If you’re struggling to pay your student loans, Income-Based Repayment and similar income-driven plans can help. These plans can be the difference between affording your payments and defaulting on your loans.
Income-driven repayment plans adjust your monthly payments along with your income. Under these plans, your student loan bills never exceed a certain percentage of your pay.
As a result, you keep more of your paycheck for yourself and don’t have to worry about missing payments. Though income-driven plans are great for many borrowers, they also come with a few major drawbacks.
Before switching to one of these plans, make sure you understand the disadvantages. Here are five drawbacks to enrolling in the popular Income-Based Repayment plan and similar income-driven plans.
1. You’ll stay in debt longer
The government offers four income-driven repayment plans:
- Income-Based Repayment (IBR)
- Income-Contingent Repayment (ICR)
- Pay As You Earn (PAYE)
- Revised Pay As You Earn (REPAYE)
All of these plans cap your student loan bills at a small percentage of your income, but they also extend your repayment terms to 20 or 25 years.
You can pay less per month because you’ll be paying for a lot longer. Instead of being debt-free in the typical 10-year time frame, you’ll be dealing with student debt payments for two decades or more.
“Borrowers will be in repayment for up to 20 or 25 years, which means they will still be repaying their own student loans when their children enroll in college,” said Mark Kantrowitz, publisher of financial aid and college admissions website Cappex.
Before switching to an income-driven plan such as IBR, make sure you’re prepared to have student loan debt in your life for a long time.
2. You might pay more in interest
Like any other debt, student loans collect interest on a daily or monthly basis. The longer you have loans, the more interest you’ll accrue. If you extend your repayment terms on an income-driven repayment plan, you could end up paying a lot more in interest overall.
Let’s say you have $30,000 in student loans at a 6.80% interest rate. On a 10-year repayment plan, you’d spend $11,429 total in interest. Extend that to a 20-year repayment plan, however, and you’d end up paying $24,960 in interest.
Income-driven plans help you pay less toward your student loans in the short-term, but they also cause you to spend a lot more overall.
3. You’ll have to re-certify your repayment plan every year
To get on an income-driven repayment plan, you need to submit an application and provide proof of your income and family size. Every year, you’ll submit another application to update your information and re-certify your plan.
On the standard 10-year plan, you can pretty much set up auto-payments and forget about your loans. But with income-driven repayment, you’ll need to keep track of your documentation and apply year after year.
“One of the most significant disadvantages of income-driven repayment plans is the need for annual paperwork to remain in the programs,” said Kantrowitz.“The form is also excessively complicated.”
To maintain income-driven repayment, you’ll need to do more work than you would on another plan.
4. You could end up with higher payments
Each income-driven plan adjusts your monthly payments based on your income. As you read above, the plan will update on a yearly basis.
If you start making more money, you will end up with higher student loan payments. Fortunately, Income-Based Repayment (IBR) and Pay As You Earn (PAYE) never ask you to pay more than you would on the standard 10-year plan.
But Income-Contingent Repayment (ICR) and Revised Pay As You Earn (REPAYE) don’t place a limit on how much your student loan bills increase. If your income rises, you could end up with even higher monthly loan payments on these plans than you would have had on the standard plan.
And if you want to change to a different plan, you could see a sudden increase in your bills. “If a borrower wants to switch out of an income-driven repayment plan, there may be a cliff effect where the monthly payment increases significantly,” said Kantrowitz.
Instead of easing the burden of your student loans, ICR and REPAYE could leave you with higher bills than when you started.
5. You might get hit with a big tax bill
The four IDR plans eventually offer loan forgiveness. Depending on the plan, the government will forgive any remaining balance after 20 or 25 years of on-time payments. If you still owe money after all this time, you won’t have to keep paying it off.
That being said, you might still owe some money in taxes. Any forgiven balance is treated as taxable income. So if the government forgives a substantial debt, you could end up paying thousands of dollars in income taxes.
Before washing your hands of your student loans, prepare for the tax bill that could come your way.
Is Income-Based Repayment a good idea?
All of these Income-Based Repayment disadvantages don’t mean that getting on one of these plans is a bad idea. In fact, many borrowers reap huge benefits from adjusting their student loan bills based on their income.
If you’re struggling to make your payments or hovering near student loan default, any income-driven plan could offer the relief you need. But if you’re able to budget for your bills, it may be better to stick to the standard 10-year plan.
The decision to apply for any of the income-driven plans depends on your personal finances. If you truly can’t afford your student loan payments, the benefits of a plan like Income-Based Repayment could outweigh its disadvantages.
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