Quitting On Income-Driven Repayment Plans: When Is It A Good Idea?
Income-Driven Repayment plans are some of the most flexible plans out there. But are they always beneficial to borrowers? When are they not? When is it a good idea to give up on them and what are the risks involved? Learn all about it.
Updated by B Harshitha on 19th February 2020
Federal student loans offer good student loan repayment flexibility. Some of their most flexible repayment plans fall under the category of income-driven repayment plans. There are four types of income-driven repayment plans offered, namely IBR, ICR, PAYE, and REPAYE.
Monthly repayments for borrowers are calculated based on their income and not how much they owe. So borrowers find income driven repayment plans to be very affordable.
Having said that, borrowers often find other means to eliminate their student loans debt faster. This is why, even though income-driven repayment plans are indeed very flexible, they may not always be the best option for borrowers. With a change in circumstances, such as a marriage or a raise, you may want to move on from income-driven repayment and explore other options. We will learn why this is something that is advised.
Making a decision as bold as exiting income-driven repayment is something that comes with its own risks. So learn more about the pros and cons involved before making a decision.
TABLE OF CONTENTS:
- Income-Driven Repayment plans
- Quitting income-driven repayment plans
- Risks involved in quitting income-driven repayment plans
- Bottom line
Income-Driven Repayment Plans
Repayment flexibility and federal student loan forgiveness are major reasons why people adopt income-driven repayment plans.
The main income-driven repayment plans are:
The basics of all these plans are similar. Borrowers will have to pay either 10 or 15 percent of their discretionary income. The debt will be forgiven after 20 or 25 years of timely repayment. All of the mentioned plans are eligible for Public Service Loan Forgiveness(PSLF).
Income-driven repayment plans are very helpful to even those who are unemployed or underemployed. People find making federal student loan payments via income-driven repayment plans a very affordable affair regardless of how much money they make. These plans also encourage people to pursue jobs and careers that are in the public interest.
If borrowers think student loan forgiveness is something they can avail and qualify for, it is advisable to stick with an income-driven repayment plan.
Refinancing your federal student loans with a private lender can cause you to lose benefits of forgiveness and income-driven repayment plans.
Quitting Income-Driven Repayment
Here are some reasons why borrowers give up on Income-Driven repayment plans.
Giving up on student loan forgiveness
Federal student loan forgiveness programs are pursued by a great deal of borrowers. But this is not beneficial for everyone. For some, it can end up costing more than it can save.
A majority of the applications submitted for Public Service Loan Forgiveness(PSLF) get rejected. That is how difficult it is to qualify for PSLF in the first place. Borrowers who have their application denied look for alternative ways to pay down their debt.
People who give up on student loan forgiveness either refinance their loans with a private lender to get better interest rates or repay their debt the usual way.
Pursuing lower interest rates
Federal student loans come with comparatively higher interest rates than private student loans. Some loans have rates above 7% while private loans start at just over 2%.
Refinancing your federal student loans with a private lender can help you get better interest rates. Smaller interest rates mean spending less on interest repayment and faster paying off. Refinancing can also help you land better repayment terms and conditions. Refinancing your student loan may cause you to lose federal benefits. It is important that you weigh the trade offs before arriving at a decision.
Raise in income
Getting raises at work or changing to a higher paying job could cause you to make bigger payments towards your income-driven repayment plans.
This is in order to make your payments proportional to your income. So the bigger your income, the more you will have to pay.
But this need not necessarily be the case always. People would want to spend a minimal amount on their loans and save up or other goals. Those goals could include saving up for retirement, purchasing a house, etc. An increased income can be very helpful in pursuing such goals since student loans are not the be-all and end-all.
Federal repayment plans such as the graduated or the extended plan come may offer lower payments to borrowers with an increased income. The downside is that they do not qualify for any forgiveness programs and the repayment term is quite long.
An unfortunate marriage penalty is imposed on borrowers who have adopted IDR plans. Your spouse’s income will be considered to calculate your monthly payment if you are married. You may opt to file your taxes separately in order to avail lower monthly payments on your student loans if you are under the IBR and PAYE plans. The REPAYE plan, on the other hand, considers your spouse’s income regardless of your tax filing status.
Risks involved with quitting income-driven repayment
Quitting on income-driven repayment plans can have its own risks. The main one would be not being able to work towards student loan forgiveness.
Interest capitalization is another major risk that borrowers face. Most borrowers have monthly payments less than the interest being generated each month. The balance grows every month but this amount is not added to the principal immediately. This is obviously a perk since borrowers do not have to pay interest on the generated interest. But changing repayment plans could cause interest capitalization to take place.
The bottom line
Do not make the common mistake of taking your eyes off debt elimination and focusing on monthly payments. Having lower monthly payments is a good thing since you can then devote more money to loans with high interest.
The debt is likely to last longer if borrowers make only minimum payments. Ultimately, you will end up spending more money in the long run. Always think about the best way to eliminate your debt entirely. Choose a repayment plan that efficiently does this.