How Income-Based Repayment Is Calculated

Understanding how income-based repayment is calculated can help you save thousands over the life of your loan. It’s not as straightforward as handing over your adjusted gross income (AGI) from your tax return and listing your dependents. The real art lies in deciphering the rules of each income-driven repayment plan and understanding how the Education Department’s definition of ‘family size’ differs from the IRS’s when it comes to income tax returns.

In the following sections, we’ll explore how each income-driven plan factors in your taxable income, family size, marital status, and student loan balance to determine your monthly payment. We’ll also demystify technical terms like ‘poverty guidelines’ and ‘discretionary income’ and explain how they can help you get the lowest monthly payment.

Related: How Income-Driven Repayment Plans Work

An Income-Based Repayment plan generally equates your monthly payment to 10% to 15% of your discretionary income. Plus, the Department of Education has your back – it ensures that your adjusted payment won’t exceed what you were shelling out under the 10-Year Standard Repayment Plan.

Wondering how long the IBR periods are?

They typically stretch between a 20 to 25-year repayment term. If you’ve not cleared your loan by the end of this period, here’s a silver lining: the remaining balance is generally forgiven.

Learn More: IBR Student Loan Forgiveness

When it comes to student loans, ‘discretionary income’ isn’t as complicated as it sounds. It’s essentially a calculation that the U.S. Department of Education uses to figure out what you can comfortably pay each month for your student loans under an income-driven repayment plan.

How do they calculate it?

The Education Department uses your adjusted gross income minus 100% or 150% of the poverty line for your family size and state. The percentage used varies by the type of plan: the PAYE, REPAYE, and IBR Plans use 150% of the poverty guideline, while the ICR plan sticks to 100%.

Learn More: How to Calculate Discretionary Income for Student Loans

‘Family size’ in income-driven repayment plans isn’t just about the number of people living under your roof. It includes you and your children (even those expected to be born within the year you’re certifying your family size) — as long as they rely on you for more than half their support.

Here’s how different plans see it:

• For Pay As You Earn (PAYE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR) plans, your spouse always counts in the family size.

• For the Revised Pay As You Earn (REPAYE) plan, your spouse is part of the family size unless their income is not considered in your payment calculation.

And there’s more. Your family size may also include others if they live with you, currently receive over half of their support from you, and will continue to do so for the year you’re certifying your family size.

Related: Does Income-Based Repayment Include Spouse’s Income?

What counts as ‘support’? It covers a wide range from money, gifts, loans, housing, food, clothes, and car expenses to medical and dental care and college costs.

Remember, the number for your ‘family size’ could differ from the number of exemptions you claim for tax purposes.

Now that we’ve got the key terms covered, let’s delve into how income-based repayments are calculated under various IDR plans:

1. Income-Based Repayment: Got loans from before July 1, 2014? You’re considered a ‘new borrower.’ Your monthly student loan payment will be 15% of your discretionary income. For loans taken out on or after this date, the figure drops to 10%.

2. Pay As You Earn: PAYE keeps it simple – your monthly payment is 10% of your discretionary income.

3. Revised Pay As You Earn: With REPAYE, too, your monthly payment holds steady at 10% of your discretionary income.

4. Income-Contingent Repayment: The ICR plan charts a different course. Your monthly payment is either 20% of your discretionary income or the sum you’d fork out on a fixed repayment plan over 12 years, adjusted as per your income. You pay whichever amount is lesser.

Bear in mind; these calculations hold true for federal student loans. Private student loans play by different rules. Plus, your monthly payment may see ups and downs year by year, driven by changes in your annual income and family size.

If IBR seems like your cup of tea, here’s what to do:

1. Check Your Eligibility: Reach out to your loan servicer to verify if you qualify for IBR. Remember, this applies only to federal student loans like Stafford, Grad PLUS, and consolidation loans (including those with Perkins loans). Regrettably, it doesn’t cover private student loans or Parent PLUS loans. But it does include Direct Consolidation Loans that paid off Parent PLUS Loans.

2. Enroll in IBR: Many borrowers can sign up for IBR online or submit a paper IDR plan request form.

3. Annual Updates: Your monthly payment under IBR adjusts each year based on changes in your income and family size. This means you need to submit updated information annually to maintain your spot in the IBR program.

So, what counts as ‘acceptable income information’?

• For most borrowers, acceptable income information is your adjusted gross income (AGI), which can be found on your federal tax return.

• If you haven’t filed a federal tax return in the past two years, or if your income has significantly changed (for example, if you’ve lost your job or taken a pay cut), your loan servicer might ask for other documentation of income, such as a pay stub.

And that’s where my team and I come in. We can help you shave hundreds off your monthly student loan bill. Let’s break this down with an example.

Picture this: you’re a traveling nurse who earned an impressive $200,000 last year. If you submitted your tax return with that AGI, your federal student loan payments would be through the roof. But here’s the twist: you’re currently between contracts. You might even be unemployed with no taxable income right now.

So what does that mean? It means that your loan payment could be zero for the upcoming year. You’re not obligated to update your income information with the Education Department until next year.

Related: Are Parent PLUS Loans Eligible for Income-Based Repayment?

Now that we’ve got a good grasp on the different IDR plans and their specifics, the real question is, ‘Which one is right for me?’ Here are some pointers to help you decide:

• Review Your Financial Situation: Assess your income, family size, loan size, and potential changes in your future income. Remember, some plans might offer lower monthly payments but could result in more interest paid over time.

• Consider Your Goals: Are you aiming for loan forgiveness? Or are you hoping to pay off your loan as quickly as possible? Different plans suit different goals.

• Think About Future Changes: Are you expecting your income to rise significantly in the future? Or are you about to start a family? These factors can influence which plan is best for you.

Still not sure? That’s okay; it’s a big decision. A tax professional or a student loan expert can guide you through these factors and help you find the best option for your situation.

Under President Biden, significant strides have been made in student loan reform, providing potential relief to borrowers:

• Income-Driven Repayment Proposal: This proposition reduces the share of discretionary income on undergraduate loans from 10% to 5%, simplifying the path to loan forgiveness.

• Bankruptcy Discharge for Student Loans: The administration simplified the process for discharging federal student loans through bankruptcy by updating attestation forms and guidelines.

• The IDR Waiver: The Department of Education introduced this one-time adjustment to rectify past errors that prevented student loan borrowers from receiving credit toward loan forgiveness. Once the IDR Waiver is implemented, borrowers will get credit for past repayment periods and some time spent in deferment and forbearance.

• The PSLF Waiver: This temporary policy broadened the pool of borrowers qualifying for the Public Service Loan Forgiveness Program. Though the Limited PSLF Waiver has ended, some aspects will become permanent from July 2023.

To elaborate on the IDR Waiver, it provides retroactive credit toward IDR forgiveness, and it credits borrowers with qualifying payments that would not count toward their 20- or 25-year IDR loan forgiveness term.

The majority of borrowers’ accounts will be adjusted automatically in late 2023.

While only Department-held loans are credited through the IDR Waiver, borrowers with FFEL or Perkins loans held by third parties can consolidate by the end of 2023 to benefit from the adjustment.

Note: President Biden also proposed a plan to forgive up to $10,000 in debt for borrowers earning less than $125,000 a year. But it was struck down by the Supreme Court.

While refinancing can seem like an attractive option for managing your student loan debt, it’s not always the wisest choice. Yes, refinancing can potentially score you a lower interest rate, reducing your monthly payment and the total amount you’ll pay over the life of the loan. But there are trade-offs.

When you refinance federal student loans with a private lender, you forfeit valuable federal protections and benefits. This includes access to income-driven repayment plans and the potential for loan forgiveness. If you’re already contemplating income-based repayment, it doesn’t make sense to refinance at this point. The terms of a refinanced loan could make it challenging to keep up with the payments, especially without the flexibility provided by income-driven repayment plans.

So, tread carefully when considering refinancing. Weigh the potential savings against the loss of federal benefits to make the decision that best aligns with your financial situation and goals.