Student Loans – Understanding Income Drive Repayments (IDR) – Part 1

Student loans are a burden on college graduates. Imagine graduating, landing your first job and then six months later having a mortgage payment but no house. This is what is happing to twenty-somethings because of decisions they made when they were 16.

The biggest problem with student loans is the drain they give on your monthly cash flow. Graduating with student loans is like trying to drive a boat with the anchor down. The student loan payments continuously pull you back from moving forward with your financial goals.

A Chinese proverb says, “the best time to plant a tree is 20 years ago, the second-best time is today”. If we could all go back and fix our mistakes from 20 years ago, we would all be better off. Too bad, we cannot.

Since we cannot fix the student loan mistakes we have made, we need to make the best decision going forward. Income-Driven Repayments give us the best tool to recover from the student loan death blow.

What Are Income-Driven Repayments?

Federal student loans have a great feature called income-driven repayments (IDR). These payments often offer lower than usual payments based on your family size and income. They offer a pardon on the sometimes absurdly large student loan payments recent graduates have.

As of right now, there are five different income-driven repayment options, and they all have various characteristics. They are:

Income Contingent Repayment

Income-Based Repayment (two versions)

Pay As You Earn

Revised Pay As You Earn

Each of these repayment plans has the same basic core features in common. That is what we will look at first.

Discretionary Income

Income-driven repayment plans allow you to base your payments on your discretionary income. Discretionary income is, in theory, the amount of money you have control over in your finances.

In contrast, non-discretionary income the amount of money you need to survive. Non-discretionary income is determined by the government, based on your family size and 1.5 times the poverty level.

In 2019 a family of three would be in poverty if they have an adjusted gross income (AGI) of less than $21,330. The same three-person family would have a non-discretionary income of $31,995.

So what does this mean? For your income-driven repayments, you would only pay a percentage of your earnings over $31,995. Exempting this non-discretionary income could end up saving you a lot of money.

Here is a chart showing the non-discretionary income limits for different family sizes.

How Much Will I Have to Pay?

Most IDR plans will have you pay 10% of your discretionary income. Multiplying your discretionary income by 10% and dividing by 12 will give you your payment.

Some income-driven repayment plans will have different required payment. If you had federal loans on or before July 1st, 2014, the Income-Based Repayment plan will require a 15% payment. If you are on a loan that only allows for the Income Contingent Repayment, you will make a 20% payment.

My next article in this series will discuss differences in how each plan treats unpaid interest. How the plans handle unpaid interest can be very important in deciding the proper income-driven repayment.

Until then, if you would like to speak about you student loans contact me today for a free consultation.