Income-Based Repayment (IBR) is one of the most widely available and use income-driven repayment plan options offered by the U.S. Department of Education. It is designed for borrowers with higher federal student loan balances, as compared to their income.
Here’s what you should understand about IBR, and when you might lose the option to switch back to it:
- IBR Plan Eligibility
- IBR Repayment & Term
- Pros to Income-Based Repayment (IBR)
- Cons to Income-Based Repayment (IBR)
- My last thoughts on IBR
- Upcoming student loan webinars
As the cost of college started to soar, monthly payments became less affordable using the Income Contingent Repayment (ICR) repayment plan.
With ICR, borrowers would pay the lesser of two options:
- 20% of their discretionary income, for a maximum of 25 years before earning forgiveness; or
- they would pay on a repayment plan with a fixed payment over 12 years, adjusted according to income.
In 2007, the federal government introduced the more generous Income-Based Repayment (IBR) plan. In 2010, Congress passed The Health Care and Education Reconciliation Act of 2010, which adjusted repayment plan terms for borrowers making the terms of IBR more generous to new borrowers after 2014.
So there are currently a couple of versions of IBR.
IBR Plan Eligibility
Income-Based Repayment (IBR) was designed to help students with higher federal student loan balances relative to their income and family size.
To be eligible for IBR, you have to demonstrate financial need. It’s available to student borrowers (not parents) with either Direct or Federal Family Education Loans (FFEL).
The fact that you need to qualify for IBR is a blind spot for busy professionals.
REPAYE ends up being the repayment plan of choice due to the lower monthly payments and the ability to earn forgiveness. However, REPAYE payments can end up higher than those on a 10-year Standard plan as your income increases due to no payment cap.
To qualify for Income-Based Repayment (IBR), your monthly payment must be less than what you would pay under the 10-year Standard Repayment plan.
Eligible Loans: Direct Loans (Subsidized and Unsubsidized), Direct Graduate PLUS loans, Direct Consolidation loans.
IBR Repayment & Term
Income-Based Repayment (IBR) is an income-driven repayment option that calculates your monthly payment by using a percentage of your “discretionary income,” whereas balanced-based programs (like 10-year Standard) calculate your payments based on your student loan balance and interest rate.
Your discretionary income is calculated by taking your Adjusted Gross Income (AGI) and subtracting 150 percent of the annual poverty line for your family size and state. This means that your monthly payments are custom-tailored to your specific needs: income, cost of living, and family size.2
Like ICR, the repayment period for IBR is up to 25 years. If the loans are not paid off within 25 years, any balance remaining is forgiven —although, as with all income-driven repayment plans, the amount forgiven is treated as taxable income.
There’s secretly two versions of IBR and payments can vary dramatically based on which one you have.
- IBR version #1. For borrowers who have disbursed their first loans before July 1, 2014, Income-Based Repayment (IBR) caps monthly payments at 15% of your discretionary income. These borrowers will also be eligible for forgiveness after 25 years of repayment.
- IBR version #2. For new borrowers —meaning you cannot have been disbursed any federal student loans —on or after July 1, 2014, Income-Based Repayment (IBR) caps monthly payments at 10% of your discretionary income. These borrowers will also be eligible for forgiveness after 20 years of repayment.
As you can see, the IBR became much more favorable after The Health Care and Education Reconciliation Act of 2010, but only applies to newer borrowers.
Income-driven repayment plans like IBR require an “income verification” process where you’ll be required to submit documentation to prove your income. If you forget or avoid these requests from your loan servicer, your payments will ratchet up to match payments on the Standard repayment plan.
That could double your amount due for that month. So stay on top of emails from your loan servicing company.
There are many upsides to Income-Based Repayment (IBR). From affordable monthly payments to the ability to earn forgiveness, it’s easy to see why it’s become a staple repayment option.
Here are just a few remarkable benefits to the program:
- Affordable monthly payments. IBR uses a percentage of your income to determine your monthly payment. This makes monthly payments more manageable to early-career professionals.
- Ability to earn forgiveness. While earning forgiveness through an income-driven repayment plan like IBR is taxed as income, not having to pay a six-figure student loan balance takes the cake. With IBR, you earn forgiveness in 20 to 25 years.
- IBR is easier to understand. Out of all your income-driven repayment options, IBR is the most straightforward. You’ll never find yourself in a sticky situation.
- PSLF friendly. If you have the right kind of loans and the right employer, you can earn forgiveness through PSLF while on IBR. It might be the more desirable repayment option for pursuers of PSLF, if you’re married.
- Marriage-friendly. With IBR, you can rest assured that you can invite Uncle Sam to the wedding without much consequence. You can control your monthly payments depending on how you file your taxes (Married Filing Separate or Married Filing Jointly).
There are pros and cons to every repayment plan. Income-Based Repayment (IBR) is no different. Here are some hurdles I’ve seen people have with the program.
- IBR is a long-term strategy. Because monthly payments are typically lower, you’ll be paying back these loans for a lot longer. That means the Net Cost of your student loans could be substantially higher than if you were aiming to pay it off —unless you’re shooting for forgiveness.
- A potential tax liability. Forgiveness through income-driven plans like IBR is treated as taxable income, unless you’re earning forgiveness through PSLF which is tax-free.
Forgiven amount: $150,000
Tax bracket: 30%
Tax liability: $45,000
Who you owe the money to: IRS
- Negative amortization. Your balance can go up despite making on-time monthly payments. Some people’s payment doesn’t cover the interest that accrues each month. This creates an “Outstanding Interest” balance that will periodically get added to your balance.
My last thoughts
Income-Based Repayment (IBR) is a very friendly repayment option. It ties your monthly payments to a percentage of your income, and for many that make those payments more manageable.
However, switching to IBR isn’t a guarantee; you do need to qualify. If you’re on a repayment plan like REPAYE, and your income explodes, you could be blocked from switching back as you’ll no longer have financial need.
If that happens, you could find that your payments may become unaffordable and your only other repayment option would be the 10-year Standard plan, ultimately erasing any hope for forgiveness.
Unfortunately, there is no “one size fits all” or a “set it and forget it” repayment option. Major life events such as marriage, divorce, children, change of employer, or changes in income will affect your repayment strategy, requiring you to re-evaluate your student loan payoff strategy
Join the webinar
There comes the point in everyone’s student loan journey where they have to question the effectiveness of their student loan payoff strategy. Obviously, there’s a lot on the line.
Perhaps you’ve been making payments for some time now but not seeing your balance go down as fast as you’d like —or worse, your balance is actually increasing.
Register for one of my upcoming Student Loan Destroyer webinars. I’ll provide you a crash course in student loan management and review a real-life case study. I’ll also share how you can have me look at your student loans and answer all your questions.
1) U.S. Department of Education, — https://studentaid.gov/manage-loans/repayment/plans/income-driven
2) U.S. Department of Health & Human Services, 2020 Poverty Guidelines —https://aspe.hhs.gov/2020-poverty-guidelines
3. 1) U.S. Department of Education, Public Service Loan Forgiveness Data — https://studentaid.gov/data-center/student/loan-forgiveness/pslf-data