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Debt

The Truth About Income-Driven Repayment Plans

If you have federal student loans, you need to know the truth about income-driven repayment plans. Although these plans get promoted as a super-package that boosts your budget today and forgives your loans tomorrow, they can actually keep you in debt decades longer than necessary—and the dream of forgiveness rarely happens! That’s what we call a bad plan.

What Are Income-Driven Repayment Plans?

Income-Driven Repayment Plans (IDR) cover four kinds of plans offered by the Department of Education to help federal student loan borrowers manage their payments. That means this program isn’t available for use with private student loans.

Another disqualifier? Having defaulted loans. Those are ineligible for any IDR plans—but you can use student loan rehabilitation or consolidation to get back on track.1

Even though the four types of IDR plans have a few differences we’ll walk you through, they all have two big things in common:

  • Lower payments. Instead of making monthly payments based on the amount of your debt, IDR payments are determined by your income—usually from 10% to 15% of your discretionary income (aka the difference between your annual income and 150% of the poverty guidelines), depending on the date you took out the loan and other factors.
     
  • Longer terms. Instead of working the standard 10-year payoff term, IDR plans typically run for 20 or 25 years. The longer term makes sense mathematically: Smaller payments and growing interest add up to long-lasting debt. But it makes zero sense if your goal is to get out of debt and build wealth.

There’s also a “promise” to forgive any remaining balance at the end of the 20- or 25-year term—but this rarely works out and has a lot of conditions around it, as you’ll see.

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The reasoning behind IDR plans is simple but flawed: Borrowers with really big balances, compared to their income, probably need help managing their student loan payments. And many people can relate! But if you know that feeling, keep in mind that both debt size and income can—and should—change over time, for the better.

As your income rises, your debt should steadily disappear. IDR plans tend to do the opposite. They lock people into a pattern of low income and zero progress on debt—or even debt that grows! That combo will only slow down your dreams of financial peace.

Types of Income-Driven Repayment Plans

Just so we’re clear: We do not recommend these plans as your best strategy to eliminate debt. We actually teach everyone to get as big a shovel—er, paycheck—as possible and use the debt snowball method as the quickest and most powerful way to become debt-free. But it’s worth knowing how IDR plans work—and why you should avoid them.

The four types of IDR plans are:

  • Income-Based Repayment (IBR)
  • Pay As You Earn (PAYE)
  • Revised Pay As You Earn (REPAYE)
  • Income-Contingent Repayment (ICR)

Income-Based Repayment (IBR)

A lot of people confuse Income-Driven Repayment (IDR) with Income-Based Repayment (IBR). Remember that IDR is the general term for these plans, while IBR is a specific type.

So, what’s IBR all about? An IBR plan sets up your monthly student loan payments based on two factors: the date when you became a new borrower and your discretionary income. Here’s how payments for the two groups of borrowers are calculated:

  • If you were a new borrower on or after July 1, 2014, you’ll generally pay 10% of your discretionary income monthly—but if that works out to be more than the 10-year Standard Repayment Plan amount, you wouldn’t qualify for IBR.
  • Or if you were a new borrower before July 1, 2014, you’ll be looking at a monthly payment of 15% of your discretionary income. But again, that only applies if the amount actually lowers your payment in comparison with the standard repayment amount.2

The repayment periods for loans placed in IBR also depend on the date the loan originated:

  • If you were a new borrower on or after July 1, 2014, it’s a 20-year term.
  • And if you got into this mess before July 1, 2014? It’s a 25-year term. Yikes!3

Recently, President Biden made changes to expand income-based repayment plans.4 As a result, about 40,000 borrowers are expected to have their student loans immediately forgiven and more people will qualify for income-based repayment.

But here’s the thing—those 40,000 borrowers have been paying on their student loans for at least 20 years. Yeah, they may have had a smaller monthly payment, but they’ve also paid thousands more than someone who paid off their loans in half that time. When all is said and done, student loan forgiveness didn’t do them any favors.

Pay As You Earn (PAYE)

On the PAYE plan, monthly payments are going to be 10% of your discretionary income.5 And similar to IBR, you can only set this plan up if the monthly payment would actually be lower than a standard payment.

One more wrinkle with PAYE is that you must meet the Department of Education’s “new borrower” requirement, defined as follows:

  • “You must have had no outstanding balance on a Direct Loan or FFEL [Federal Family Education Loan] Program loan on or after October 1, 2007,” and
  • “You must have received a disbursement of a Direct Loan on or after October 1, 2011.”6

Revised Pay As You Earn (REPAYE)

The name of this plan probably gives you a hint that it’s somewhat similar to PAYE, with a couple of differences. The main features of the REPAYE plan are:

  • Any borrower with federal student loans can use this plan.
  • Your payment is always based on your income and family size. So, if your income increases over time, there’s a chance you can end up with a higher payment than you would have had to pay with the 10-year Standard Repayment Plan.
  • The term of repayment on REPAYE is 20 years, so long as all the loans were used for undergraduate study.
  • But the term of repayment will be 25 years if any of the loans were used for graduate study—which should be more than enough to convince you to skip that master’s program in poultry science.7

Income-Contingent Repayment

This is the only form of IDR available for Parent PLUS Loan borrowers. But keep in mind that if you’re the parent in this scenario and your child is the student, you are not eligible for any kind of IDR—at least not with a normal Parent PLUS Loan.

The only way to use an ICR for your repayment is by first consolidating your PLUS Loan into a Direct Consolidation Loan with any other student loans you have as the parent.

The monthly payment amount for an Income-Contingent Repayment (ICR) plan is calculated differently than for any other kind of IDR. It will be whichever amount is lower:

  • “20% of your discretionary income,” or
  • “What you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income.”8

You can also look forward to a silver anniversary on this plan, because the term of repayment is 25 years.9

Income-Driven Student Loan Cancellation

If you’ve come this far, you’re probably wondering how the student loan forgiveness or cancellation works for IDR plans. For all four types of IDR, if you have any remaining balance at the end of the term, it will be forgiven. Sounds great! Except for a few problems.

As we’ve seen, all of these plans are built around staying in debt for at least 20 years, and some plans run as long as 25 years! Can you imagine having student loan debt well into your 50s? Or if you’re a parent, that could mean a future that includes paying off student loans as a senior citizen!

That length of time should already be a red flag that this is a very expensive form of forgiveness! It’s like getting your hopes up that if you will just agree to live in a shack for a couple of decades, there will be a modest brick ranch waiting for you as a reward on the other side.

But actually, it’s worse than that. Why?

Because even if you make steady payments on the loans for years, there are all kinds of rules and potential legal changes you must keep up with in order to preserve your eligibility for the “forgiveness.” Let’s see what they are:

  • In most cases, you have to make sure your income always stays low enough that you qualify for the IDR plan—which means it can’t go above the level where your payment would be higher than 10% of your monthly discretionary income. So, a promotion at work would probably put the kibosh on a loan cancellation. Your goal is literally to keep your income low in the hopes of getting some unknown future amount of the debt forgiven. That’s pretty dumb.
     
  • Missing recertification in REPAYE automatically kicks you out of the program into another plan that won’t be based on your income. In fact, it will speed your debt deadline way up—even if you’ve jumped through all the hoops for years. The Department of Education will now treat your loan as if it’s on a new 10-year repayment plan, or it will require full repayment by the original term of your REPAYE, whichever falls sooner. Look at it like a balloon lease on your student loan—it could explode at any time.
     
  • And in the other three IDR plans, missing recertification even once also disqualifies you from making income-based payments. You’ll remain on your previous schedule. It’s just that you will now owe standard monthly payments as determined by your original loan amount. At least the payment hike is only temporary—if you recertify later, you can be reinstated into PAYE, IBR or ICR even after missing a deadline.
     
  • Here’s one more gotcha with missing the certification deadline even once on IBR, PAYE or REPAYE: Any unpaid interest will now be added to the principal of your loans, which will be subject to compound growth as well.10

All of these potential pitfalls start to make it look as if IDRs and their promise of a faraway forgiveness someday are really just a ticket to decades of debt.

If the publicly posted rules about how to achieve loan forgiveness aren’t enough to keep you far from IDRs, consider this: A March 2021 report from the National Consumer Law Center says that among the roughly 2 million borrowers in an IDR who have been making payments for 20 years or more, only 32 applicants ever received total cancellation.11

What?

Yes. Let’s say it again so it sinks in: Only 32 people out of the 2 million who have ever started an IDR have actually managed to get their debt balances forgiven. And even as Biden continues to tweak policies so more people qualify for IDRs, it’s still only a very small percentage of borrowers who ever see loan forgiveness.

Oh, and we haven’t even talked about the true cost of IDRs.

The True Cost of Income-Driven Repayment Plans

On March 11, 2021, President Joe Biden signed into law a $1.9 trillion stimulus package that included a change to standing student loan law.12 Prior to the new legislation, anyone who managed to stay qualified for their full 20 or 25 years of scheduled payments in an IDR—remember, not many people have done so—would also be subject to hefty taxes at the time of forgiveness.

Talk about forgiveness with strings attached.

Now, don’t misunderstand—we love the fact that the new law would suspend this tax for those rare ones who cross the forgiveness finish line. But the key word here is suspend. For now, student loan forgiveness is exempt from federal tax. But the relief measure is only temporary. It’s currently set to expire on January 1, 2026.13 And as political winds blow, this miraculous tax break could vanish overnight.

We don’t know about you, but a new five-year window of time when forgiveness isn’t taxed isn’t nearly enough reason for us to sign up for an IDR. Tax laws come and go, but there’s no substitute for focused intensity and the power of taking control of your money—regardless of what’s happening in Washington.

Applying for Income-Driven Repayment Plans

Still not convinced that IDRs are bad news? Okay, we’ll give you the lowdown on how to apply. But don’t say we didn’t warn you off of these scams.

The Department of Education has an application and approval process for any IDR. If you have federal student loans—remember private loans don’t qualify—you can request an IDR either through your lender or at studentaid.gov.

As we’ve mentioned several times, getting an IDR is all about certifying your income to prove it’s low enough to qualify for the “benefit.” And the obligation to recertify continues every year until you pay the loan off or get it forgiven after 20 or 25 years. (Surely the debt snowball method is calling your name by now?)

Is an Income-Driven Repayment Plan Right for You?

How about no? Seriously. You are smarter than an IDR plan.

Instead of speeding up your debt payoff, these plans slow it way down. Instead of inspiring you to find new forms of income, they encourage you to keep your income low. And among the millions of people who have endured 20 or more years inside an IDR, only a small percentage have ever been forgiven by the Department of Education!

We think a much better plan than an IDR is to work the Baby Steps. Here’s where you start:

  • Once you have your $1,000 starter emergency fund, you’re going to get intensely focused on paying off all of your debts.
  • First, list all your debts from the smallest balance to largest balance. If you’ve got more than just student loans (aka credit card debt, car loans, personal loans), include those too! Ignore the interest rates for now—we know that seems weird, but just trust us on this.
  • Throw any extra money you can find toward paying off your smallest debt, while still paying the minimum payments on your other debts. The name of the game here is to attack that first debt with everything you’ve got!
  • Once you’ve paid off your smallest debt, move to the second-smallest debt. Take everything you were putting toward the first one and add it to the minimum payment of the second one. The more you pay off, the more money you free up to use as fuel—like a snowball rolling downhill.
  • Once that debt is paid off, move on to the next one and repeat the process until you’re finally out of debt! Boom.

Here’s the deal: You don’t have to carry around student loan debt for the next 20 years. Check out our free Guide to Getting Rid of Your Student Loans. It’ll walk you through what’s currently happening with student loans, relief options, how to budget for your student loan payment and more. You can get rid of your student loans for good!

Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.

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