If you’re struggling to afford repayments on your federal student loans, you may be able to lower them in the short term by signing up for an income-driven repayment (IDR) plan.
Through these plans, the US Department of Education (DoE) uses a percentage of your discretionary income to calculate your monthly student loan payments. They set your repayments based on any income you don’t spend on necessities like food and rent. In other words, any leftover funds you might normally use for traveling overseas or a night on the town.
If you have little money left over after making your student loan repayments on your current salary, an IDR plan may provide much-needed relief. It all starts with understanding how to calculate your discretionary income.
What is discretionary income?
Discretionary income is what remains after necessities — like taxes, utilities, rent and food — are deducted from your disposable income.
Discretionary income is a bit different when it comes to student loans. Instead of looking at your individual expenses, the DoE calculates your discretionary income based on your adjusted gross income (AGI) minus 150% of the poverty guidelines for your state and family size.
Say you’re single, live in Colorado and your annual salary is $34,000. You’re trying to determine your discretionary income for the IBR Plan — which is your AGI minus 150% of the poverty guidelines.
According to the chart above, the poverty guideline for a one-person household with no dependents is $12,490.
This means you would multiply $12,490 by 1.5, which equals $18,735.
You would then subtract that from $34,000 to get a discretionary income of $15,265.
What does discretionary income mean for my student loans?
Income-driven repayment plans adjust your federal student loan payments at an amount that is affordable for you based on your state, family size and income.
The federal government caps your monthly payments on the different IDR plans at a specific percentage of your discretionary income. Here’s how it breaks down:
Federal repayment plan
% of monthly discretionary income
Undergraduate loans: 20 years Graduate loans: 25 years
Loans issued before July 1, 2014: 15% Loans issued after July 1, 2014: 10%
Loans issued before July 1, 2014: 25 years Loans issued after July 1, 2014: 20 years
While having lower student loan payments may seem fantastic, it can also mean you’ll be paying on your loans longer. That’s because these plans come with terms of 20 or 25 years depending on the type of student loans you have and when they were issued. However, keep in mind your remaining balance is forgiven at the end of your loan term.
How to calculate your monthly payment
So you’ve figured out your annual discretionary income and know what plan you want to sign up for. The next step is calculating your monthly payment based on the percentage in the table above:
Take your annual discretionary income and multiply that number by the percentage above. For example, you would multiply your income by 0.2 if you were signing up for the ICR plan.
Divide that number by 12 — for each month of the year. That new number is your monthly discretionary income.
How much you pay each year will vary based on changes in your family size, the poverty guidelines and your income. In fact, you need to recertify your income and family size each year to stay on any IDR plan.
What about the Income-Sensitive Repayment Plan?
The Income-Sensitive Repayment Plan is unlike the other IDR plans. Instead of basing repayments on your monthly discretionary income, they’re based on your gross monthly income — what you make before taxes and deductions are taken out.
This plan is only available for FFEL Loans, comes with a shorter term of 10 years and doesn’t offer forgiveness once the term is up. But if you have FFEL loans, it could provide some short-term relief from high repayments.
Income-driven student loan repayments are based on what you make — not what you owe. Having an understanding of how discretionary income works and how to calculate it can help you estimate your new monthly payments. When you’re on a tight budget with little wiggle room, the right IDR plan can give you a reason to be optimistic about your financial future.
If you lost your job, instead of calculating your student loan monthly payments using your adjusted gross income (AGI), you will be asked to provide supporting paperwork proving your current income — or lack of it. Your new monthly loan payment is calculated based on that new amount.
Disposable income is the net income you have to save or spend after income taxes. Meanwhile, discretionary income is what you have to spend or save after taxes and necessities like rent and food are paid. The two are similar — but disposable income doesn’t take into account necessities.
There is no hard-and-fast rule regarding how much of your paycheck should be used for discretionary income. However, Senator Elizabeth Warren introduced a budgeting strategy called the 50-30-20 rule. In other words, spend 50% on things you need, like food and clothing. Spend 30% on things you want, like entertainment or a trip to a fancy restaurant — this is discretionary income. And put 20% away for savings.
Kathryn Pomroy was a writer for Finder, specializing in loans. She has written for dozens of major publications, small businesses and many well-known personal finance companies, including LendingTree, Money Crashers, Quickbooks/Intuit, BankRate, LendEDU and more. Kathryn holds a BA in Journalism and drinks super bold coffee while eating peanut butter and honey toast.
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