The lower payments often offered by income-driven repayment (IDR) plans can be a huge boon to federal student loan borrowers.
These programs cap your monthly loan payments at a small percentage of your income. The plans can make your payments manageable, but they can increase the total amount of interest charges you pay.
Understanding how student loan interest works on IDR plans is key to deciding if you should enroll in any of the programs and in choosing a plan. Here are five facts about IDR interest costs you must know before signing up.
1. Income-driven repayment plans don’t affect your interest rate
An income-driven repayment plan won’t change your student loan interest rate. Switching to an IDR plan can lower the amount you’re required to pay each month while it extends your repayment period.
However, this move won’t affect your interest rates. Interest will be assessed and charged in the same way it was before you enrolled in the plan.
2. You might pay more in total interest on an IDR plan
Even though your interest rate won’t change on an IDR plan, you can wind up paying more in total interest charges over the life of the loan.
That’s because the lower monthly payments on an IDR plan won’t reduce your balance as quickly as a standard repayment plan. You’ll be charged interest on a balance that’s higher than it would be if you followed the traditional 10-year repayment schedule.
Take, for example, this comparison of interest costs on $25,000 in federal student loans. Assuming interest rates of 4.5% and an income of $30,000, the monthly payment on an Income-Based Repayment (IBR) Plan is $149 — that’s $110 less than the $259 payment on a Standard Repayment Plan.
In the first year of signing up, here’s a look at the interest costs, which are included in the monthly payments.
Standard Repayment Plan
Income-Based Repayment Plan
|Monthly payments||Monthly interest||Loan balance||Monthly interest||
By the end of the first year of being enrolled in an IBR plan, a borrower will have a balance that’s $1,349 higher than on a standard plan and will pay $27 more in interest.
This effect also will compound for each year the borrower is enrolled in IBR. By staying on this plan, the borrower will pay $3,811 more in interest over the life of these loans.
3. Monthly payments don’t always cover interest charges
A standard repayment plan for federal student loans will get you out of debt within 10 years. Monthly payments are set to cover both interest charges and repayment of the principal within that time.
An income-driven repayment plan, on the other hand, is designed to have affordable monthly payments based on your current income. It typically won’t help you save on interest costs or get out of debt faster.
In fact, many IDR participants will have monthly payments that are less than what they owe on interest alone. Low payments that result in unpaid interest is called negative amortization.
Say you qualified for a $50 monthly payment under an IDR, for example, but your student loan results in $80 of interest charges per month. That leaves $30 of unpaid interest each month that can accrue and be capitalized, or added to, your student loan balance.
4. Unpaid interest will be added to your balance
Unpaid interest charges will accrue and eventually be added to your student loan balance. This capitalized interest will become part of a new, higher balance that will increase the amount on which you’re charged interest.
Certain actions can trigger a capitalization of unpaid interest on an IDR plan. Each income-driven repayment plan has its own rules and limits on when and how this unpaid interest is capitalized.
|Income-driven repayment plan||When will unpaid interest be capitalized?||How much interest can capitalize?|
|Pay As You Earn (PAYE)||If you no longer qualify for reduced payments under PAYE or leave the plan||10% of your initial debt balance when you enrolled in the plan|
|Revised Pay As You Earn (REPAYE)||If you fail to recertify your income or leave the plan||No limit|
|Income-Based Repayment (IBR)||If you no longer qualify for reduced payments or leave the plan||No limit|
|Income-Contingent Repayment (ICR)||Annually||Annual capitalized interest is limited to 10% of initial debt balance upon enrollment|
5. Some IDRs help cover unpaid interest
Some federal student loans and IDR plans will help you cover the costs of negative amortization.
If you have subsidized loans, for instance, your student loan interest subsidy might apply to any interest not covered by your monthly IDR payments. On the REPAYE, PAYE, and IBR plans, the U.S. government will pay this leftover interest for the first three years of enrollment.
The REPAYE plan also offers its own interest benefit, which pays 50% of monthly unpaid interest on nonsubsidized loans. This benefit also is applied to subsidized loans when the 100% subsidy expires after three years.
Which IDR plan is most beneficial will largely depend on your debt and financial situation. Our online calculators can help you preview what your payments and interest might look like after enrolling in an IDR plan.
Ultimately, you need to understand the potential costs of an IDR plan and compare your options to make the best decision possible.
Interested in refinancing student loans?Here are the top 6 lenders of 2019!
|Lender||Variable APR||Eligible Degrees|
|Check out the testimonials and our in-depth reviews!
1 Important Disclosures for SoFi.
2 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 7.89% APR (with Auto Pay). Variable rate loan rates range from 2.50% APR (with Auto Pay) to 7.27% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of April 17, 2019, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 04/17/2019. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at firstname.lastname@example.org, or call 888-601-2801 for more information on our student loan refinance product.
© 2018 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
3 Important Disclosures for Laurel Road.
Laurel Road Disclosures
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the fixed rate will decrease by 0.25%, and will increase back up to the regular fixed interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the variable rate will decrease by 0.25%, and will increase back up to the regular variable interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown.
All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 2.49% effective March 10, 2019.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.50% – 7.27%1||Undergrad & Graduate|
|2.50% – 7.12%3||Undergrad & Graduate|
|2.53% – 8.79%4||Undergrad & Graduate|
|2.50% – 6.65%2||Undergrad & Graduate|
|2.55% – 7.12%5||Undergrad & Graduate|
|3.00% – 9.74%6||Undergrad & Graduate|