When you splurge on a new video game or a new pair of shoes on payday, you’re using the income you have after your set expenses. If you have student loans, you might have very little income left over, so luxuries and small extras might be few.
If you’re struggling to keep up with your student loan payments on your current salary, one option is to sign up for an income-driven repayment (IDR) plan. With IDR, the money you have after expenses — your discretionary income — becomes very important.
Here’s how your discretionary income impacts your repayment plan.
What is discretionary income?
Discretionary income is the money you have after paying for necessary expenses like rent, utilities, and food. It’s what you use to buy non-essentials throughout the month.
If you’re short on cash or if you lose your job, the first thing you’ll do is reduce spending of your discretionary income. While you can’t eliminate rent payments, you have more control over your discretionary spending. You might go on a shopping ban to cut down on Target purchases or shop for cheaper alternatives, instead.
For example, let’s say you bring home $3,000 a month after taxes. Your rent and utilities are $1,000, and you spend $400 a month on groceries and $100 per month for car insurance. That means you have $1,500 of essential expenses and $1,500 in discretionary income.
One important thing to keep in mind is that some people use credit cards or other lines of credit to finance vacations, high-end clothing, or regular shopping sprees. This approach doesn’t count as discretionary income; using a credit card to pay for items, and not paying off the balance, is spending money you don’t have.
Discretionary income and student loans
When it comes to federal student loans and IDR plans, discretionary income works a little differently. Rather than looking at your individual expenses, the U.S. Department of Education considers your discretionary income to be your gross — after tax — income minus the poverty guidelines for your family size.
Each plan differs slightly, but for most IDR plans, your loan servicer will set your discretionary income as the difference between your income and 150 percent of the poverty guideline.
How to calculate discretionary income
Before you have to pay anything on most IDR plans, the government lets you keep your total salary (pre-tax) up to 150 percent of the poverty guideline. They consider that portion to be essential and non-discretionary.
For example, if you are single and your income is $30,000, you would subtract 150 percent of the poverty guideline for a one-person household: $18,090.
Your remaining income, $11,910, is considered your discretionary income. Split up over twelve months, that means you have $992.50 a month for non-essentials.
If, like me, math isn’t your strong point, don’t panic. You don’t have to do these calculations on your own. When you apply for an IDR plan, the government will ask for information about your expenses and income. They will do the calculations for you.
But having an understanding of how discretionary income works and how to calculate it can help you estimate your new payments.
How your discretionary income affects your payments
If you have several hundred dollars in discretionary income, that doesn’t mean all of your extra money will go toward your student loans. Instead, the government caps your payments at just a percentage of your discretionary income.
For IDR plans, you’ll pay between 10 and 20 percent of your discretionary income toward your loans each month. If you have little extra money, your payment could be much lower or you could even qualify for a $0 monthly payment.
Using the information from the above example, say you signed up for a Revised Pay As You Earn (REPAYE) plan and had $992.50 a month in discretionary income. REPAYE generally caps your payments at 10 percent of your discretionary income, so your monthly payment can’t exceed $99.25. If your loans are large, that can be a significant reduction.
However, while IDR plans can free up more cash flow each month, there are some downsides to consider. The government extends your repayment term to as long as 25 years. Even with lower payments, that means you could be paying much more in interest over the length of your loan. Make sure you understand how much you’ll spend on an IDR plan before signing up.
Reducing your student loan payment
When your budget is so tight that you have little to no breathing room, an IDR plan can be a lifesaver. Depending on your discretionary income, you can dramatically reduce your payments and make your loans more manageable.
If you’re ready to sign up for an income-driven repayment plan, we can help you through the process for free.
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