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There’s a Catch to Income-Based Repayment That Could Cost You Money

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When it comes to dealing with student loans it can be a good news-bad news situation. While there are some good options to dealing with student loans when you can’t afford the payments, not all loans are the same. Federal student loans have a number of repayment options while private student loans tend to be more limited in terms of repayment plans that adjust the payment. In fact, some borrowers have found private student loan repayment options to be so limited that they have considered a strategic default.

The vast majority of student loan assistance companies promote the Income-Based Repayment plan and similar programs as a fix for troubled student loan debt. But are there downsides to IBR? Yes, and it’s important to weigh the considerations carefully before you decide.

Lower Payment Now Can Cost Later

IBR can give you a lower monthly payment right now while your income is low. But your low payment can rise in the future as your income increases. In addition, if your income increases above “financial hardship” status, and unpaid student loan debt and interest will then be added to your balance, leaving you owing more money.

The Department of Education does make the risks of the income-driven plans well known to borrowers. When it comes to IBR, the Pay As Your Earn (PAYE) Plan, and the Income Contingent Repayment (ICR) Plan it warns: “Income-driven repayment plans may lower your federal student loan payments. However, whenever you make lower payments or extend your repayment period, you will likely pay more in interest over time — sometimes significantly more. In addition, under current Internal Revenue Service (IRS) rules, you may be required to pay income tax on any amount that is forgiven if you still have a remaining balance at the end of your repayment period for an income-driven repayment plan.”

It further advises, “If the payment amount based on your income and family size ever increases to the point that it is higher than the amount you would have to pay under the 10-year Standard Repayment Plan, your payment will no longer be based on your income and family size. Instead, your payment will be the amount you would have had to pay under the 10-year Standard Repayment Plan. This amount will be determined based on the loan amount you owed when you first entered the IBR or Pay As You Earn plan.”

An exception to the standard payment stopgap limit are payments under ICR. Those payments are based on family size and income but they can rise above what the 10-year Standard Repayment would be.

Unfortunately for some borrowers, enrolling in an income-based repayment program alone may not ultimately resolve their household financial struggles. While bankruptcy isn’t always the best option, some consumers may want to consider eliminating other consumer debt through bankruptcy first to allow them to get back to the standard 10-year payment, which may then be the least expensive way to pay off the student loan debt.

A recent study has shown that those who do file for bankruptcy wind up doing better, have higher credit scores and earn more money than those who continue to struggle. (You can check your credit scores for free on Credit.com to see how your debts are affecting your credit.)

More on Student Loans:

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  • nancyfarmer

    What’s missing in this discussion of strategies for handling student loans and debt is a
    reminder that the best solution is to avoid debt by planning and saving for
    college. I am President of a consortium of 278 private colleges and
    universities that voluntarily sponsor a prepaid tuition plan, Private College
    529 Plan. Section 529 savings and prepaid plans offer tax breaks for families
    and even small, regular contributions to a 529 Plan will add up over
    time. Bottom line: earn interest rather than pay it. It is interesting
    that in our own survey of more than 1,000 teens last spring, more than 90
    percent said college saving is important to them and plan to minimize the
    amount they borrow for college. This year’s survey results will be released in May.

    • stubbikins

      That is hilarious that you think teens can save tens of thousands of dollars in a couple years of working part time while in school…

  • Valery Hill

    I know a couple who are deliberately working these IBR loans to their advantage and have no intention of ever paying it off. They borrow as much in student loans as they possibly can — even using student loan money to pay off credit card balances, etc. To keep their payments low, they’ve been having one kid after the next, and she’s gone back for her Masters. The object is to borrow as much as they can and keep their payments as low as they can until the 25 years expires. I’m sure they’re not the only ones. That’s why these welfare schemes rarely help honest people and almost always fund theft and irresponsibility. It’s pathetic.

    • maiamorgan

      Or they are designed for people like me who are single mothers working a full time job and have had to quit school to support their child. (I’m divorced before you go and make an assumption).
      This program is allowing me, because of my low income, to not pay anything at the moment, which is letting me save money so I can finish my last year of school and become a teacher.

      Not everything has to be so negative. For every 1 person gaming the system, there are 5000 doing things the right way.

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