These plans aim to help struggling student loan borrowers. Here’s what can go wrong

Personal finance

With more and more student loan borrowers falling behind, it’s clear many people need a way to make their monthly bills more manageable. Enter income-driven repayment plans, which some 8 million borrowers are enrolled in.

In theory, the plans are simple: Borrowers’ bills are capped at a portion of their income. Some payments wind up being as little as $0. (Presidential contender Joe Biden has proposed allowing people who earn less than $25,000 to not make any payments, without interest accruing on their debt.) Any remaining debt is typically cancelled after 20 or 25 years.

In practice? The programs can lead to a knot of paperwork and pitfalls that can ding borrowers with extra costs or exclude them entirely. “A lot can go wrong if you’re not careful,” said Will Sealy, co-founder and CEO of Summer, a company that helps borrowers simplify and save on their student debt.

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To begin, borrowers should think twice before they enroll in one of the plans. While you might be enticed by smaller monthly bills, the repayment terms on them are decades long and you’ll typically end up paying more overall than in the federal standard 10-year plan.

“The standard repayment plan is almost always the cheapest plan over time,” said Betsy Mayotte, president of The Institute of Student Loan Advisors, a nonprofit that helps student loan borrowers with free advice and dispute resolution.

But if you can’t afford the payments on the standard repayment plan, it makes sense to consider an income-driven one. You have four to choose from.

Borrowers should first check to see if they qualify for the pay-as-you-earn plan, said Mark Kantrowitz, publisher of SavingforCollege.com. That’s because it’s the most affordable option: Your monthly bills will be limited to 10% of your discretionary income and your debt will be wiped out after 20 years.

If you don’t qualify for that plan, Kantrowitz said, your next most affordable options are the revised pay-as-you-earn plan, in which your payments are set at 10% of your discretionary income, or the income-based repayment plan, in which bills are capped at 15% of your discretionary pay. On the income-contingent repayment plan, the least preferable option, your monthly bills will be 20% of your discretionary income.

Once you’re on the right plan for you, once a year you’ll have to go through the so-called rectification process in which you show proof of income to your lender. More than half of borrowers on income-driven repayment plans miss their certification date, according to the U.S. Education Department.

That can cost you.

“If you miss the deadline, the accrued interest will be capitalized, increasing the amount of debt,” Kantrowitz said.

A calendar reminder can help you meet the deadline, said Elaine Griffin Rubin, senior contributor and communications specialist at Edvisors. “Make sure to read the correspondence sent to you by your servicer,” she added. “Your servicers will send you reminders to re-certify.”

If your income changes, you should re-evaluate which repayment plan makes sense for you, Kantrowitz said.

If your financial situation improves considerably, for example, you might want to switch into the standard repayment plan, under which you’re student-debt free after 10 years.

On the other hand, Sealy said, “if your income lowers substantially, either due to job loss or change in employment, it might be worth re-certifying earlier to benefit from a lower monthly payment.” (You can let your lender know that your income has changed at any time in the year.)

The size of your family also matters. For example, some plans will add your spouse’s income into what you can pay. As a result, some borrowers will be better off filing their taxes without their partner, to keep their payment from jumping. “Though it’s important to consult an accountant to assess the loss in tax benefits if they were to file separately,” Sealy said.

If you have a child, it also makes sense to re-certify your income, since family size is factored into your monthly payment.

Don’t accept the first payment your lender has calculated.

Sealy said his company, Summer, has worked with several borrowers who weren’t paying the accurate amount. “We found a few instances of borrowers who’d been over-billed,” Sealy said.

Another tip: When you’re on an income-driven plan, it doesn’t make sense to pay more than your minimum payments, Kantrowitz said. That’s because ultimately you’ll have your debt forgiven. (That’s also the case if you’re pursuing public service loan forgiveness, since you’re due to get your debt cancelled after 10 years.)

When you finally reach the end of your repayment timeline, Kantrowitz said, any forgiven debt is considered taxable income. As a result, he said, “it’s important to save money to cover the cost of that future tax bill.”

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