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Why You Should Think Carefully Before Applying for Income-Driven Repayment

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Income Driven Repayment

If you have federal student loans, then you’ve surely heard about income-driven repayment plans. Income-driven repayment plans, a collection of federal programs that allow graduates to lower their monthly student loan payments to a level that is manageable relative to their income, are understandably one of the most well-known features of federal student loan repayment.

While these plans can be reassuring, there are income-based repayment disadvantages worth considering before you decide to apply. Here’s what you need to know to determine if an income-driven repayment plan is truly right for your student loan situation:

When an income-driven repayment plan can be a life raft

If you really can’t make your monthly payments, income-driven repayment can be a great option. I took advantage of income-driven repayment back in 2009, when I had $28,000 in student debt and (thanks to the recession) the only job I had been able to find after graduation paid me a whopping total of $18,000 a year.

My standard monthly payments would have been several hundred dollars, a huge percentage of my take-home pay. However, income-driven repayment allowed me to bring this amount down to $98 a month. This was still a lot of money, but it was manageable, and I remember feeling grateful and relieved that I could make my payments and also pay rent and buy gas and groceries.

In situations where you feel like you’re drowning in student loan payments, an income-driven repayment plan can act as a life preserver.

Income-based repayment disadvantages to consider

There are income-based repayment disadvantages that you should know about before deciding on a plan. Just because you qualify for an income-driven repayment plan doesn’t necessarily mean you should sign up for one.

Let’s say you owe $50,000 in federal direct student loans and make $50,000 a year. You can calculate your options for income-driven repayment using student loan calculators available at MagnifyMoney. The calculator asks for the amount you owe, your current monthly payment, your interest rate, your adjusted gross income (AGI), your family size, your state of residence, your estimated annual income growth and your marital status. In addition to the debt and AGI details, I entered an interest rate of 6.8%, a family size of one person and selected “Continental U.S.” for state (for Massachusetts). According to the calculator, if you were in this situation, your standard loan payment would be $575 a month.

However, you would also be eligible for four types of income-driven repayment: Revised Pay As You Earn (REPAYE) repayment plan, Pay As You Earn (PAYE) repayment plan, Income-Based Repayment (IBR) plan and Income-Contingent Repayment (ICR) plan. While each of these plans differs a bit from the others, each one would allow you to start off with a monthly payment that’s lower than the standard $575. ICR, for example, would lower your starting monthly payment to $485. REPAYE would lower your starting monthly payment even further, bringing it down to $266.

At first glance, this looks great. After all, who wouldn’t want to have their monthly payment temporarily lowered by several hundred dollars? That’s more money in your pocket, right? Not so fast.

The importance of understanding how interest works

Taking a look at the bigger picture through the calculations above shows income-based repayment disadvantages.

Your monthly payment isn’t the only thing that income-driven repayment adjusts. Selecting a lower starting monthly payment will also change the total amount you will pay over the entire period of loan repayment, as well as how many months it will take you to repay the loan.

While income-driven repayment options may seem like the best choice right now, they do not stop interest from accruing. Over time, this interest can add up in a major way.

Deciding if an income-driven repayment plan is right for you

It is therefore worth thinking carefully about how much you can realistically afford to pay each month. If you’re making $50,000 a year, then your take-home pay, depending on your federal and state withholdings and contributions to benefits, might be somewhere around $2,800 per month. By applying for income-driven repayment, you would basically be saying that you cannot live off of $2,225 per month (that’s $2,800 minus the $575 standard monthly payment).

But is that really true? Can you really not live off of $2,225 per month? And, more to the point, is having a few hundred extra dollars in your pocket each month worth paying potentially thousands of dollars more in interest over the course of your repayment?

Instead, you could consider lowering your living expenses a little. Perhaps you can go out to eat less, quit your gym membership or get a roommate, all of which could save you money in the long run.

And what if you can live off of even less and make bigger payments? For example, if you lived extremely frugally and paid $1,000 per month toward your loans, you’d be debt-free in about 58 months and would only end up paying $58,000 in total. A payment of $1,000 per month may sound like a lot of money — and it is. But if you can make it work, you’ll be saving yourself thousands of dollars in the long run.

In short, while income-driven repayment plans can be a good option in some situations, it’s important to remember that they do not keep interest from accruing. The bottom line is, the bigger the payments you can make on your loans, the sooner they will be paid off, and the less you will have to pay in total over the lifetime of the loan.

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How to Set Up IBR, PAYE and ICR Student Loan Repayment Plans

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How to Set Up IBR, PAYE, and ICR Student Loan Repayment Plans

Does the amount you earn on a yearly basis pale in comparison to your monthly student loan payments? Do you have federal student loans? If the answer is “yes” to both of these, then you might benefit from a student loan repayment plan. These income-driven plans include:

Income-driven repayment plans can reduce your monthly payment amount — sometimes dramatically — because they cap that payment at a (hopefully) affordable level, based on your income and family size. Your payment adjusts annually according to these factors.

Specifically, the amount you pay is calculated as a percentage of your discretionary income. According to the Federal Student Aid office, for IBR and PAYE, discretionary income is the difference between your income and 150% of the poverty guideline for your family size and state of residence. For ICR, it’s the difference between your income and 100% of the poverty guideline. (You can look up the poverty guidelines used to determine eligibility for some federal programs, if you want more information.)

A great benefit of these plans is that each has a maximum length — usually 20 or 25 years — after which all remaining loan balances are forgiven. Note, however, that you will generally be taxed on the amount that gets wiped away.

Want to find out how to apply for an income-driven repayment plan? Read on for information on how the process works.

Getting started with income-driven repayment plans

Generally, if you want to set up your student loan account on an income-driven repayment plan, your best bet is to first contact your student loan servicer. (Not sure which loan servicer you have? You can check on the National Student Loan Data System website.)

If you log into your account online, you should see a section for changing your repayment plan. At the least, your servicer should address the issue in an FAQ section of its site.

It’s your loan servicer’s job to help you find the best plan for your situation, but you need to contact it as soon as you start having difficulty in making payments. You don’t want to miss any payments and end up delinquent (or worse, in default) because you couldn’t pay. Plus, loans that are in default aren’t eligible for income-driven repayment plans.

How to apply for income-driven student loan repayment

The application process is very simple and straightforward. The first step is to fill out the Income-Driven Repayment Plan Request form. This can be done online, or you can apply with a paper application supplied by your student loan servicer.

When you make your request, you have to choose the specific plan you’d like to go with. You can select one yourself, or you can ask your loan servicer to choose the plan with the lowest monthly payment amount.

Since you’re applying for a repayment plan based on your taxable income, you will need to provide proof of income. The easiest way is to use your most recent tax return, as long as your income hasn’t changed significantly from the date you filed. You will also need to have filed a federal income tax return for the past two years.

The online application makes it easy to find your adjusted gross income (AGI) — you can use the IRS Data Retrieval Tool to import your income information. If you apply with a paper application, you’ll need to supply a paper copy of your most recent federal tax return or an IRS tax return transcript.

If your income has changed a lot since you last filed, or if you haven’t filed two federal tax returns yet, there are other ways of proving your income.

First, if you don’t have any source of income at all, you just need to indicate that on your application. Only taxable income counts. So if you receive any government assistance or any other income that’s not considered taxable, you don’t need to report it here.

If you do earn an income, you’ll need to provide your most recent pay stubs or other alternative documentation that shows how much you make.

Additionally, if you have federal loans with multiple loan servicers, you must request income-driven repayment for each loan individually. There’s a section of the application that asks if you have eligible loans with more than one servicer, so you can indicate that there.

The application itself shouldn’t take long to complete, but the entire process can take a few weeks, depending on which loan servicer you have.

If you have an immediate need to lessen your payments, your loan servicer may apply a forbearance to your federal loans while the process wraps up. That’s why it’s important to contact your servicer as soon as you realize that you can’t make your payments.

You have to reapply annually

You’ll be required to submit your proof of income on an annual basis after you apply the first time. As your income changes, so does your payment, so you need to provide this information continuously. However, there’s no income limit for income-driven repayment plans.

If you start earning more and you’re on an IBR or PAYE plan, your payment amount is capped at the amount you’d be paying under the standard 10-year repayment plan. It will never exceed that amount. Technically, your loans will still be under your chosen income-driven repayment plan, but your monthly payment is no longer based on your income. You can still have your outstanding loan balance forgiven after your repayment term ends (if you don’t pay your loan off before then).

For ICR plans, your payment amount could fluctuate between the lesser of 20% of your discretionary income and what your monthly payment would be if you had a 12-year fixed plan. On a REPAYE plan, your monthly payment is simply 10% of your discretionary income.

Whose income is taken Into consideration?

If you’re married and wondering if your spouse’s income will be taken into consideration, it depends on how you file your federal taxes.

Filing separately means only your income and loans will matter (unless you’re on a REPAYE plan, which considers both incomes, regardless of how you file).

Filing jointly means your monthly payment will be based off of your joint income. If you and your spouse file jointly and you both have eligible federal student loans, all of them will be taken into consideration, but your spouse doesn’t have to enter into an income-driven repayment plan for you to join.

Meet the income-driven repayment plans

Now, let’s take a look at each major plan type and some of their respective details:

Income-Based Repayment plan overview

You don’t qualify for IBR unless your payment amount would be less than what you’re paying under the standard 10-year repayment plan.

A good way to estimate whether you’ll qualify is to check if your total student loan debt is higher than (or makes up a significant portion of) your annual discretionary income, which would reduce your monthly payment under IBR. If your debt-to-income ratio — how much student loans and other debt you have relative to your income — is high, you may qualify for this option. You can calculate your DTI in a few simple steps using information about your monthly income, debts and payments.

Borrowers who got their first student loans after July 1, 2014, have a maximum term of 20 years under IBR plans, while borrowers who had loan balances before July 1, 2014, have a maximum 25 year term. Anything left after those terms expire will be forgiven.

Pay As You Earn plan overview

For PAYE, your monthly payment will be about 10% of your discretionary income, and never more than what you’re paying under the standard 10-year payment plan.

You have a maximum of 20 years to pay back your loans under this plan, after which your balance is forgiven.

The qualifications for PAYE are the same as IBR — you must be paying less under PAYE than you were under the standard 10-year plan.

However, PAYE is only available to those who were new, first-time borrowers as of Oct. 1, 2007, and who received a disbursement in the form of a direct loan on or after Oct. 1, 2011.

Revised Pay As You Earn plan overview

REPAYE is a fairly recent addition to the income-driven repayment plan menu. It’s similar to PAYE in many ways but distinct in a few key ones.

For example, unlike with PAYE, REPAYE is available to any borrower, regardless of when you received your first federal student loan. And, if you’re married, your spouse’s income will be considered in calculating your monthly payment, no matter how you file your taxes.

Under this plan, your monthly payment is 10% of your discretionary income, and you must repay your loans for 20 years if they were used for undergraduate studies (or 25 years if you took out loans for graduate or professional studies) before they are forgiven.

Income-Contingent Repayment plan overview

Your monthly payment under the ICR plan is the lesser of these two options: 20% of your discretionary income, or the amount you would pay on a 12-year fixed repayment plan, adjusted according to your income.

Under this plan, your term is 25 years before you can receive forgiveness. There are no initial guidelines you must qualify under — anyone can choose this plan to repay their student loans.

Benefits of income-driven repayment plans

As mentioned, the big bonus for all four of these repayment plans is that your outstanding balance is forgiven after your repayment term is complete. Also, if you qualify for forgiveness after 10 years through the Public Service Loan Forgiveness program, that takes precedence.

IBR, PAYE and REPAYE have an extra perk if you took out a subsidized student loan: If your monthly payment isn’t enough to cover any interest that accrues monthly on your subsidized loan, the government will pay the difference for the first three years. For REPAYE plans, the government will also pay half of the difference on your unsubsidized loan and continue to cover half of the difference after three years on your subsidized loan.

You can use MagnifyMoney’s student loan calculators to see which plans could offer you the lowest monthly payment. Income-driven plans aren’t guaranteed to give you the lowest possible payment — all situations are different. And don’t forget that there are other repayment plans that aren’t reliant upon your income but can still lower your monthly payment, such as the graduated and extended repayment plans.

Check with your loan servicer first

Before applying for an income-driven repayment plan, it’s best to check with your loan servicer to get its input. You don’t want to end up owing more per month than you do now. These repayment plans are designed to help you, not hurt you.

You may find that forbearance or deferment is a better option, especially if you’re only experiencing a temporary economic hardship. Note that both forbearance and deferment can result in interest piling up, so be careful to examine all your options before you decide.

And while it’s crucial to check with your servicer, remember that this is your decision, and you don’t have to follow your servicer’s advice. The best solution will be the one that saves you the most money while also fitting with your own financial goals.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Can I Refinance Student Loans While I’m Still in School?

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If you’re wondering whether you can consolidate student loans while in school, congratulations: By already asking great questions about your upcoming debt repayment, you’re at the top of your class.

Unfortunately, you might be too fast for your own good.

It’s difficult — albeit not impossible — to consolidate or refinance student loans while still in school. But that said, it’s still worth reviewing your options to adjust your repayment before you leave campus.

Can you consolidate student loans while in school?

To brush up on the basics, remember that student loan consolidation occurs when you group your debt into a new, single loan with a weighted, average interest rate. You could accomplish this via a federal direct consolidation loan.

To be eligible for federal loan consolidation, you must either be enjoying your six-month grace period or already be in repayment — in other words, off campus and into the real world.

Refinancing takes consolidation a step further. It, too, groups your loans into one new loan, but it also could lower your interest rate. By reducing your rate, you’d pay less interest over the life of your loan, potentially saving you significant money when kept at the same term.

Say you borrowed $20,000 on a 10-year term and with an average rate of 7%. By refinancing that amount at 5% and for the same 10-year term, for example, you’d shave off $2,410 in interest over the life of the loan.

Refinancing could also allow you to choose a new lender, but note that only private lenders offer refinancing. This means you’ll lose exclusive protections on your federal debt since only federal loans feature access to income-driven repayment plans, flexible deferment and forbearance options, as well as pathways to loan forgiveness.

For this reason, if you decide you want to refinance federal student loans rather than consolidate them, make sure the benefits outweigh the drawbacks for your particular situation. And if you do go ahead with it, try to shop around for a good refinancing rate.

Can you refinance student loans while still in school?

Unlike with federal loans, private lenders employ underwriting criteria to gauge your ability to repay your new, refinanced loan (along with your other debt, if you have any). You typically need to have a strong credit score and proof of a steady income — or a cosigner who has both.

Unfortunately, being a college graduate is also among most lenders’ requirements. Generally, lenders require that refinancing borrowers have graduated from a Title IV school. An associate degree is sometimes acceptable.

But if you don’t have a degree (yet), consider these two lenders:

  1. Earnest: If you’re within one semester of graduating, you could apply and be approved for refinancing a little ahead of schedule. You could also qualify if you’re a part-time student, enrolled less than “half-time.”
  2. Citizens Bank: If you take a break from school and make 12 on-time payments toward your loans, you could refinance them without having earned a degree.
  3. SunTrust Bank: If you only need to refinance private student loans, not federal ones, then SunTrust has an option too, so long as you loans are current.

Grad students eligible for refinancing

If you’re seeking a second degree, meanwhile, you might be looking to refinance your undergraduate loans.

In this case, your undergraduate degree will likely qualify you to refinance with most lenders. Keep in mind that both your current lender and your potential refinancing lender will typically allow you to defer your loan repayment once you re-enroll.

On the other hand, you might want to delay refinancing until you earn a second degree and perhaps establish a longer credit history or steady income stream. This way, you’d score a lower interest rate.

Parents could refinance PLUS loans

If your parent is looking to refinance federal PLUS loans, they won’t have to wait until you’re done with school to refinance. That’s because Mom or Dad is listed as the primary borrower.

PLUS loans are prime targets for refinancing because they’re tagged with relatively high interest rates. As of October 2018, parent PLUS loans carried a 7.60% fixed interest rate, plus a 4.25% loan origination fee.

Before your parent seeks a lower rate from a refinancing company, however, it might be worth reminding them about what they’d be giving up. Just as with private student loans, privately refinanced parent loans don’t always feature government-like protections such as deferment and forbearance options.

Perhaps you and your parent had a handshake deal that you’d eventually handle the repayment for the PLUS loan. In this case, they could refinance the loan under your name — but you’d have to finish school first.

Making in-school payments is the next best thing

If your goal of refinancing was to lower your interest rate, you’d likely have to wait until you’re a college grad.

With that said, there are measures you can take now to save money later.

Whether you have federal or private loans, making in-school payments can stop your balance from ballooning while you’re in the classroom.

For federal loans, contact your servicer to learn about how to make in-school payments. Although subsidized direct loans won’t accrue interest until you’re six months out of school, other federal loans will, so it’s wise to begin repayment ahead of schedule if you can afford it.

With a private lender, your in-school repayment options were (hopefully) presented at the time you decided to borrow. Lenders offer a mix of choices, including:

  • Deferring payment until graduation, allowing interest to pile up
  • Making small fixed payments to save some money on interest while you’re enrolled
  • Making interest-only payments to keep your balance from growing at all
  • Making full payments to attack your debt from the start

Of course, the more money you put toward your loan balance while you’re in school, the less you’ll have to pay when you graduate.

Laying the groundwork now to refinance later

If you begin making in-school payments, you’re not just saving money. You’re also building up your credit score.

In fact, 35% of your FICO score, one of the most commonly cited credit scores, is based on your debt payment history. If you start repaying your loans while you’re in school (and repay credit card debt on time), you’re starting to build that history.

That takes care of one of refinance companies’ underwriting criteria. However, there are more ways to put yourself in a position to refinance not long after receiving your degree.

Maybe you don’t have the bandwidth for a full-time job while in college, but scoring a part-time position or internship now could lead to a good-paying gig later.

Eventually, having that consistent paycheck will not only help you repay your loans, but also prove to refinance companies that you have the income to cover your newly consolidated debt.

That’s the silver lining of it all. Yes, you might not be eligible to refinance student loans while still in school, but you can begin strengthening your application for the future.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Disclaimer

Student Loan
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Refinance with Earnest

Refinancing rates from 3.21% APR. Checking your rates won’t affect your credit score.