Income Based Repayment

The Income-Based Repayment (IBR) option will afford student loan borrowers the opportunity to have the monthly payment on their federal loans calculated as a percentage of available income rather than being dependent upon the amount borrowed. This will make a significant difference to borrowers with lower incomes and large federal student loan debt.

The amount of the payment is calculated by calculating a borrower’s “discretionary income” and limiting the loan payment to 15% of that discretionary income. Discretionary income is calculated by subtracting 150% of the poverty guideline for that borrower’s family size and location from the adjusted gross income. The remaining amount is the annual discretionary income. That amount is then multiplied by 15% to calculate the annual loan payment responsibility. That amount is divided by 12 to arrive at the monthly payment amount.

For example:

• Assume borrower earns $40,000 annually
• IBR monthly payment = $285/month to start

          $40,000 (AGI)
     —  $17,235 (150% of poverty guideline for a single person in the 48 contiguous United States)

    =   $22,765 (discretionary income)
     x   15%
     =   $3,415 (annual loan payment responsibility)
     ÷   12 months
     =   $285/month

You may wish to use an online calculator to estimate monthly payments under IBR.

The borrower’s monthly payment amount will be re-evaluated annually. After 25 years of on-time payments on the Income Based plan, the remaining federal loan balance will be forgiven. There are a few negatives attached to IBR, however. First, there is a marriage penalty associated with this program. If the borrower is married and files federal taxes jointly, the spouse’s income is included in calculating the income based payment. The workaround for this problem is for the married couple to file their taxes separately. This may, however, result in higher income tax liability.

Second, the borrower should be at least a bit concerned with negative amortization. If the loan debt is significant, it is quite possible that the amount of the monthly payments is not large enough to cover the accruing interest on the student loan. The unpaid interest would be added on to the principal balance if the borrower should leave IBR. This could leave the borrower after several years of repayment owing a larger debt than they started with, so borrowers should be careful to weigh options thoroughly before selecting IBR.

The third negative associated with IBR is tied to the forgiveness of the debt after 25 years of payments. The way the law reads at this time, this type of forgiveness is a taxable event, so the borrower would need to be prepared for increased tax liability in the year the forgiveness occurs.