Can’t afford your student loan payment? Do you have federal student loans? Don’t worry.
Lowering your student loan payment can be fairly straight-forward.
I help clients do this all the time.
It’s not a secret at all.
Getting a lower student loan payment is about 2 things: counting your family size correctly and finding ways to decrease your discretionary income.
The key to reducing student loan payments comes down to finding ways to decrease your discretionary income. (You could also increase your family size but that’s harder to do.)
In this post, you’ll learn everything you need to know to lower your payment amount by decreasing your discretionary income.
What is Discretionary Income
The Department of Education defines discretionary income as the difference between two things:
- your adjusted gross income and
- the poverty guidelines for your family size.
Of course, that definition leads us to ask two more questions:
- What is adjusted gross income? and
- What are the “poverty guidelines”?
As to the first question, your adjusted gross income is your total earnings less certain deductions for things like business expenses, IRA contributions, etc. This is why your AGI is often less than your taxable income.
Discretionary income accounts for necessary expenses, but it does not include costs for what are deemed as non-essentials like credit card debt, medical bills, car payments, private student loan payments, etc.
As for the second question...
What is the Federal Poverty Guideline 
The federal poverty guidelines are a simplified version of the poverty thresholds, which are set by the Census Bureau. They are issued each year in late January by the Department of Health and Human Services.
The guidelines are based on your family size and state of residence.
2019 Poverty Guidelines
For most student loan borrowers, what state they live in doesn’t matter. The poverty guidelines are the same for the 48 contiguous states. Both Alaska and Hawaii. There, the amounts are higher.
How to Calculate Discretionary Income
To calculate your discretionary income for student loans, you’ll need to know:
- Your family size (this may be different than the number of dependents you claim on your taxes)
- The poverty guideline for your state;
- The income-driven repayment plan (IDR plan) you want to pay under; and
- Your AGI from your last income tax return.
When you have this information, calculating your discretionary income is straightforward.
First, find the poverty level for your family size.
Next, multiply the poverty amount by 1.5 if you’re going to repay your loans under either the Income-Based Repayment, Pay As You Earn, or Revised Pay As You Earn plan. If you’re going to pay your loans under the Income-Contingent Repayment plan (because you have Parent Plus loans) there’s no need to multiply; your discretionary income is the same as the poverty guideline for your family size.
Finally, subtract the multiplied amount from your AGI. The resulting total is your discretionary income.
Let’s use an example to lock in the math.
- You live in Missouri and have a family size of 3.
- The poverty guideline for your family size is $21,330.
- Multiplied by 1.5, that amount becomes $31,995.
- Your AGI from your recent tax return was $50 thousand.
- Your discretionary income is $19,005.
Okay, so now that we know how to calculate discretionary income, we still need to understand how discretionary income impacts your student loan repayment.
Reducing Student Loan Payments With Discretionary Income
The U.S. Department of Education uses your discretionary income to calculate your monthly payment under the various income-driven repayment plans.
The Department uses slightly different formulas depending on which repayment plan you're in.
Not all loans are eligible for the different repayment plans. For instance, Federal Family Education Loans and Parent Plus Loans aren't eligible for the REPAYE plan. With FFEL loans, there's a saving grace: you can apply for loan consolidation and consolidate your FFEL loans into a Direct Loan Consolidation. Unfortunately, this doesn't work for Parent Plus Loans.
Discretionary Income & REPAYE/PAYE/IBR for New Borrowers
The REPAYE, PAYE, and IBR for new borrower plan each calculate your monthly payment at 10% of your discretionary income divided by 12.
Let's use our example from above to see how this works.
Earlier we said your discretionary income was $19,005.
Ten percent of that is $1,900.5.
Finally, we divide that amount by 12 to get your new payment: $190 per month.
Discretionary Income & IBR/ICR
Under the Income-Based Repayment and Income-Contingent Repayment plans, you'll pay more each month than you would under the REPAYE or PAYE plans.
This is because both the IBR and ICR plan require you to pay more of your discretionary income over your repayment term.
The IBR plan asks for your 15% of your discretionary income.
Meanwhile, the ICR plan wants 20%.
Given the same numbers from above, you'll pay $237 per month under the IBR plan and double that, $478, under the ICR plan.
FYI. In case you're doing the math, the ICR plan doesn't use 150% of the poverty level for your family size. It doesn't use any adjustment. So for the ICR plan, just take the amount listed for your family size.
This potential for increased payments is why for most borrowers, I think PAYE and REPAYE are the best repayment plans.
Consider Changing Plans & Reducing Your AGI to Lower Your Payment
The easiest way to get a lower payment for your federal student loans is to switch to the REPAYE plan.
For most single borrowers, that plan offers the lowest monthly payment because it asks for the lowest share of your discretionary income.
Admittedly, PAYE and IBR for new borrowers both ask for the same 10% of discretionary income as does the REPAYE plan. Most borrowers, however, aren't eligible for those 2 plans.
So you know, there's one big drawback to switching repayment plans:
The interest that accrued while you're in the will capitalized to your principal balance. And when that happens, your student loan debt will increase substantially.
Okay, back to the other way to reduce your monthly payment: reduce your discretionary income.
Remember, your monthly payment under an IDR plan isn't necessarily tied to your loan amount.
Instead, it's tied to your discretionary income and family size.
Of the two, your discretionary income is easier to manipulate.
Contribute more to your retirement plans, declare the losses on your business, contribute to a health savings account, etc.