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Student Loans 102: Making Monthly Payments Affordable (IBR, PAYE)

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By William Peacock, Esq. on October 14, 2014 9:51 AM

Raise your hand if, at some point, you got slapped with a student loan bill for more than $1,000 per month.

If you haven't yet, and took out loans for law school, it's only a matter of time before some idiot loan servicer sends you a bill requesting more than half of your take-home pay. And for many people, their response will be to utter a few choice profanities and then to ignore the letter.

Don't. Default is bad, at least if you ever want to have a respectable credit score, own a home, or get out of debt. Instead, take a look at the available income-driven repayment plans. If you're working in public interest, your debt will disappear in 10 to 15 years. If not, you're looking at reduced payments until right around the time your child goes to college. Funny how that works, isn't it?

Last week, we talked about consolidating your loans to make them more manageable. Today, we'll look at reducing your monthly payments on your federal loans:

Income-Based Repayment (IBR) and Pay As You Earn (PAYE)

This is the traditional income-based plan, the one that pretty much everyone qualifies for. For nearly all existing loans, the terms are:

  • You generally repay 15 percent of your discretionary income (capped at the 10-year Standard Repayment Plan amount).
  • You're eligible for Public Service Loan Forgiveness program after 15 years (tax-free).
  • Otherwise, any outstanding balance is forgiven after 25 years (likely taxable).

However, any new borrowers (new loans, with no previous outstanding federal loan debt, as of July 1, 2014) get extra-special terms, similar to Pay As You Earn (PAYE):

  • You generally repay 10 percent of your discretionary income (capped at the 10-year Standard Repayment Plan amount).
  • You're eligible for Public Service Loan Forgiveness program after 10 years (tax-free).
  • Otherwise, any outstanding balance is forgiven after 20 years (likely taxable).

Pay As You Earn (PAYE), as indicated, has more favorable terms than traditional IBR, but has a ridiculous time restriction: The borrower must be a "new borrower" as of October 1, 2007, and have received a disbursement of a Direct Loan on or after October 1, 2011.

President Obama announced earlier this year that his administration would expand the PAYE program to all borrowers by the end of his term in 2015. Until then, however, the vast majority of graduates are stuck with the traditional IBR repayment terms.

Income-Contingent Repayment (ICR)

In the rare cases where you don't qualify for IBR or PAYE (you make too much money and your IBR payment would be more than the standard 10-year repayment plan amount), income-contingent repayment is an option. Under ICR, your monthly payment is the lesser of:

  • 20 percent of your discretionary income; or
  • What you'd pay on a fixed payment plan over the course of 12 years, adjusted according to your income.

Any outstanding balance is forgiven after 25 years (likely taxable).

Remember to Re-Up Annually

One thing that has tripped me up personally is the requirement to re-up your IBR every year. The process requires you to go through the IRS' website and authorize them to share your tax information with your loan servicer, which will then adjust your payment based on last year's income. If you don't, expect to be surprised by a four-figure bill.

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