What Is Income-Based Repayment?

What Is Income-Based Repayment? article image.

Income-based repayment is one of the four income-driven repayment programs offered to federal student loan borrowers. If you qualify based on your financial need, you can get your monthly payment reduced to as low as 10% of your discretionary income.

If you're struggling to keep up with your federal student loan payments, here's what to consider before applying for an income-based repayment plan.

How Does Income-Based Repayment Work?

An income-based repayment plan, called IBR for short, reduces your monthly payment to 10% or 15% of your discretionary income and extends your repayment term to 20 or 25 years.

The lower payment amount and shorter term are reserved for new borrowers who took out their first loan on or after July 1, 2014. For borrowers who received loans before that, the 15% rate and 25-year term apply.

The U.S. Department of Education calculates your discretionary income by taking the difference between your annual income and 150% of the poverty guideline for your state of residence and family size. You'll need to recertify these details every year, which means your payment may increase as your income does, but it will never exceed the monthly payment you'd otherwise pay based on the 10-year standard repayment plan.

If you still have a balance left over after your repayment term under the plan ends, it'll be forgiven. However, the forgiven debt will be considered taxable income.

IBR isn't the only student loan repayment plan the federal government offers, nor is it necessarily the best plan for your financial situation. It may be beneficial, however if you don't qualify for the Pay As You Earn (PAYE) plan, which offers a 10% payment and 20-year term.

It can also be worth considering if you don't expect your income to increase much over time, as that could make it more likely that you'll receive forgiveness for some of your balance after 20 or 25 years.

Who Is Eligible for Income-Based Repayment?

Only federal student loans are eligible for the Department of Education's income-driven repayment plans, and that includes IBR. However, it's one of two such plans that require you to show financial need to get approved—the other being the previously mentioned PAYE plan.

More specifically, you must show that your monthly payment under the IBR plan would be less than what you're currently paying on a standard repayment plan. In general, you'll meet this requirement if your student loan debt represents a significant portion of your annual income, or your debt is higher than your annual discretionary income.

Additionally, only certain loans are eligible for the program. That includes:

  • Direct subsidized loans
  • Direct unsubsidized loans
  • Direct PLUS loans made to graduate or professional students
  • Direct consolidation loans
  • Subsidized federal Stafford loans
  • Unsubsidized federal Stafford loans
  • Federal Family Education (FFEL) PLUS loans
  • FFEL consolidation loans

If you have Federal Perkins loans, you can access the program by consolidating them with a direct consolidation loan. However, federal loans made to parents do not qualify, even if they're consolidated with the direct or FFEL programs.

Private student loans are also not eligible for the federal program. However, some private lenders may offer similar accommodations to borrowers looking to reduce their payments—the Rhode Island Student Loan Authority is one notable lender that offers an IBR plan.

How Do I Apply for Income-Based Repayment?

Before you apply for an IBR plan, research the other income-driven repayment plans to make sure you choose the one that's the right fit for you. You may even want to call your loan servicer to get more information about your options.

When you're ready to apply, fill out an income-driven repayment plan request form, which you can submit online or via a paper form. The form allows you to select the plan you want to apply for, but you can also leave it blank to allow your servicer to put you on the plan with the lowest monthly payment you can qualify for.

Note that if you have more than one servicer for your federal loans, you'll need to submit a separate request form with each one.

Because you're considering IBR, you'll need to provide income documentation to help your servicer determine your eligibility. Depending on your situation, you'll need your tax return or an alternative form of documentation, such as a pay stub.

You'll also need your Federal Student Aid (FSA) ID—find it or create one on the FSA website—and some personal information, including your permanent address, email address and phone numbers.

After you submit your request, it can take a few weeks for your servicer to process it. To speed up the process, apply online and submit all the required documentation as soon as possible.

How Much Will My Payments Be for Income-Based Repayment?

If you qualify for an IBR plan, your monthly payment will be determined by two things: your discretionary income and when you became a new borrower of federal loans.

If you were a new borrower before July 1, 2014, your payment would be 15% of your discretionary income. If you became a new borrower on or after that date, though, it'd be 10% of your discretionary income.

Your discretionary income is the difference between your annual household income and 150% of the poverty guideline for your state and family size. To get an accurate estimate of what your payment will be, use the Department of Education's loan simulator tool.

Also, note that your payment will not remain the same for the remainder of your repayment term. Each year, you'll be required to recertify your income and family size with your loan servicer. Also, federal poverty guidelines can change from year to year. Each year when you recertify, your monthly payment will be recalculated based on the updated information.

If you neglect to recertify your income and family size, you'll remain on the IBR plan, but your monthly payment will revert to what you were paying on the original 10-year standard repayment plan until you provide your servicer with the necessary details.

Are There Downsides to the Student Loan Income-Based Repayment Plan?

IBR can provide much-needed relief to federal student loan borrowers who are struggling to get by, and if your income doesn't increase much over time, you may even qualify to have a portion of your student loan debt forgiven. However, there are also some disadvantages to consider before you apply:

  • Longer debt term: Instead of the standard 10-year repayment plan with federal loans, your repayment term will be 20 or 25 years, depending on when you first started borrowing federal loan money. If 10 years sounds like a long time to be in debt, the idea of doubling that time (or more) may not sound too appealing.
  • Interest: Because your repayment term will be extended to up to 25 years, you'll end up paying more in interest than if you were to stay on the standard plan. Your payments may not even be enough to cover the accrued interest, which means your student loan balance may grow over time.
  • Taxable forgiveness: While you may qualify to have a portion of your debt forgiven after your repayment term ends, that amount will be taxable as income. Depending on how much it is, you may end up with a sizable tax bill, which you'll need to plan for, so you don't end up in debt to the IRS.
  • Recertification requirement: You'll need to remember to recertify your income and household size every year to continue to have your payments based on your income. If you forget, your payments will go back to what they were before until you provide the necessary information.

Alternatives to Income-Based Repayment

The federal government offers four income-driven repayment plans in total, so it's important to consider all of them to make sure you find the right fit.

The other available plans include:

  • Pay As You Earn (PAYE): With this plan, your payment will be 10% of your discretionary income and will never be higher than your payment on the standard 10-year plan. Your repayment term will be extended to 20 years. Only borrowers who provide evidence of financial need are eligible for this plan.
  • Revised Pay As You Earn (REPAYE): Under this plan, your payment will be 10% of your discretionary income, and your repayment term will be 20 years for undergraduate loans and 25 years for graduate and professional loans. There's no cap on what your payment can be, so it may end up higher than your current one. Anyone with an eligible loan can get on a REPAYE plan.
  • Income-Contingent Repayment (ICR): This plan is the only one that's available to all federal loan borrowers, including parents. Your repayment term will be 25 years, and your monthly payment will be the lesser of 20% of your discretionary income (this time based on 100% of the federal poverty guideline), or what you would pay on a 12-year repayment term, adjusted according to your income.

Consider consulting with your loan servicer to help determine which plan is the right fit for you and your situation.

How Does Income-Based Repayment Affect Credit Scores?

Getting on an IBR plan won't directly impact your credit score because you aren't changing your total loan balance or opening a new credit account. However, lenders consider more than just your credit score when you apply for credit. Here are a couple of potential consequences to watch out for:

  • Debt-to-income ratio: Lowering your monthly payment can help reduce your monthly debt obligations, which could make it easier to qualify to borrow more if you're buying a house.
  • Debt term: If you're applying for new credit, lenders will consider how much you owe on existing debts. With an IBR plan, you'll have a balance for up to 25 years instead of 10, which means it could affect your chances of getting new credit for much longer.

To make sure you're using your student loan debt to improve your credit, pay your bills on time every month, preferably with automatic payments. Also, once you're financially able to pay more, consider adding extra payments, even if you don't need to. Not only will this help you save money on interest, but it'll also get you to debt-free status more quickly.

Stay on Top of Your Credit to Improve Your Long-Term Financial Standing

While you may be struggling now and need an income-driven repayment plan, it's important to take steps to improve your financial well-being over time. One way to do that is to establish and maintain a good credit history. With great credit, you can score lower interest rates on loans and credit cards, save money on car and homeowners insurance, and more.

Keep track of your credit score to have an idea of where you stand and where you can put your focus to make improvements. Experian's credit monitoring service not only gives you free access to your FICO® Score powered by Experian data but also helps you monitor your spending and provides real-time alerts about certain changes to your Experian credit report.

As you take steps to build your credit history and maintain a good credit score, you'll have a better chance of achieving your financial goals.