With student loan debt now the second-highest category of consumer debt in the nation, repaying those loans could become a major challenge for some people.
If you aren’t earning enough income to cover your federal student loan payments each month, your choices can feel grim. Either you struggle to make payments at the expense of other necessities, or you can risk becoming delinquent, or even defaulting, on your loan. In either case, you could end up seriously damaging your credit and having to repair your credit score.
Fortunately, there are more options to pay back loans than you might think. Some repayment options like deferment and forbearance allow you to temporarily stop making payments or reduce what you pay per month for a set amount of time. But another option you may not know about is an income-driven repayment plan.
Let’s talk about how this plan works and if it might be right for you.
How income-driven repayment works
An income-driven repayment plan resets your monthly payments and loan term based on your income.
Your monthly payment is adjusted to a percentage of your discretionary income and is determined by when you took out your first loan. If it was before July 1, 2014, your payments are capped at 15 percent. If it was on or after July 1, 2014, your payments are capped at 10 percent.
The amount you pay per month can increase or decrease based on changes in your income or family size. Instead of paying your loan over 10 years (the standard term for federal loans), the term is increased. You can repay in 20 years if you borrowed on or after July 1, 2014, or 25 years if you borrowed before July 1, 2014.
If there is any remaining balance at the end of the term, it’s typically forgiven. But you will have to pay income taxes on it. And most people pay off their loans before they actually reach the point of balance forgiveness. Keep in mind that paying a lower amount per month means you’ll end up paying more interest over time.
Meeting eligibility
In order to be eligible for income-driven repayment, you need to meet some criteria:
- Your federal loan needs to be either a direct loan or an FFEL (Federal Family Education Loan). PLUS loans for parents are not eligible.
- You need to show a partial financial hardship. This means the amount you would otherwise pay on the standard 10-year plan has to be more than what you’d pay on an income-driven plan.
- You need to recertify your income every year to stay qualified. If you don’t, your repayment could revert back to the standard 10-year plan with the higher amount due every month.
Is an Income-Driven Repayment Plan Right for You?
Since there are several different income-based repayment plans available for federal loans, it’s important to do your research. For example, you could be a good candidate for options like Pay as You Earn (PAYE) or the newer Revised Pay as You Earn (REPAYE), both which cap your payments at 10 percent of your income.
Many of these repayment plans come with a long list of highly specific requirements you’ll need to meet. Just be sure that you don’t let your financial hardship prevent you from making your payments as expected. Before you face delinquency or default, educate yourself on what’s out there and right for you.
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