question.

Some numbers are set by law or by the Department of Education each year. The poverty guideline used in the formula comes from the Department of Health and Human Services. It changes with family size and can change every year. The number to use is the current figure, which the official source publishes each year. The share of income that counts as protected from the formula depends on the plan, and that is the current figure, which the official source publishes each year.

The numbers that belong to you are simple. Your adjusted gross income is on your federal tax return. Your family size is who you support, and you count yourself. Your loan balance and interest rate are on your servicer's site and on StudentAid.gov once you log in with your FSA ID. The Loan Simulator on StudentAid.gov lets you plug in your own figures and see estimated payments under each plan you qualify for. It is a free tool from the Department of Education, and it is the best first stop.

Write your numbers down before you start. Five minutes now saves an hour later.

A worked example

I want to tell you about a woman named Maria, who is made up for this page but whose situation is common. Maria is single, lives alone, and earns a salary of 52,000 dollars. She owes 40,000 dollars in federal loans. Under the standard ten year plan, her bill would be a fixed amount that leaves little room for rent and groceries.

Say the plan she picks sets her payment at 10 percent of discretionary income, and say the protected amount is 150 percent of a poverty guideline of 15,000 dollars for one person. These are her plain figures for the sake of the example, not official limits. First we find the protected amount. 150 percent of 15,000 dollars is 15,000 times 1.5, which equals 22,500 dollars. Next we find her discretionary income. That is 52,000 minus 22,500, which equals 29,500 dollars. Then we take 10 percent of that. 29,500 times 0.10 equals 2,950 dollars a year. Divide by twelve months, and 2,950 divided by 12 comes to about 246 dollars a month.

So Maria pays roughly 246 dollars each month, based on these made up inputs. If her pay drops to 20,000 dollars, her discretionary income would be 20,000 minus 22,500, which is below zero, so her payment would be zero dollars. Her payment follows her paycheck. That is the whole idea.

Now the other side. If her monthly interest is larger than 246 dollars, her balance could grow even while she pays. The plan you pick decides how that is treated, so check before you sign.

Where it goes wrong

I have seen good people trip over the same few things, and none of them are a mark on your character. They are just easy to miss.

The first is forgetting to recertify. Your servicer will send notices, but mail gets lost and emails land in spam. Set a reminder. The second is assuming a low payment means a shrinking balance. As we saw with Maria, a small payment can leave the balance flat or higher for a while. That may be a fair trade for you, but go in knowing it.

The third is the tax bill. The tax rules on forgiven loan balances have been changed by law before, and the rule that applies to you is the one in force when your balance is forgiven. Check the IRS website, or ask a tax professional, close to the time it would apply to you.

The fourth is timing and eligibility. Plans open and close, and court decisions have paused or reshaped some of them. Use StudentAid.gov as your source, and be wary of any company that charges a fee to enroll you. The application is free. Nobody needs to be paid to do it for you.

The fifth is the mix of loan types. Some federal loans do not qualify unless consolidated, and consolidating can affect the count of qualifying payments. Ask your servicer before you make that move.

Questions to answer before you leave this page

Which of my loans are federal, and which are private, and where can I confirm that on StudentAid.gov? What is my adjusted gross income on my most recent tax return, and how many people are in my household? What does the Loan Simulator show as my monthly payment under each plan I can join? Will my payment cover the monthly interest, and if it does not, how does my plan treat the gap? When is my recertification date, and have I put it somewhere I will actually see it? What does the IRS say today about how forgiven balances are taxed? And have I made sure no one is charging me a fee for something the government does for free?