Income-Driven Repayment plans (IDR) add a large layer of complexity to student loans. Income-driven repayment is a catch all phrase the government uses to describe the following repayment plans: Income-Based Repayment (IBR), Pay As You Earn (PAYE) Revised Pay As You Earn (REPAYE), and Income-Contingent Repayment (ICR). This article details how users of income-driven repayment plans are misusing them so that way you are not the one of the many in a bad financial situation down the road.
Income-Driven Repayment In Context
Income-driven repayment plans are the fastest growing student loan plans in the country. Below is a chart that highlights how fast they have grown.
Income-Driven Repayment Plans Are Extremely Confusing
Just to illustrate how confusing these plans are, the term “Income-Based Repayment” is what most students, new grads, and industry professionals call these plans.
However, “Income-Based Repayment” (IBR) is actually the formal name of only one Income-Driven Repayment plan offered by the government. The term IBR should not be used as a “catch all” acronym when discussing Income-Driven Repayment plans. As I mentioned in the first paragraph, there are now five types of income-driven repayment plans which makes it extremely confusing.
The Fastest Growing Segment
In general, a great (albeit incomplete) sales pitch…
Picture this: You are a new grad and you are told your standard payment is $750 per month if you remain on the standard 10-year Federal student loan plan.
But, then you are told that you qualify for a 20-year plan with the following characteristics:
- Your monthly payment would only be $150 per month.
- Your payment would be tied to your income. Therefore, if your income goes down so does your payment. Thus, your payment is always affordable.
- THE KICKER…at the end of 20 years, whatever you still owe is forgiven by the government.
That is the tip of the iceberg. The bottom of the iceberg is the ugly implications that most borrowers don’t know about.
There are two main caveats missing from the “sales pitch” above:
- The monthly payments aren’t actually enough to cover the interest on the loans. Therefore, the loan balance (what they owe) will keep increasing day after day, and
- People on income-driven repayment plans will owe taxes on the amount forgiven at the end of their plan.
To make things worse, most people new grads go to for help aren’t equipped to help them.
This is important to understand because there are two key places new grads go to for help:
- Financial Aid Officers: These individuals are not financial experts. Their primary purpose is to help you get a loan, not instruct you how to pay them off.
- Loan Servicers: They are not there to help figure out the optimal path forward. Their job is to collect payments for the government.
Here is a secret that is hidden from most borrowers… loan servicers are required by law to recommend to new grads the repayment plan with the lowest monthly payment. Guess which plans are going to have the lowest monthly payments most of the time… You guessed it, income-driven repayment plans. Borrowers think they are getting a good recommendation from their loan servicer because for some odd reason they trust them. However, you now know that they are required to recommend this and not that they are doing so because they are some type of financial expert with a good recommendation.
Recent graduates who are proactive and want to understand the different repayment options will often times log into the Government’s calculator and compare the costs of the programs. However, this can make the problem worse.
The government’s calculator doesn’t show an estimated tax amount and some of the assumptions used are not realistic, in our opinion. On top of that, you shouldn’t necessarily be comparing costs between plans. You should be saying which one allows me to execute my financial plan then if it is more costly than other plans, decide if its worth the costs. If you want help calculating the tax on these plans, check out our income-driven repayment calculator.
Note: Need help building a financial plan that complements your life instead of dictating it? Check out our new technology.
FitBUX’s IDR Survey
Having helped young professionals manage and eliminate over $1 billion in student loans, we were (and still are) astonished at the lack of understanding and planning around income-driven repayment plans.
Specifically, the lack of understanding when it comes to income-driven repayment plans and the tax implications.
Here are a few mind-bogging quotes we’ve heard:
“My school had someone come in to talk to us. He basically told us we are all stupid if we don’t use an income-driven repayment plan. That is really all I know about them.”
“What do you mean there is a tax?”
“I wasn’t aware that my payment wasn’t enough to cover the interest so my loan keeps getting bigger and bigger.”
“Financial aid didn’t tell me anything nor did my loan servicer. I only know about the tax because of a FitBUX student loan workshop I attended.”
We kept hearing quotes like these so we decided to put some numbers around it. We surveyed approximately 550 young professionals including physical therapist, occupational therapists, physician assistants, physicians, dentists, lawyers etc…,
As we discussed above, the tax liability is a big component of these plans. Yet, 88% don’t know about it (those answering ‘What are IDR plans’ and ‘No, I wasn’t aware of it’). This is a ticking time bomb to put it mildly.
More Data About Income-Driven Repayment
We’ve gathered other data points based on FitBUX’s proprietary research.
Thanks to our uniquely targeted set of data gathered from our Members and other surveys we’ve done for FitBUX Articles, we’re able to provide unique insights into the student loan crisis. Below are a few examples as to why the lower monthly payments of income-driven repayment plans are so appealing:
- There are plenty of reports indicating that more and more recent graduates elect to move back home after graduation. One of the main reasons cited is the need to save money and use this “rent money” to pay off student loans. To put things in perspective, 37% of FitBUX’s Members have moved back home post-graduation.
- Financial institutions heavily rely on an applicant’s Debt-To-Income ratio to assess his/her financial health. At FitBUX, we like to go a little bit deeper when it comes to student loans and use a Student Debt-To-Income ratio (SDTI) to quantify the student debt load of our members.
- The median gross income for all FitBUX members is $65,000 ($58,000 average) with an median of $121,000 in student debt.
- If one were to stay on the default 10-year plan to pay off that student debt and a 6% interest rate, the required monthly payment would be $1,343. Using the median gross income above, this represents 24.5% of gross income.
When trying to answer “is going to college worth it?, the recommended SDTI ratio is 15% or less, using a traditional 10-year plan. To stay within these recommended ratios, this means that someone making $65,000 should have $75,000 in student debt at most….
Rapid Fire IDR Questions
What is income-driven repayment?
Income-driven repayment is a catch all term to describe 4 student loan repayment plans: IBR, PAYE, REPAYE, ICR.
What are the cons of an income-driven repayment plan?
1) Interest may accrue on the loans, i.e. your loan balance can go up. 2) When it is forgiven, you have to pay taxes on the amount that is forgiven.
Is income-based repayment the same as income-driven repayment?
No. Income-based repayment is a type of income-driven repayment plan.
If you need help or have questions, our FREE student loan planners have helped thousands of Young Professionals manage and eliminate over $1.4 billion in student loans. We help you develop your plan for free because planning your financial future should not cost you your financial future.