Income-driven repayment plans such as Income-Based Repayment (IBR) and Pay As You Earn (PAYE) offer millions of federal student loan borrowers the opportunity to have a uniquely tailored monthly payment based on their income and family size. The programs also offer forgiveness of any remaining loan balance at the end of their respective repayment terms (20 or 25 years, depending on the program). Although far from perfect, for many borrowers these programs are the only thing standing between them and default, as “regular” repayment plans based on the loan balance would be unaffordable.
Income-driven repayment plans can be complicated to navigate, however, and not everyone knows some of the features that can provide even more relief. Here’s a short list of the most glaringly lesser-known programmatic features of income-driven repayment:
Adjusted Gross Income Is Key
The most common way of calculating your monthly payment under an income-driven repayment plan is to provide your loan servicer with a copy of your most recently filed tax return. The figure used to calculate your payment is “Adjusted Gross Income” (AGI). This is your gross taxable income, but, by definition, it is “adjusted” and reduced following certain types of pre-tax deductions. For example, certain retirement contributions and itemized business expenses can reduce your AGI, which will in turn reduce your income-driven monthly payments. Talk to an accountant or a qualified tax advisor to discuss ways of reducing your AGI.
Alternative Documentation of Income
As stated above, the most common way of calculating your monthly payment under an income-driven repayment plan is to provide a copy of your most recently filed tax return. But your tax return may not provide the most accurate picture of what you are earning now. After all, it’s about your income from last year. What if your income has dropped since then? Or what if last year’s taxable income was misleadingly inflated by a one-time payout or windfall?
Luckily, federal regulations allow student loan borrowers to submit alternative documentation of income that may be more reflective of current circumstances than a tax return. There are many types of documents that are acceptable as proof of income such as a pay stub, a letter from an employer, a canceled check, a bank account statement, or even a self-certifying affidavit in some circumstances. Talk to your loan servicer for more details.
Voluntary Re-Calculation of Your Monthly Payment
When you submit documentation of income for an income-driven repayment plan, your student loan servicer will calculate a monthly payment that will last for 12 months. Towards the end of this 12-month period, student loan borrowers are required to re-certify their income and have their monthly payment recalculated for the next 12 month cycle. But what happens if your income drops before the 12-month period expires, and you can no longer afford the current payments?
Borrowers are not required to “wait it out” until it is time to re-certify their income. Federal regulations permit borrowers to request that their monthly payment be recalculated based on changed circumstances. So if your income drops, you can submit a new application (along with documentation of your reduced income) to request that your loan servicer recalculate your monthly payment amount. This will begin a new 12-month cycle with that reduced monthly payment.
Income-Driven Repayment Is Better than a Deferment or Forbearance
During times of economic hardship, many borrowers flock towards deferment or forbearance, which allows them to postpone their payments for a period of time. However, there are many pitfalls of these programs, and they eventually expire, leaving borrowers with no recourse if they encounter problems again down the road.
Many student loan borrowers don’t realize that income-driven repayment plans are an excellent substitute for a deferment or forbearance. If you experience a drop in income, or you become completely unemployed and are earning no income at all, you can request a re-calculation of your monthly payment, rather than going into deferment or forbearance. Depending on how low your income is, your new calculated monthly payment amount may be extremely low – as low as $0/month. Even $0 “payments” count towards loan forgiveness and keep you in good standing on your student loans, without needing to deplete or exhaust your deferment and forbearance options.
