Student Loans: How Income-Based Repayment Will Make You Poorer

Income-Based Repayment, or IBR, is intended to help struggling federal student loan borrowers The federal government introduced Income-Based Repayment, or IBR, last year to provide relief to federal student loan borrowers who are struggling to manage their loan payments.

IBR provides a formula that caps monthly payments at 15% of discretionary income. Borrowers who make all their income-based payments for 25 years have the balance of their federal student loan debt forgiven at the end of that period. To find out how that would work for you, use this calculator.

Education lender Sallie Mae recently noted in a press release that "Since IBR was introduced last July, approximately 23,000 Sallie Mae customers have enrolled in the plan. Under IBR, in addition to paying a lower amount each month, eligible customers can extend their payment term from the standard 10-year term up to 25 years."

How to Dramatically Increase the Cost of Student Loans

The problem for borrowers is that extending your repayment term will dramatically increase the amount of interest you'll pay over the life of the loan -- and, if you take the full 25 years to repay your debt, you'll be around 46 by the time you're debt-free. That's a very, very hard way to establish a solid financial life. Let's look at how this works with real numbers using this handy calculator from FinAid.org:
  • Student A borrows $30,000 with a Federal Stafford Loan at 6.8% and opts for the standard 10-year repayment plan. He'll make 120 payments of $345.24 before he is debt-free, having paid back a total of $41,428.97; $11,428.97 of that amount will consist of interest.
  • Student B borrows $30,000 with a Federal Stafford Loan at 6.8% and stretches his repayment out over 25 years. His monthly payment will be $208.22 and he'll make that payment for 301 months. He'll pay back a total of $62,467.29, of which $32,467.29 will be interest.
(I'm assuming, for simplicity, that after 25 years, you will have paid off your loan in full, which will likely be the result for most borrowers; I'm also making the payments the same each year because there's no way to actually incorporate changing payments from changing incomes into this equation.)

Now That's Just Dumb

Here's the problem with this scenario: In order to reduce your monthly payments by 40%, you'll have to increase the number of payments you make by 150%. That's dumb!

The single most powerful thing you can do to improve your financial life is to get out of debt. The sooner you do that, the better -- and healthier! -- you'll be.

IBR is a valuable tool if you literally can't afford to make your payments and put food on the table. But if there's any way that you can possibly scrimp together the cash to make your loan payments, it'll be a lot better for your total cost and financial health. My concern is that too many borrowers are opting for IBR as a way to lower the monthly student loan expenses even when they could find a way to make the full payments. If you can afford to eat out or go see movies, you should skip IBR and opt for a standard repayment plan.

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Math

Also was left out the fact that if you're income level is low enough and you have a Federally subsidized loan IBR basically act as up to three years of additional deferment with no interest. Pretty cool.

September 23 2011 at 4:08 PM Report abuse rate up rate down Reply
Neal

I agree that this option is not wise but it is helpful for someone in my situation--I make only $9.50 an hour (but have a stable, full-time job with good, relatively inexpensive benefits), meaning I only bring in just over $1,000 per month, near or below the poverty line (not sure which). In my case, the IBR plan will allow me to use the almost $400 a month I pay in loans to pay for my cheap apartment, allowing me to survive for the time being until I can find a better-paying job or a second job. I only plan on doing this for a year or so.

August 11 2011 at 10:59 PM Report abuse rate up rate down Reply
Sajila Wakas

Hi
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May 30 2011 at 12:09 PM Report abuse rate up rate down Reply
Shoal Creek

You over-simplified. The way IBR works is this: AGI - 150% * Fed Poverty Level for your family = disposable income.

Now, take 15% of disposable income, this is one possible payment amount. Next, amortize the student loans over twelve years. This is the other possible payment. These two possibilities are compared. The lesser of the two payments is the payment amount chosen for IBR. Every year, you must re-certify your income and the payment is adjusted accordingly.

Thus, if you have a high income and choose IBR, you will pay off in twelve years, max. If you have a low income and choose IBR, it will take however long it takes up to 25 years. If you're not paid off after 25 years, the remainder can be canceled, if you meet all the conditions. If you work for NGO's or as a public employee, you can have the remainder forgiven after ten years.

See http://studentaid.ed.gov/PORTALSWebApp/students/english/IBRPlan.jsp for more details.

April 28 2011 at 12:57 AM Report abuse +1 rate up rate down Reply
rpdr123

Yeah, I'm with Balkwyll. For those of us who want to go into public or government service, IBR seems like a great deal, especially when, under the public service option, the full debt (with the interest capitalized as far as I can tell) is written-off tax-free after 10 years. Granted this requires complete government or public service for that decade, but part of the reason I am going to law school is to help out those least able to help themselves. It has literally made possible my dreams of joining an immigrant rights group or legal service agency instead of a BigLaw firm that will chew you up and spit you out after a few years of work for them (the rank and yank system is quite prevalent in firms where it is nearly close to impossible to make partner or to stick around indefinitely).

Besides, at 50K to 60K a year (the going rate for public interest and government lawyers), the income is sufficient to do some careful saving and investing if you're frugal enough. So public interest IBR is not, as the author of the article implies, some parade of financial horribles (especially when he trots out the fact that the interest is accummulating, but that interest is going to be forgiven after a period of time anyway). For some people it's a great program that incentivizes them to undertake jobs that are not remunerative, but that help out society in really significant ways.

January 24 2011 at 6:42 PM Report abuse +1 rate up rate down Reply
balkwyll

The Income Based Repayment Plan is a great plan for those who have large student loans and are using the Public Service forgiveness option. I have nearly $100,000.00 in loans and have minimized payments under the IBR thanks to a lower income with a State agency. I couldn't even pay the interest on my loans under the Extended Repayment Plan, which would have allowed loan forgiveness after 25 years of payments. The problem there is the amount forgiven would have been a taxable event which would have caused a huge tax burden. The Public Service option allows me to make low monthly payments for 10 years and then forgive the remainder of the loans without any tax event. There are times when the IBR provides a smart option to borrowers.

January 09 2011 at 1:25 PM Report abuse +1 rate up rate down Reply