If you’re considering taking out federal student loans, it’s a good idea to first consider the repayment plans that will be available to you. One of the advantages of federal student loans over private student loans is that federal loans offer more flexible options for repayment. But which plan is best for you will depend on the repayment options available for your type of loan and your financial situation.

In part one of our post “Understanding Federal Payment Plans For Paying Back Student Loans,” we explained the Standard Plan, Graduated Repayment Plan, Extended Repayment Plan, and Income-Sensitive Repayment Plan. You can read about those options here. In part two, we’ll discuss the four income-driven repayment plans offered by the Department of Education

Income-Contingent Repayment Plan (ICR)
The Income-Contingent Repayment Plan, or ICR, is the oldest income-driven repayment plan offered by the Department of Education. Like other income-driven plans, your payments on the ICR are based on your income and family size. Other similar plans, such as the PAYE and REPAYE plans, are often cheaper in the long run, however, the ICR is the only income-contingent repayment plan for borrowers with Parent PLUS loans.

On the ICR plan, payments are set at 20% of your discretionary income or what you would pay on the Standard plan with a 12-year repayment term. These payments are recalculated annually and may increase or decrease if your income or family situation change. Unlike with the PAYE plan, your spouse’s income will not be included in this calculation if you file taxes separately.

The repayment term for the ICR is 25 years. If you have made all of your payments during that time, the remaining balance on your loan will be forgiven at that point. Like with the PAYE and REPAYE plans, any forgiven balance will be subject to income tax. 

• may offer smaller monthly payments

• monthly payments are larger than on other income-driven plans

• payments can be higher than on the Standard plan

• payments are eligible for Public Service Loan Forgiveness (PSLF)

• Parent Plus Loans are eligible

• parent borrowers are eligible to enroll

• borrowers pay more total than they would on the Standard Plan

Income-driven Repayment Plan (IBR)

Income-driven repayment plans offer students monthly payments that are based on their income level rather than a predetermined amount. This can be helpful to students who start careers with unusually low starting salaries or who job-hop before settling into a career.

Payments on the IBR plan are set at 10% of your discretionary income. The specific amount a borrower pays is determined by the Department of Education, and borrowers will need to submit recertification paperwork every year to remain on the plan. Your payments on this plan will change if your income or family situation changes (for example, if you get a raise, get married, or have a baby), however, payments will never be higher than they would be on the Standard Plan.

Similar to the PAYE and REPAYE plans, your repayment term with an IBR plan is set at 20 years for both undergraduate and graduate students. When your repayment term ends, the remainder of your loan will be forgiven. This forgiven balance will be treated as taxable income during the year you finish paying your loan.

• has a shorter repayment term than similar income-driven repayment plans

• has smaller payments than similar income-driven repayment plans

• payments will never be higher than they would be on the Standard Plan

• does not include your spouse’s income when calculating your payments if you and your spouse file taxes separately

• payments on this plan count toward Public Service Loan Forgiveness (PSLF)

• has longer repayment term than the Standard Plan

• eligibility is based on income

Pay As You Earn (PAYE)

One of the most popular methods for paying student loans is the Pay As You Earn (PAYE) plan. With this plan, your payments are set at no more than 10% of your discretionary income. (Discretionary income is what’s left after paying for necessities, such as food and rent.) If your income increases, your payments will as well, but they will never be more than they would be on the Standard plan, and they will never be more than 10% of your discretionary income. After twenty years of payments, any remaining debt is forgiven.

The Department of Education calculates discretionary income based on your annual income, the poverty guidelines for the state you live in, and the size of your family. Each year, this amount will be calculated for you when you submit a recertification form that updates this information. If any of these details change—such as you get a raise, move to a new state, or have a baby—then your monthly payments will change.

Many borrowers are drawn to the PAYE plan because it includes loan forgiveness, and this can be a huge advantage. However, the forgiven portion of the loan is considered taxable income for the year the loan is forgiven. The amount of tax you owe will depend on your tax bracket for that year. For some borrowers, this tax can amount to thousands of dollars. Some financial experts even encourage students to start saving money early so they will be able to afford these taxes.

Another downside to the PAYE plan is that it can allow interest to build up, leaving you with more loan to forgive at the end. This happens because when you make a student loan payment, it is first applied to the interest and then whatever is left is applied to the principle of the loan. With the PAYE plan, sometimes a borrower’s monthly payments are too low to cover all of the interest. This means part of the interest and the whole principle are left unpaid. That unpaid interest can then be added to the principle of the loan. As a result, you can pay on your student loans but still have them grow. 

If the principle of your loan grows under the PAYE plan, your unpaid loan will still be forgiven at the end of 20 years. However, you will have to pay a larger tax when your loans are forgiven. Additionally, if at some point you no longer qualify for the PAYE plan then you may be stuck paying on much larger loans.

• offer the lowest payments

• borrowers receive loan forgiveness if the loan is not paid off in 20 years

• monthly payments are tied to your income, so they will decrease if your income decreases

• payments will increase if your income increases

• the amount of loan forgiven is taxable

• the principle of the loan can grow substantially

• not all borrowers qualify for the plan (learn more here)

Revised Pay As You Earn (REPAYE)

Introduced in 2015, the Revised Pay As You Earn (or REPAYE) plan is an expansion of the Pay As You Earn plan. Like with the original PAYE plan, payments are set at 10% of the borrower’s discretionary income and can increase (or decrease) if the borrower’s financial situation changes.

Like with the original PAYE plan, the REPAYE plan offers borrowers loan forgiveness after 20 years of regular payments on undergraduate loans or 25 years of payments on graduate loans. Any remaining balance on the loan will be taxed during the year the loan is forgiven. The amount of tax you owe will depend on your tax bracket for that year, but be warned that for some borrowers this tax can amount to thousands of dollars.

There are subtle differences between the original PAYE plan and the REPAYE plan. One difference is that the Department of Education will use both your income and your spouse’s income when calculating your monthly payments on the REPAYE plan, even if you file your income taxes separately.

Another difference is how monthly interest charges are handled. Some borrowers on the REPAYE plan find their monthly payments are not enough to cover both the principle and the monthly interest charges on their loan. On the traditional PAYE plan, this can lead to a larger remaining balance (and larger income tax) during the year they pay off their loans. 

However, the REPAYE plan includes an interest loan subsidy. For borrowers with subsidized student loans, the government will pay any accrued interest not covered by regular payments for three years of the loan. Afterward, it will cover 50% of the remaining accrued interest. For students with unsubsidized loans, the government will pay 50% of the accrued interest not covered by regular payments for the entire life of the loan. This leads to smaller final balances for borrowers.

• offers some of the lowest monthly payments of any plan

• will have higher total cost than faster repayment plans

• borrowers receive loan forgiveness if the loan is not paid off in 20 years

• monthly payments are tied to your income, so they will decrease if your income decreases

• payments will increase if your income increases

• the amount of loan forgiven is taxable

• longer repayment terms for graduate loans

• calculates your payments based on the incomes of both you and your spouse even if you file taxes separately

This is part two of a two-part series. You can read Part 1 here to learn about four more repayment plans available for federal student loans.

Private Student Loans: Are They Right For You?

It is important that students understand they are not stuck with one repayment plan. If their situation changes because of a job loss, career change, or other crisis, they can renegotiate their federal student loan repayment plan by contacting their lender.

The conditions of repayment on private students loans are set by the private lender. This means conditions of repayment can vary a great deal from lender to lender, so the burden is on the student to understand whether the conditions of repayment are fair and manageable or not. While most private lenders are reputable institutions, there are those that practice predatory lending, and uninformed students can find themselves struggling with much larger payments than they had anticipated.