With more than 70% of all students graduating college in debt, choosing a student loan repayment plan is as much a part of the graduation routine as ordering your cap and gown.
I often get email inquiries about the various student loan repayment programs as graduates are trying to plan their future with student debt as their companion. While I can’t say what plan is right for you, I hope that sharing how we came to our conclusion will help you sort out your own federal student debt repayment options.
Income Based Repayment (IBR) Basics
In order to qualify for Income Based Repayment (IBR), you must have at least a partial financial hardship. Your loan servicer will look at your income and family size, calculate your discretionary income and compare it to the payment required on the standard 10-year plan. In an IBR plan:
- Payments are generally 15% of your discretionary income (10% for new borrowers after July 1, 2014).
- Payments will never be higher than the payments on a 10-year standard repayment plan.
- The repayment period is extended to 25 years (20 years for new borrowers after July 1, 2014). After the repayment period, if there is anything left unpaid on your loan, it will be forgiven.
- You may be required to pay income tax on the portion of the loan that is forgiven.
Another income-driven repayment plan “Pay As You Earn” is available and has lower payments and fewer years before forgiveness than the original IBR.
We Needed Flexibility
At the end of school, my husband ended up with a JD/MBA and $130,000 of student loan debt. He had a job lined up working for a small law firm making 30% commission on fees he earned and collected. The firm would provide office space, front desk staff, malpractice insurance, etc and he would be responsible for finding his own clients and doing the work. We knew that in the beginning his pay would be low, as he would also be building a business.
We weren’t sure if he would receive straight commission (every paycheck varying) or if his commissioned pay would be regulated by a “draw”, in which each paycheck is the same and the draw amount is adjusted to match his average commission. In the first scenario, having a big loan payment due with varying monthly paychecks would be extremely stressful.
We Didn’t Care About Forgiveness
IBR does offer loan forgiveness after 25 years, but we simply did not factor that into the decision. It’s not only difficult to trust that the government-run forgiveness program would still be operating under the same rules 25 years from now, but even if it were, counting on eventual forgiveness could also end up being the more expensive route.
Here’s an illustration. Let’s say that the the rules stay the same, that Mr. SixFiguresUnder never makes more than he’s making now, and that under IBR, we never had to make a single loan payment because of our income and family size. After 25 years of 6.55% interest, the total loan amount would be just under $600,000. If that $600,000 were forgiven, it would count as income to us, and we would owe taxes as if we had earned $639,000 that year. With income that high, our marginal tax rate would be 39.6%, and our total tax bill for the year would be about $200,000!
In reality, we have a choice to pay less than $200,000 now, and be loan free for the next 20 years, or carry the loan, unpaid to the end, hope for forgiveness, and find a $200,000 tax bill waiting for us. Forgiveness becomes less attractive in that light.
Just as importantly for us, we feel a moral obligation to repay money that we borrowed. If you are interested in the possibility of Public Service Loan Forgiveness, you might want to read about risks and considerations before putting your eggs in that basket.
How It’s Working Out
My husband’s income turned out to be a “draw” which evens out his actual commission into equal payments each month. This is much nicer to work with than varying paychecks of straight commission. Currently he makes $39,000 pretax. With our family of five, that put our monthly loan payments at $0.
If you have read our story, you know that we have a huge goal of paying off our student loan debt by the end of 2016. We’ve made some headway but we have a long way to go. While we choose to make payments of more than what our payments would be on the standard 10-year plan, having the flexibility offered by IBR has been a major asset. Instead of having a payment that is automatically spread across all of our loans, we can focus on knocking out one loan at a time.
If you qualify for Income Based Repayment, the flexibility it offers can relieve stress and allow you to lead your own debt repayment. Once you have that flexibility though, instead of banking on the forgiveness plan, aim for the fast track to paying off your student loans.