Income-Based Payment Plan Offers Student Loan Borrowers Relief

by Dawn Handschuh, Personal Finance Writer   

After the college graduation parties wind down and the beaming faces of your parents fade into memory, the grim reality starts settling in: You owe thousands of dollars in student loans, and you hold an entry-level, low-paying job. The prospect of having to repay big-time student loans on a small-time income is daunting. If you've completed graduate or professional studies, your loan balance might even exceed $100,000.

Would the thought of paying 15% or less of your income toward student loan debt make you feel any better?

Effective July 2009, a new program that makes federal student loan repayments more affordable allows students to sign up for income-based repayment plans. The plan is available for student borrowers of federal student loans through either the Direct or Guaranteed (FFEL) loan programs, including Stafford, Grad Plus and federal Consolidation loans (those that don't include Parent PLUS loans). Perkins loans are also eligible if you consolidated them into a federal Guaranteed (FFEL) or Direct loan.

The income-based repayment plan, which is available to both undergraduate and post-graduate students, can also help those who took out federal student loans before the income-based repayment plan was created.

Here's how it works.

Eligibility

First, to be eligible to participate, you have to have enough debt that it would take more than 15% of whatever you earn above 150% of the poverty level to pay off your loans under a conventional 10-year repayment plan. The Project on Student Debt provides a calculator you can use to determine your eligibility. 

If you've ever defaulted on a student loan, you won't be eligible to participate in this program.

The Sliding Scale Repayment Plan

The program uses a sliding scale that caps your repayments at 15% of whatever you earn above 150% of the poverty level for your family size. For most borrowers, that will work out to be less than 10% of your total income. 

For example, a single borrower earning $20,000 a year will only be required to pay 3.3% of his income toward student loan repayments. The same borrower making $60,000 a year would need to make student loan repayments representing 11.1% of his income. A married couple filing a joint IRS tax return with a gross annual income of $100,000 would need to make payments equaling 11.9% of their income.

Of course, the amount of your student loan repayments will increase if your income rises. On the other hand, if you earn below 150% of the poverty level, your required loan payment will be $0.

For some borrowers with lots of student loan debt, the minimum payment requirement wouldn't actually cover their loan's interest payments. In those cases, the federal government would pay the interest on Subsidized Stafford Loans for three years; after that (and for other types of loans), loan interest would be tacked onto the balance of the loan, effectively increasing the original loan balance. The silver lining here is that after 25 years of making payments, any remaining loan balance would be forgiven. This is a significant change from years past, when student loans were exceedingly difficult to discharge.

The income-based sliding scale represents a huge boon to students who are typically required to start loan repayments within six months of graduation. While students can defer payments for up to three years due to unemployment, interest would normally continue to accumulate during the deferral period.

The income-based repayment plan doesn't apply to private student loans or PLUS loans made to parents. Sorry, Mom and Dad.