Why I Switched to Income-Driven Loan Repayment
While student loans are certainly not fun, they've become somewhat of a necessity these days for most students attending college. The average student graduates with $35,000 in loan debt. For many new college graduates, this is the first time they've had to deal with a major monthly expense that they're responsible to pay all on their own. The loan payments might be manageable if recent graduates weren't also taking on so many other new expenses at the same time. For many, this is also the first time they've had to pay rent, car payments, and phone bills, not to mention the other overlooked expenses that often pop up for recent grads. Even things like buying a professional wardrobe can have a major impact on your financial situation if you're on an entry-level salary.
When I first graduated, I was living at home with my parents and had no problem making the monthly payments on my federal loans using the Standard 10-year Repayment Plan. In fact, I often paid extra towards my loan. But once I moved out of my parents' house, I was now looking at rent and utilities every month. I also started paying my car insurance and phone bill, expenses my parents had covered when I was in college. Suddenly finding the money to cover my monthly loan payment wasn't so easy.
That's why I'm so glad the income-driven repayment plans exists for federal student loans. Generally, your payment amount under an income-driven repayment plan is a percentage of your discretionary income (and note, that's of your discretionary income, not even your total income). There are four different options of these repayment plans. The percentage you pay differs depending on which one you chose, but the majority of them use 10% of your discretionary income.
Currently, I am on the Pay As You Earn (PAYE) plan. This plan requires a payment of 10 percent of your discretionary income, but never more than the 10-year Standard Repayment Plan required amount. Switching to the PAYE plan helped give me some breathing room when it came to my finances. When I don't have much money for the month, I simply make my required monthly payment, and for months when I do have some extra money, I make a larger payment similar to the one I was making on my 10-year plan. Having the freedom to choose how much to pay saves me a lot of stress.
Applying for an income-driven repayment plan is pretty easy. You can do it online by logging in to your loan servicer's website or over the phone. You'll be required to submit your most recent tax information, and you'll receive your new monthly amount based off of that. When I first switched to the plan, my income was not very high. As a result, I owed $0 a month. Since then, my monthly payment has gone up due to my income increasing, but it's never anything I can't handle or find unreasonable.
Is switching to an income-driven repayment plan right for you? It depends. These plans can only be used for federal loans, so if you have private loans, talk to your private loan servicer to see if they offer any similar options for modified payment plans. Another thing to consider is by making lower monthly payments, you're most likely extending your repayment period. This likely means more interest, which means the total amount you'll pay towards the loan will be greater. And if you make it to the end of your repayment period and still have a remaining balance, though your balance may be forgiven, you'll have to pay income tax on that amount. As well, know that the debt-to-income ratio used for some lenders in reviewing your application for a home mortgage may not take into account your new, lower monthly loan payments.
Overall, the PAYE plan was 100% the right decision for me. It was easy to switch to and allows me to make monthly payments that are relative to my salary. Being able to use my money towards other expenses is the best fit for my life situation at the moment. And if down the road I change my mind, I can always switch back to the standard repayment plan!