What Is Income-Based Repayment of Student Loans?

What is income based repayment (IBR)?

The crazy thing about student loans is that… you have to pay them back. Who knew? Of course, we all know that the loans have to be paid off eventually. But when you’re in school, the prospect of paying them off sometimes feels abstract and distant. You know that someday you’ll be making those monthly payments, but in the meantime you’re focused on other things (coursework, internships, etc.) And then suddenly you graduate and someday becomes today.

Over the last few years, the global financial crisis and recession have forced many graduates to start making their student loan payments while looking for jobs or doing unpaid internships after getting their degrees. Even for those who have jobs, the total amount of your monthly loan payments can sometimes feel insurmountable. Fortunately, if you are finding it difficult to make your monthly loan payment while still having enough income leftover to cover other essential expenses, the Income-Based Repayment (IBR) program may be a life saver.

Traditionally, there hasn’t been much leeway for student loan borrowers, but IBR can make a significant difference in your financial situation because it caps the amount you have to pay each month, based on your income. There are certain thresholds (see below) which determine the percentage of your income you need to pay. In most cases, it is 15% or less. That means there’s a light at the end of the tunnel for those who are eligible!

How does Income-Based Repayment work?

The purpose of the income-based repayment program is to give relief to people who are making a good faith effort to pay back their loans but who are struggling due to financial circumstances. To qualify for the program, a borrower must prove “partial financial hardship.” If the minimum payments on your federal loans are more than 15% of your income each month that is considered “partial financial hardship.”

When you are accepted into the IBR plan, your payments will be based on your family size and your income. For example, if you are a single individual and make an income of $40,000 per year, your payments would be approximately 8.7% of your monthly income. If you have a family of four and a total family income of $60,000, your payments would be 6.4% of monthly income. (See the chart on this page for a more detailed explanation)

When you enroll in IBR, your repayment plan will be extended up to 25 years. After 25 years of making payments under the IBR plan, any remaining debt will be forgiven. That means, as long as you make the reduced payments and continue to do so for 25 years, you don’t need to stress out about defaulting on your loan!

How to Apply for an Income-Based Repayment Plan

So how do you sign up? Well, there are specific requirements for being eligible for IBR. The plan is available for anyone who has either direct (FDSL) or gauranteed (FFEL) student loans. To be considered, these loans must not be in default.

To get an estimate of whether you are eligible (and how the plan might affect you), you should try this calculator:

IBR Calculator

If you do qualify, then you’ll need to submit an application to your loan servicer. The procedure varies depending on which company it is. Here is information on how to apply to some of the most common ones:

If you don’t know who your servicer is, you can use the National Student Loan Data System database to find out.

What Are the Advantages of Income-Based Repayment?

There are certainly many pros to entering this program. Borrowers can pay as they earn and not feel as bad a strain on their finances as they would have on a standard repayment plan. The government will also pay the interest on any subsidized Stafford loans for the first 3 years, if the borrower’s monthly payment in the program does not cover interest. Better still: loans taken after 2012 are eligible under a new rule created by President Obama that decreases IBR monthly payments from 15% of income, to 10%, and allows you to have your remaining loan forgiven after 20 years instead of 25. (And, as with any federal loans, the 10-year public service forgiveness also applies!)

What Are the Disadvantages of Income-Based Repayment?

There are a few things that could be seen as disadvantages, as well. Borrowers are required to annually submit documentation proving income and family size in order to set the proper payment amount. This is crucial to remaining in the program and, if the documentation is not provided, the monthly amount increases to what it would have been on a standard 10-year repayment plan. And if you reach the point where your remaining loans are forgiven, that amount will be considered income and you’ll have to pay taxes on it. Another drawback is that you will wind up paying more interest in the long run due to smaller payments. Lastly, you just might not qualify…

…but if that’s the case, don’t lose hope yet! In addition to IBR, there is also the income-contingent repayment program (ICR). Partial hardship is not required for ICR, so those who may not qualify for IBR still have a shot. While FinAid.org states that, “calculating the cost of a loan in the ICR program can be somewhat complex, in part due to the need to make assumptions about future income and inflation increases” the site does provide a comprehensive calculator to help you determine monthly payments.

The Bottom Line

According to CBS News, only 2.25% of federal student loan borrowers are enrolled in the IBR program, though 10% are qualified. If you are one of those who has not yet enrolled, you should definitely consider it. However, it is important to also consider the disadvantages – specifically, the prospect of paying more interest over the life of the loan. If you have the ability to make monthly payments on a standard 10-year plan, you’d be better off continuing with that plan. (Heck, you could even be earning interest on that money later, instead of spending money on interest) But if you need the extra breathing room that IBR will afford you, there’s no reason you shouldn’t apply now!

Hopefully now you have an answer to the question, “What is Income-Based Repayment?” And if you need to track all your debt easily and conveniently in one place, click below to give ReadyForZero a try.

This article is part of our Student Loan Debt Resource Center.  If you’re looking for additional information about student loans, be sure to pay a visit!

Image credit: gadgetdude

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  • Rachel

    This article was very helpful, for I am contemplating this type of repayment plan for my newest federal loan. I have over $100,000 in student loans. I’ve been managing to pay to three of my services. I recently finished my second masters and now have $500 month payments I’m expected to pay. Even though 25 years is such a long time, I think this option would be good for me. I hope I’m making the right decision! 

    • http://www.readyforzero.com ReadyForZero

      Rachel- Glad you found the article helpful and that the IBR program is beneficial for you. You can always choose this option for now, and then make more payments once you are able. What did you study?

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  • NW

    I’ve been doing research and have found that if the loan is not paid off in 25 years, the balance is forgiven but you are required to pay INCOME TAXES on the forgiven amount on this tax year.  Also, I believe that the new Obama legislation only applies to loans disbursed after the law goes into effect.  Do you know of any other major drawbacks to this plan?  I currently make $20,000 a year as a graphic designer yet owe $900 a month from grad loans for my MFA.  I have been making payments for 2 years, but it is really difficult to keep going and still make my own art besides!

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      That’s a good point about the income taxes – I will add that to the article. Thanks! I don’t know of any other drawbacks to the plan, other than what was mentioned in the article, which is that you will end up paying more interest in total when you switch to a longer loan repayment term. Sorry to hear your loans have been weighing you down! Best of luck. And do try out ReadyForZero and let us know if it helps.

  • Guest

    I ended up with income contingent repayment and so far so good.  One payment and lower interest.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Very glad to hear it’s working well for you! 

  • sue

    what about wells Fargo colligate loans do they qualify for income based repayment?

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      They might. If it’s a private loan from Wells Fargo, you’ll need to call them up and find out what kind of income based repayment options they have. Good luck!