6 Must-Know Facts About Income-Based Repayment

Loans, Student Loans
How Income-Driven Student Loan Repayment Helped One Borrower — and What It Could Do for You

You might hear “income-based repayment” used to describe any payback plan that gives you a federal student loan bill based on how much you earn.

But the government actually offers four income-driven plans, each of which has different requirements. The one officially known as income-based repayment is best for you if you meet these two criteria:

  • Your current federal loan bill is more than 10% of your income
  • You started borrowing money for school after July 1, 2014

If that doesn’t sound like you, the Pay as You Earn, Revised Pay As You Earn or income-contingent plans might be better bets.

Check out our list of student loan repayment plans for more details on all of your options.

Or, if you want to save on the total cost of your loan and you have strong credit as well as a steady income, consider student loan refinancing. When you refinance with a private lender, the current loan is replaced with a new loan at a lower interest rate and a new term; the shorter the term, the more you’ll save.

Refinancing is a good choice for borrowers with private loans or those with federal student loans who don’t plan to use an income-driven repayment plan, federal loan forgiveness programs or other protections. Consider all options and compare offers before refinancing.

Still interested in income-based repayment? Read this primer before you sign up.

1. You must meet income requirements

Income-based repayment requires you to show a partial financial hardship. That means the amount you’d pay on the 10-year standard plan must be more than what you’d pay on the income-based plan.

Here’s how to figure out what your income-based repayment bill would be. If you took out your first federal student loan before July 1, 2014, your loan payments will be capped at 15% of your discretionary income. If you took out your first loan on or after July 1, 2014, the cap is 10%. The government defines discretionary income as the amount you earn per year beyond 150% of the federal poverty level.

If you don’t meet the income threshold for income-based repayment but want to lower your bill to 10% of your earnings, sign up for Revised Pay As You Earn, known as REPAYE. It doesn’t have a partial financial hardship requirement.

2. There are more generous options if you borrowed before July 1, 2014

Since income-based repayment debuted, the U.S. Department of Education has released additional plans that offer better deals for some borrowers.

If you took out loans earlier than July 1, 2014, look into REPAYE or Pay as You Earn, known as PAYE. These two plans max out your monthly payments at 10% of income, making them a better deal than the original version of income-based repayment. REPAYE does, however, extend repayment to 25 years for any borrower with grad school loans, and it requires you to include your spouse’s income on your application even if you file taxes separately.

3. Direct loans and most FFEL loans are eligible

Your federal loans must be direct loans or loans made under the Federal Family Education Loan (FFEL) program to be eligible. PLUS loans made to parents, whether they’re part of the direct loan program or the FFEL program, aren’t eligible for income-based repayment. You can consolidate Perkins loans in order to repay them on the income-based plan. But take care: When you consolidate Perkins loans, you’ll lose access to public-service loan cancellation programs that could wipe out your entire Perkins loan balance. Check this chart to see whether your loans can be repaid under income-based repayment.

» MORE: Guide to student loan consolidation

4. You’ll get forgiveness after 20 or 25 years

New borrowers as of July 1, 2014, will have the remainder of their loans forgiven after 20 years of payments, and those who borrowed before that will see forgiveness after 25 years.

Current IRS rules state you’ll have to pay income tax on the amount forgiven. The promise of forgiveness might be a relief while you’re in repayment, but interest will accrue faster than you can pay it, leaving you with a potentially big balance in the future. Consider starting to save for your tax bill now or paying more than you need to during months when you have extra cash.

Many borrowers on income-based repayment won’t receive forgiveness because they’ll pay off their loans before 20 or 25 years are up. Check Federal Student Aid’s repayment estimator to find out if that’s the case for you.

5. It’s free to sign up

Charging to process income-driven repayment applications is one of the most common ways student debt relief companies prey on borrowers. It’s free to sign up for income-driven repayment on your own on studentloans.gov, and the application isn’t as complicated as it may seem.

“While there are now multiple plans and it can be confusing, you don’t have to learn all the details to benefit from them,” says Lauren Asher, president of the Institute for College Access & Success, a nonprofit research and advocacy group.

Complete an income-driven repayment plan request on the Federal Student Aid website. You’ll be able to import your income information from your most recent tax return. Married borrowers can file taxes separately so both spouses’ incomes aren’t included in the calculation.

If you know income-based repayment is the plan you want, choose it on the form. If you’re not sure which plan to go with, you can check the box requesting the plan that will give you the lowest monthly payment.

6. You must reapply every year

Remember to recertify your income every year you’re on income-based repayment so you don’t revert to the 10-year standard repayment plan. If you don’t recertify, your bill will jump to the higher amount you’d pay on the standard plan, which could be a big shock to your bank account.

Your student loan servicer should send you a reminder when your annual application is due, but just to be sure, add a reminder to your calendar or on your phone to make sure you don’t miss it. You’ll use the same request form.

Your payment will increase or decrease as your income and family size change, but it will never be more than what you’d pay on the standard plan, even if your income rises dramatically.

Brianna McGurran is a staff writer at NerdWallet. Email: bmcgurran@nerdwallet.com. Twitter: @briannamcscribe.

Updated Sept. 29, 2016.

A previous version of this article misstated the types of loans eligible to be repaid on this plan. The article has been corrected.