Income Based Repayment Plan: Is It Right for You?

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Income Based Repayment Plan: Is It Right for You?
Sat, 06/13/2009 - 18:00 | by jvholloman


Starting July 1st, the Income Based Repayment Plan (IBR) will be rolled out. The IBR is a part of The College Cost Reduction and Access Act of 2007. Since July is right around the corner, it’s time for us to take a look at the IBR and what it might mean for you.

What is it?
The IBR is a plan designed to help people who want to pursue lower paying jobs that still require a college education and the related costs. It also includes a provision for forgiving any remaining debt after 25 years.

How does it work?
The IBR sets a maximum monthly payment based on 15% of your discretionary income, which is defined as the difference between your Adjusted Gross Income and 150% of the Federal Poverty Level for your sized family. For a family of three with an AGI of $42,000, the poverty line would be $18,310, making the monthly payment $181.69 (42,000 - (18,310 * 1.5) * .15 / 12).

This amount is subject to fluctuation as your income raises or lowers and is reviewed once a year. Single-income families earning less than $50,000 and dual-income families with two children earning less than $100,000 are eligible for the program.

After twenty-five years, any remaining balance will be forgiven. The only catch is that it will be considered taxable income. Given the current rate of government spending and the bound to happen tax increases to pay for it, that could be a rather pricey tax bill down the road.

How does it compare to the Income Contingent Repayment Plan?
The ICR works on a similar model, without the 25 year forgiveness. The major payment difference is that the ICR is based on a maximum payment of 20% of the difference in AGI and 100% of the poverty level for your size family. Using the same example family from above, their monthly payment would be $394.83, a difference of more than $200 a month.

Is it right for me?
That depends. If you are able to meet your current loan payments and it isn't too much of a burden (repaying loans will be a burden, at least to a certain extent - if you can pay your monthly living expenses and then are still able to pay your loan payment, that is probably an acceptable burden) then taking the standard 10 year repayment route is the best idea. You will pay less interest over time, the interest is tax-deductible and you will pay off your loan fairly quickly.

If your job doesn't pay much, or you are struggling to make your payment and you meet the income guidelines, then the new IBR is worth looking at. It could allow much needed financial breathing room and have a firm end date on the (distant) horizon.

If you are considering a career that is on the lower paying end of the spectrum (most public service oriented careers are) the Income Based Repayment plan can provide you with a means of knowing that you will have affordable payments, and that you won't be saddled with them for more than 25 years, so you can retire without owing student loans.

The downside is the taxation of the amount forgiven after 25 years. Since you will most likely still be working, the amount will be added on top of your salary, so you will be taxed at your highest rate for that money. Still not a bad deal, since after 25 years you will probably have paid down a decent bit of the balance.

The one potential snafu is if your monthly payment isn't enough to cover the interest due. Not only will you not be paying anything toward the principal, you will actually be adding unpaid interest to the balance, which will accrue more interest. I could see where this could add up to a hefty sum to be forgiven after 25 years, leading to a tax nightmare.

The best course of action for anyone on IBR would be to rely on it during the lean years when you are establishing your family and career and work at paying the loan down/off after you move a few rungs up the career ladder.