If you have federal student loans, you have several different repayment options. You can stick with the standard payoff plan, which would have you debt-free in a decade with fixed monthly payments. You can also opt for alternatives such as income-driven plans.
There are several income-driven options, each of which cap payments at a percentage of discretionary income (10% to 20% depending on the plan). But before you select any of them as your payoff option, it's important to consider the pros and cons. Here's what you should know.
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The pros of income-driven repayment
These are the biggest advantages of income-driven payment plans for federal student loans.
- Your monthly payments may be lower: Your monthly payments on an income-driven plan are capped at a percentage of income. If you don't make very much money, your payments could be very low -- sometimes as low as $0 every month. If you're struggling to afford your student loans, reducing your monthly obligation is a huge benefit.
- You may be able to benefit from Public Service Loan Forgiveness: If you work full-time for an eligible government agency or not-for-profit, you may be eligible to participate in the Public Service Loan Forgiveness (PSLF) program. This program enables you to have any remaining loan balance forgiven after 120 qualifying payments (and the forgiven debt is not taxed). You'll have to choose an income-driven plan to participate in the PSLF program.
- You can have any remaining loan balance forgiven after a certain number of years: Income-driven plans also provide the opportunity to have any remaining loan balance forgiven after a certain number of years -- even if you are not taking part in PSLF. After 20 or 25 years (depending on the plan), you would no longer be responsible for any remaining debt. So, there's a definite endpoint to your payoff obligations and you might not have to repay all you own.
The cons of income-driven repayment
There are also some big downsides to picking an income-driven plan. Here are some of the disadvantages.
- You could end up paying much more interest over time: If you choose an income-driven plan, there's a good chance you'll carry a balance for a longer period of time. That means you will pay interest for longer. Your total interest costs paid could be far higher under an income-driven plan than under a standard plan.
- You could be in debt for longer: As already mentioned, an income-driven plan can stretch out your payoff time. But, think about what this means. For many more years, you will be obligated to send in payments on your educational debt. This could interfere with other financial goals and leave you less to save and spend.
- You could be taxed on forgiven debt: If your debt is forgiven on an income-driven plan (rather than through Public Service Loan Forgiveness), you could potentially be taxed at the federal or state level. Forgiven student debt is tax exempt through 2025, but unless this exemption is extended, the IRS will once again come calling if your debt is forgiven. This could lead to a hefty tax bill.
It's important to weigh each of these pros and cons before deciding if income-driven payment is the best approach to dealing with your student debt.
