Q: How do student loans calculate discretionary income?

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Discretionary income is the amount of money you have leftover after paying necessary expenses (mortgage/rent, utilities, groceries, etc.). Student loan servicers use discretionary income to calculate monthly payments under income-driven repayment plans.

What is discretionary income?

In general, discretionary income is the amount of income you have left for spending, investing, or saving after paying taxes and paying for personal necessities, such as food, shelter, and clothing. The Department of Education uses your discretionary income to calculate how much you can afford to pay each month toward your student loans when entering into an income-driven repayment plan.

Discretionary Income Student Loans. Discretionary income is the difference between your adjusted gross income and 100 or 150% of the poverty guideline for your family size and state of residence. The IBR, PAYE, and ICR Plans use 150% of the poverty guidelines. However, the ICR Plan uses 100%.

Discretionary Income vs. Disposable Income

While discretionary income is the money left after paying necessary expenses, disposable income is the net income a household or individual has left to invest, save, or spend after income taxes have been deducted from your paycheck.

Your discretionary income is the money you have left after using your disposable pay to pay for your household essentials. It's the money you have leftover to buy discretionary expenses like luxury items, vacations, and entertainment.

How to calculate discretionary income student loans

  1. Locate your AGI. AGI is your adjusted gross income, which is your gross income after eligible deductions. Your AGI is listed on line 11 of the 2019 and 2020 federal income tax returns.
  2. Count your family size. Your family size includes any child you provide more than 50% for no matter where they live. It also includes any adult that lives with you more than 50% of the year and that you provide more than 50% of their support.
  3. Check the poverty line. Each year, the Department of Health and Human Services (HHS) releases a federal poverty guideline for the 48 contiguous states and the District of Columbia, and Alaska and Hawaii. The last two states have a higher cost of living, so the HHS generates a different poverty line for those states. The poverty guideline measures the federal poverty level for your family size.
  4. Multiply the poverty line by 150%. The IBR, PAYE, and REPAYE student loan repayment plans calculate your monthly payment amounts by using 150% of the poverty line for your family size.
  5. Calculate your discretionary income. Those same three plans define discretionary income as your adjusted gross income minus 150% of the poverty line of your family size.

Discretionary Income Example. Kate is single. She has no children and lives alone. She lives in California. She's repaying her loans under the REPAYE Plan. The adjusted gross income on her 2020 federal tax return is $50 thousand. The federal poverty line for a family size of one in California is $12,880. Multiplied by 150%, that amount becomes $19,320. The final step is for Kate to subtract $19,320 from her AGI, $50 thousand. Kate's discretionary income for her federal student loan debt is $31,680.

Discretionary Income & IDR Plans

The federal government offers borrowers four payment plans based on their income:

Each of these federal student loan repayment plans uses a different formula to calculate your monthly payment, typically either 10 or 15% of your discretionary income. These plans also offer loan forgiveness at the end of the repayment term.

Let's return to the example from above.

Kate's discretionary income is $31,680. She's in the REPAYE Plan, which uses 10% of her discretionary income to calculate her monthly payment. Ten percent of Kate's discretionary income is $3,168. Finally, to find her monthly payment, we have to divide that amount by 12. Kate's monthly payment based on 10% of her discretionary income is $264.

IDR Calculator. While borrowers can calculate their discretionary income and monthly payment by hand, they don't have to. The Federal Student Aid website, studentaid.gov, allows federal student loan borrowers to estimate their monthly payment under the various repayment plans using the Loan Simulator.

How discretionary income changes

Discretionary income changes. Your family size increases or decreases. Your pay does the same.

Each year, you'll need to submit an annual recertification to remain in your IDR Plan. The annual recertification asks you to confirm your family size and income when you're signing the Income-Driven Repayment Plan Request form.

Changes in your family size or your income (or spouse's income) can affect your monthly payment year to year.

Discretionary income can be unfair

Your family size and the federal poverty level aren't always fair indicators of your necessary expenses. When calculating your discretionary income, the IDR Plans include your debt from credit cards, car payments, medical bills, child support, and private student loan debt.

As a result of those expenses, some federal student loan borrowers won't get an affordable monthly payment under the IBR Plan. Instead, they'll need to repay their loans under the Graduated or Extended Repayment Plan. And if you can't afford those payments, ask for a deferment or forbearance.

Lower AGI: Tips

Under an IDR Plan, your monthly payment is based on, among other things, your AGI.

You can lower your AGI by increasing your contributions to retirement accounts like a 401(k) or traditional IRA.

Of course, not all borrowers have money left over after paying their essential expenses to contribute more towards retirement. But those who can do so can lower their monthly student loan payment.

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