Income Based Repayment Disadvantages and Advantages

There’s no doubt that high education can be expensive. Let’s not even get into technical careers, such as lawyers, doctors, and engineers.

Sure, those jobs can potentially earn you six-plus figures a year. But there are some problems with it:

  • Most students don’t want to waste their 20s stuck on a job, repaying their student debt
  • Some careers require you to borrow $100K+ to get the degree, excluding the interest
  • Students are unlikely to land a high-paying job the first day they graduate. However, lenders require them to pay back everything within six months after graduating

Imagine how stressful that has to be. You can barely keep up with your exams, yet they think you can make money out of thin air. And if a job is your best hope, that’s still 5+ years you’re going to spend paying for those loans.

What the hell were we thinking?

Don’t worry. There is a way to make student loans a lot easier. IBR plans( also known as income-based repayment):

  • Pay a low amount every month
  • Get your debt forgiven after 20 years
  • It doesn’t affect your credit score

But an IBR isn’t all about pros. There’s no free money here. It’s a program to help you pay just what you can afford.

Income-based Repayment Disadvantages and Advantages

IBR Pros and Cons

It’s unlikely that you can pay six figures worth of loans after graduating. In that case, IBR plans present the following advantages:

PRO: Low Monthly Payments

If you borrowed after 2014, you only need to pay an annual 10% of all your discretionary spending. And the way they calculate it is by adding everything you earn after ~$24.5K, which is 150% over the national poverty line.

That means that if you earn $34.5K this year, you got $10K of discretionary spending. $1000 of that goes for paying your student loans. That’s about $84 per month, excluding interest rates.

Compared to the average $150-$300 per month, it’s a pretty reasonable number.

You basically keep paying this amount until: 

  • You pay for the equivalent amount you owed in the Standard Plan OR
  • 20 years pass (more on that later)

Whatever comes first.

So you don’t have to worry about your student loans, even if you don’t earn a lot. This allows students to apply for expensive careers and still afford the loans.

CON: Worst Long-Term Plan

Keep in mind that we haven’t included the interest rate. It may first look like the lender is doing you a favor. But the way they make this possible is by increasing the interest rates.

Not only that, but your term changes from 10 to 20 years. That’s two decades where you’ll be paying for the loan plus interest. After that time, you might have spent 20% more than the original loan amount.

It’s not a very good deal as you can see.

PRO: Debt Forgiven After 20 Years

Once you pay for the standard loan amount (excluding interest), you paid 100% of your loan. But if you have too much debt and can’t pay it back for some reason, they forgive your debt after 20 years. It doesn’t matter if there’s $50K or $500K left.

Best of all, there are no credit consequences. You can, of course, build your credit if you pay in full. But if you just meet your monthly payments, loan forgiveness doesn’t do any harm.

CON: Loan forgiveness doesn’t offer enough benefits

Forgiveness sounds attractive. But there are three problems that outweigh this advantage:

  • You immediately need to pay taxes on the forgiven amount
  • By the time they forgive your loan, you’ll have overpaid because of 20 years of interest payments
  • You lose the IBR benefits after crossing $55K per year (pre-tax). In 20 years, it’s highly unlikely that that doesn’t happen

If you earn $55K per year (pre-tax), that’s about an extra $30K above the limit (150% over the poverty line). 10% of that is $3K, which is $250 per month. If you earn more, it jumps to the standard $400 per month.

At that rate, you’re more likely to pay your loan in full plus interest before they forgive it to you.

PRO: You pay way less than what you earn

Here’s the beauty of IBR plans:

  • You don’t pay anything if you earn less than $20K per year in pre-tax dollars
  • After $25K, you only pay 10% of the rest per year
  • Further discounts apply depending on your location, marital status, and family size

You will pay more as you increase your annual income. But if you barely make more than $25K, it will be basically free.

However, after you earn $55K or more, the monthly payment rises to ~$400, which is the average for the standard loan plan.

CON: You need to recertify every year

With some programs, you just need to qualify once, and then you can do what you want. With IBR plans, you need to recertify your income every year. And if you forget doing it or stop qualifying, your loan payments revert to the Standard Plan.

Keep in mind that the government can change the conditions anytime they want. There’s no guarantee you will stay in the IBR plan for the next 20 years.

For example, those who borrowed before July 2014 were paying 15% of their discretionary income. New borrowers pay 10% instead.

Although it benefits us in this case, it won’t be always that way.

As of 2020, Direct Loans and Federal Family Education Loans are eligible. Private student loans from banks and other lenders don’t qualify.

Who’s the Right Person for IBR Plans?

The Right Person for IBR Plans

IBRs make it affordable to pay for student loans short-term and build your credit score. However, don’t expect to save much in the long run.

Depending on your situation, this could be a smart or dumb idea. For example, public-service workers qualify for loan forgiveness in ten years and not twenty. So if you can afford the taxes that come with it, it saves a lot in interest and time.Before you go ahead, make sure you compare IBRs with other repayment programs such as Pay As You Earn, REPAYE, or ICR.

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