The Pros and Cons of Income-Driven Repayment Plans

Kat Tretina
refinance federal student loans
refinance federal student loans

“There’s no way I can afford these student loan payments.”

Sound familiar? You’re not the only one. According to the U.S. Department of Education, the national federal student loan cohort default rate — a measure of how many people haven’t made payments for at least 270 days — is over 10%.

If you’re struggling to afford your federal student loan payments, one way to get help is to apply for an income-driven repayment (IDR) plan. But while they can give you some financial relief, there are some serious drawbacks to IDR plans, too.

Here’s what you need to know — plus an alternative student loan repayment solution that may be a better fit for your needs.

How income-driven repayment plans work

With IDR plans, your loan servicer caps your monthly payment at a percentage of your discretionary income. The percentage that you’ll pay and your repayment term varies by plan.

There are four different IDR plans:

  • Income-Based Repayment: 10% of your discretionary income with a 20-year term, but your payment will never be higher than your monthly payment under a 10-year Standard Repayment Plan.
  • Income-Contingent Repayment: Either 20% of your discretionary income with a 25-year term or what you’ll pay with a fixed repayment term over 12 years, whichever is less.
  • Pay As You Earn: 10% of your discretionary income with a 20-year term, but your payment will never be higher than your monthly payment under a 10-year Standard Repayment Plan.
  • Revised Pay As You Earn: 10% of your discretionary income with a 20-year term for undergraduate loans, 25-year term if any of your loans were for graduate school.

Pros of income-driven repayment plans

If you can’t afford your payments, it’s important to understand the benefits of IDR plans:

1. You can reduce your monthly payment

If you apply for an IDR plan, the loan servicer bases your monthly payment on your discretionary income and family size. Depending on your circumstances, you could qualify for a dramatically lower payment. Some low-income borrowers even qualify for $0 payments, meaning they don’t have to make payments each month.

2. You can have a portion of your loan balance discharged

After making payments for 20 to 25 years — depending on which IDR plan you’re on — your loan servicer will forgive your remaining loan balance if you have any debt left over. If you have a substantial amount of debt and a low income — and therefore qualify for low monthly payments — you could be eligible for significant loan forgiveness.

3. Payments made under an IDR plan count toward Public Service Loan Forgiveness

If you work for a non-profit organization or government agency, it’s a good idea to enroll in an IDR plan. As a non-profit or government employee, you can qualify for Public Service Loan Forgiveness (PSLF). After working for an eligible employer for ten years and making 120 qualifying monthly payments, the government will forgive your student loans — tax-free.

Payments you make under an IDR plan count as qualifying payments. Even if you’re eligible for a $0 payment, you’ll get credit toward the 120 necessary payments for PSLF.

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Cons of income-driven repayment plans

While IDR plans can be useful for some borrowers, they’re not for everyone. Here are some drawbacks of IDR plans to keep in mind before applying.

1. Not all borrowers are eligible for IDR plans

Only some student loan borrowers are eligible for IDR plans. To qualify for an IDR plan, you must have federal Direct student loans. If you have other types of federal loans, you can only qualify for an IDR plan if you first consolidate them with a Direct Consolidation Loan.

Private student loan borrowers are not eligible for IDR plans.

2. You’ll pay more in interest over time

Depending on which repayment plan you qualify for, your repayment term could be 20 or 25 years in length. With a longer repayment term than a 10-year Standard Repayment Plan, you could end up paying far more in interest charges.

For example, if you had $35,000 in student loans at 4.53% interest, your monthly payment under a 10-year repayment plan would be $363 per month. By the end of your repayment term, you’d pay a total of $43,589.

If you had an income of $30,000 per year and applied for an income-contingent repayment plan, your monthly payment would start at just $223 per month. However, your repayment term would last for 25 years, and you’d repay a total of $53,617 because of the longer loan term.

3. You have to recertify every year

Each year, you have to recertify your income and family size, meaning you have to submit another IDR plan application. Even if there’s no change to your situation, you still have to send in your information.

If you miss the recertification deadline, the loan servicer will lower your family size — increasing your monthly payment. Depending on what plan you’re on, unpaid interest can be capitalized, adding to the total cost of your loan.

4. Your payment can go up, or you could lose eligibility

Because your monthly payments are determined by your income and family size, they can fluctuate along with any changes in your life. If you receive a big bonus at work or a promotion, your monthly loan payments could increase, or you could lose your eligibility for the IDR plan altogether.

5. You could face a hefty tax bill

After 20 to 25 years of making payments, you can qualify to have your remaining loan balance discharged. However, there are some strings attached to that benefit. The IRS requires student loan borrowers to pay income taxes on any amount that is forgiven at the end of your repayment period, which could cost you thousands of dollars at tax time.

Student loan refinancing: An alternative to IDR plans

While applying for an IDR plan can reduce your monthly payments, you could end up paying thousands more in interest charges. And, you may end up being in debt for decades.

If you want to save debt and pay off your debt sooner — or if you have private loans and are ineligible for an IDR plan — another repayment strategy is student loan refinancing.

With this method, you apply for a loan from a private lender for the amount of your existing debt. You can qualify for a refinancing loan if you have federal or private loans or even a mix of both.

If you have good credit — or have a friend or relative with good credit who can act as a cosigner — you can qualify for a loan with a lower interest rate than you have now, helping you save money over time. With a lower rate and by extending your repayment term, you can even reduce your monthly payment, making it more affordable.

If you think that refinancing sounds like a better option for you than an IDR plan, shop around with different lenders first before applying to maximize your savings. You can use Purefy’s Compare Rates tool to get rate estimates from top refinancing lenders — all in one place with one fast form, and no impact to your credit whatsoever.

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4 ELFI Rate Disclosure:

Education Loan Finance is a nationwide student loan debt consolidation and refinance program offered by Tennessee based SouthEast Bank. ELFI is designed to assist borrowers through consolidating and refinancing loans into one single loan that effectively lowers your cost of education debt and/or makes repayment very simple. Subject to credit approval. See Terms & Conditions. Interest rates current as of 01/01/2023. The interest rate and monthly payment for a variable rate loan may increase after closing, but will never exceed 9.95% APR. Interest rates may be different from the rates shown above and will be based on the term of your loan, your financial history, and other factors, including your cosigner’s (if any) financial history. For example, a 10-year loan with a fixed rate of 6% would have 120 payments of $11.00 per $1,000 borrowed. Rates are subject to change.

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Fixed rates range from 4.49% APR to 8.99% APR with a 0.25% autopay discount. Variable rates from 5.09% APR to 8.99% APR with a 0.25% autopay discount. Unless required to be lower to comply with applicable law, Variable Interest rates on 5-, 7-, and 10-year terms are capped at 8.95% APR; 15- and 20-year terms are capped at 9.95% APR. Your actual rate will be within the range of rates listed above and will depend on the term you select, evaluation of your creditworthiness, income, presence of a co-signer and a variety of other factors. Lowest rates reserved for the most creditworthy borrowers. For the SoFi variable-rate product, the variable interest rate for a given month is derived by adding a margin to the 30-day average SOFR index, published two business days preceding such calendar month, rounded up to the nearest one hundredth of one percent (0.01% or 0.0001). APRs for variable-rate loans may increase after origination if the SOFR index increases. The SoFi 0.25% autopay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. This benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account. The benefit lowers your interest rate but does not change the amount of your monthly payment. This benefit is suspended during periods of deferment and forbearance. Autopay is not required to receive a loan from SoFi.

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Actual rate and available repayment terms will vary based on your income. Fixed rates range from 4.64% APR to 9.24% APR (excludes 0.25% Auto Pay discount). Variable rates range from 4.64% APR to 9.19% APR (excludes 0.25% Auto Pay discount). Earnest variable interest rate student loan refinance loans are based on a publicly available index, the 30-day Average Secured Overnight Financing Rate (SOFR) published by the Federal Reserve Bank of New York. The variable rate is based on the rate published on the 25th day, or the next business day, of the preceding calendar month, rounded to the nearest hundredth of a percent. The rate will not increase more than once per month. The maximum rate for your loan is 8.95% if your loan term is 10 years or less. For loan terms of more than 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95%. Please note, we are not able to offer variable rate loans in AK, IL, MN, NH, OH, TN, and TX. Our lowest rates are only available for our most credit qualified borrowers and contain our .25% auto pay discount from a checking or savings account.

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Fixed Rate Loan Terms: 5 years/60 monthly payments, 7 years/84 monthly payments, 10 years/120 monthly payments, 15 years/180 monthly payments, or 20 years/240 monthly payments. Annual Percentage Rate [APR] is the cost of credit calculating the interest rate, loan amount, repayment term and the timing of payments. This rate is expressed as an APR. Fixed APRs range from 6.94% to 11.58% APR [low to high range with 0.25% auto-debit rate reduction]. Rates are subject to change without notice. Fixed rates will not change during the term. Since there are no fees associated with this loan offer, the APR is the same percentage as the actual interest rate of the loan including a 0.25% auto-debit rate reduction. These rates are subject to additional terms and conditions, and rates are subject to change at any time without notice. All estimates are based on information provided by you and are for informational purposes only, accuracy is not guaranteed and may not reflect actual rates or savings and do not constitute an offer of credit. Your actual rate, payment and savings may be different based on credit history, actual interest rate, loan amount, and term, including your cosigner [if applicable]. If applying with a cosigner, we use the higher credit score between the borrower and the cosigner for approval purposes. All loans are subject to credit approval.

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