I got an email saying to sign up for IDR on my student loans. Is it really a good idea?
Income-driven repayments require a long-term commitment that isn’t right for all borrowers.
Federal student loan borrowers received an email or text message Wednesday afternoon from the Department of Education. It encouraged borrowers to “consider applying for an income-driven repayment plan to potentially lower your monthly student loan payment before payments resume in January 2021.”
Federal student loan repayments are currently in automatic, interest-free forbearance until December 31, 2020, thanks to the most recent stimulus bill.
Income-driven repayment plans, or IDR, appear to provide additional relief while we wait for another round of stimulus. But it can come with hidden costs that could make your student loans more expensive in the future.
How IDRs work
Currently, there are five types of IDR plans available on federal student loans. Different plans cater to different types of borrowers depending on the type of student loans you have, when you borrowed, what type of degree you paid for and how you file your taxes.
But generally, you’ll pay between 10% and 20% of your discretionary income over a term of 20 to 25 years. After the loan term is up, the Department of Education forgives any remaining balance.
Discretionary income is whatever you earn after you’ve covered your basic expenses. You can calculate it by multiplying the poverty rate for your family size in your state by 1.5 and subtracting your income.
What this means is that low-income and unemployed borrowers can pay $0 per month as long as they’re unemployed — without any extra cost.
Why IDR isn’t always a good choice
IDRs sound great. But there are a few situations where it’s costly or just doesn’t make sense. Here are a few reasons to avoid a repayment plan based on your income.
The dirty secret of IDR is that interest capitalizes if you ever decide to change plans or refinance with a private lender. This means all the interest that accumulated while you made reduced repayments gets added to your loan balance.
Some plans have limits on how much interest can get capitalized, while others don’t. But if you switch plans, you pay interest on interest. And you have a higher balance that you have to repay over a shorter period of time.
Don’t sign up for an IDR unless you plan on sticking it out until the end.
Higher monthly repayments — in some cases
Even if you’re not making much money now, getting a promotion in the future could lead to higher monthly repayments. In some cases, you might owe even more than what you would have paid on a 10-year standard repayment plan.
This isn’t necessarily a bad thing — you’ll get out of debt faster and could save on interest with higher monthly repayments. But you won’t qualify for forgiveness at the end of your term. And in some cases, like with the Pay As You Earn (PAYE) plan, you’ll actually get kicked off your IDR if your income gets too high.
IDR is really designed for people in consistently low-paying careers.
Certifying your income can get complicated
Enrolling in an IDR requires you to submit paperwork every year to certify your income. This can be complicated if you don’t have a regular salaried position or work in an industry where you get paid in cash. If you’re working abroad and get paid in a foreign currency, keeping up an IDR can be nearly impossible.
Limited options for Parent PLUS and FFEL loans
Parent PLUS loans are only eligible for Income Contingent Repayments (ICR), which costs twice the amount of a PAYE or REPAYE plan with a 25-year term.
FFEL loans are only eligible for Income Sensitive Repayment, which costs 4% to 25% of your gross monthly income and only has a term of 10 years.
It’s likely that you’ll have more favorable options available to you. Skip IDR unless you’re planning on applying for Public Service Loan Forgiveness, which requires you to be enrolled in an IDR.
Getting married can affect your payments
If you think there’s a chance you’ll tie the knot sometime during your IDR term, be careful about the plan you pick. A Revised Pay as You Earn (REPAYE) works best for unmarried borrowers because it considers both you and your spouse’s income, even if you file separately.
Other options do not — but come with other drawbacks like charging a higher percentage of your income that you might otherwise avoid. Since even switching to another IDR plan can trigger interest capitalization, try to pick a plan that you can stick with.
Other ways to lower monthly repayments
- Deferment or forbearance. This pauses your loan repayments for up to 36 months for temporary relief. While interest capitalizes under this option, it’s over a shorter period of time than an IDR, so you won’t pay as much in extra interest.
- Graduated repayment plans. Even if you have a low-paying position now, an IDR isn’t a good choice if you expect to earn a lot more in the future. With a graduated repayment plan, repayments start low and increase every two years.
- Extended repayment plan. This stretches out your term over 25 years to lower your monthly cost. A long term leaves more time for interest to accrue. But it’s easy to switch out of once the economy is more stable.
- Refinancing. APRs are at record lows, meaning you might be able to qualify for a lower rate by refinancing with a private company, which can lower your monthly cost. But you’ll need a credit score and low debt-to-income ratio to qualify.
You can compare all of your federal loan repayment plan options on the Federal Student Aid website or use its loan simulator to get a suggestion. And you can apply for a new plan or forbearance through your servicer. Refinancing is available through private student loan providers.
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