With more than 70% of all students graduating college in debt, choosing a student loan repayment plan is as much a part of the graduation routine as ordering your cap and gown.
I often get email inquiries about the various student loan repayment programs as graduates are trying to plan their future with student debt as their companion. While I can’t say what plan is right for you, I hope that sharing how we came to our conclusion will help you sort out your own federal student debt repayment options.
Income Based Repayment (IBR) Basics
In order to qualify for Income Based Repayment (IBR), you must have at least a partial financial hardship. Your loan servicer will look at your income and family size, calculate your discretionary income and compare it to the payment required on the standard 10-year plan. In an IBR plan:
- Payments are generally 15% of your discretionary income (10% for new borrowers after July 1, 2014).
- Payments will never be higher than the payments on a 10-year standard repayment plan.
- The repayment period is extended to 25 years (20 years for new borrowers after July 1, 2014). After the repayment period, if there is anything left unpaid on your loan, it will be forgiven.
- You may be required to pay income tax on the portion of the loan that is forgiven.
Another income-driven repayment plan “Pay As You Earn” is available and has lower payments and fewer years before forgiveness than the original IBR.
We Needed Flexibility
At the end of school, my husband ended up with a JD/MBA and $130,000 of student loan debt. He had a job lined up working for a small law firm making 30% commission on fees he earned and collected. The firm would provide office space, front desk staff, malpractice insurance, etc and he would be responsible for finding his own clients and doing the work. We knew that in the beginning his pay would be low, as he would also be building a business.
We weren’t sure if he would receive straight commission (every paycheck varying) or if his commissioned pay would be regulated by a “draw”, in which each paycheck is the same and the draw amount is adjusted to match his average commission. In the first scenario, having a big loan payment due with varying monthly paychecks would be extremely stressful.
We Didn’t Care About Forgiveness
IBR does offer loan forgiveness after 25 years, but we simply did not factor that into the decision. It’s not only difficult to trust that the government-run forgiveness program would still be operating under the same rules 25 years from now, but even if it were, counting on eventual forgiveness could also end up being the more expensive route.
Here’s an illustration. Let’s say that the the rules stay the same, that Mr. SixFiguresUnder never makes more than he’s making now, and that under IBR, we never had to make a single loan payment because of our income and family size. After 25 years of 6.55% interest, the total loan amount would be just under $600,000. If that $600,000 were forgiven, it would count as income to us, and we would owe taxes as if we had earned $639,000 that year. With income that high, our marginal tax rate would be 39.6%, and our total tax bill for the year would be about $200,000!
In reality, we have a choice to pay less than $200,000 now, and be loan free for the next 20 years, or carry the loan, unpaid to the end, hope for forgiveness, and find a $200,000 tax bill waiting for us. Forgiveness becomes less attractive in that light.
Just as importantly for us, we feel a moral obligation to repay money that we borrowed. If you are interested in the possibility of Public Service Loan Forgiveness, you might want to read about risks and considerations before putting your eggs in that basket.
How It’s Working Out
My husband’s income turned out to be a “draw” which evens out his actual commission into equal payments each month. This is much nicer to work with than varying paychecks of straight commission. Currently he makes $39,000 pretax. With our family of five, that put our monthly loan payments at $0.
If you have read our story, you know that we have a huge goal of paying off our student loan debt by the end of 2016. We’ve made some headway but we have a long way to go. While we choose to make payments of more than what our payments would be on the standard 10-year plan, having the flexibility offered by IBR has been a major asset. Instead of having a payment that is automatically spread across all of our loans, we can focus on knocking out one loan at a time.
Recommendation
If you qualify for Income Based Repayment, the flexibility it offers can relieve stress and allow you to lead your own debt repayment. Once you have that flexibility though, instead of banking on the forgiveness plan, aim for the fast track to paying off your student loans.
You’re forgetting that if you’re insolvent (which isn’t hard to be, even without being conventionally broke) you will not have to pay taxes on the forgiven amount. I found a great article by another law grad about how to make yourself strategically insolvent and would love to link it but unfortunately I can’t find it.
Hi Stephanie,
My fiance and I are trying to get our student loans in check. He currently owes $110K in student loans. He is on a yearly draw of $50K plus commissions. He chose to do the REPAYE and every year you have to re-certify and they make you pull your W2 directly from the IRS site. He’s currently paying $564 monthly on last year’s W2 income of $96K. 2016 his total income ended up being $141K pretax. That’s not subtracting the $40K in heavy taxes they took on commissions. We are concerned that his payments are going to sky rocket when he goes to re-certify. We don’t have kids and aren’t married to help offset anything. How can we get his evaluation based on his $50K draw since that is technically stable income versus including commissions that he isn’t guaranteed to receive the following year? ANY HELP is GREATLY APPRECIATED!!!!
Hey Stephanie! We feel your pain with the 6 figures of debt. We are similarly situated– I went to law school and hubby went to dental school. We are candid about our earnings and debt load (which is literally about 5 times the amount of your debt- yikes). Anyway, thanks for sharing. So, are you still signed up for IBR and just making more substantial payments each month? Or have you changed your repayment plan?
Hi Amber! We were on IBR the entire time. In fact, the whole time we never actually owed payments because our income wasn’t high enough. We are done paying for student loans through the student loan servicer (we still owe $25K to a relative). I hope that helps. Feel free to ask if you have other questions! 🙂
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When you were paying $0 under IBR, did you make payments to cover interest on the other loans? Or did you just not put anything toward others so that you could put as much as you could toward the one you were praying off? Thank you!
*paying off
Hi Lisa,
We are still on IBR and have $0 monthly payments. Even though we don’t earn enough (for our family size) to have payments due, we are still making big payments (much more than just interest). Our student loans are the only debt we have (so our total minimum payment for all debt is $0 each month). We are making sacrifices (like living in my in-laws’ basement, spending very little, etc) so that we can pay them off as soon as we can.
Does that make sense? Feel free to ask other questions if it doesn’t! 🙂
Ok that makes sense. What I was more wondering is are your big payments all going to one loan at a time? If so, are your other loans still gaining interest? For example, my husband has four smaller loans that we can’t consolidate, and I think we’d qualify for $0 IBR. Would your system just make payments on one until it was gone then move on to the next? Or should we make enough payments on the others to at least cover interest so that those loans don’t keep growing?
I just found this site in the last month and have read a ton of it. We finally hit the point where we’re ready to be done and do what’s necessary. And this is all really encouraging.
I think our student loans are currently 5 different loans. We do focus all of our payment on one loan at a time and don’t pay attention to the other loans. We started first with the unsubsidized loans because for a while the subsidized ones weren’t accruing interest. They are now though. When we very first started, we had some loans that had a higher interest rate, so we paid those off first.
That’s exciting that you are ready to focus and be done with your debt! It’s not easy, but it’s so worth it! 🙂
I didn’t know that the income-based repayment plans offered forgiveness after 25 years. It’s so smart that you took into account the taxes you’d have to pay on that loan forgiveness. Yikes! That could be pretty scary.
It sounds like a “deal” at first, until you look closely. And 25 years from now is a long time away! We’ll be grandparents by then! Who wants to be paying student loans when you’re a grandparent?!
Hi Stephanie! This post was perfect timing for me as I will need to start paying back my student loans in mid-December. I graduated with my M.S. degree in June and only this month began working full-time, so I have some catching up to do in terms of getting myself back on track financially – I will need to make the lowest possible payments on my student loans while I do this. I am single and my pre-tax income is $33,500.
I am definitely thinking along the same lines in terms of selecting the IBR plan for its flexibility, but I am also curious about the “Pay as you Earn” plan, which brings the payments down even more. If I know my income won’t be going up for the foreseeable future, do you think this would be a good option for me as well?
I think either IBR of PAYE would work well for you. PAYE would make payments lower (unless they’re already at 0), which could come in handy. Just don’t let yourself get too comfortable with the low payments.