Are IDR plans right for clients with student loan debt?

Your client’s children are struggling to make their monthly student loan payments. After graduation, they found the job market a little tougher than they anticipated. They are all back at home, sitting on the couch, playing video games. It is as if they never left. What guidance can you provide?  

One option your clients may want to consider are Income-Driven Repayment (IDR) plans. These plans are available to help borrowers avoid delinquency and default when their monthly debt repayment consumes a high proportion of their monthly income. IDR plans do have a downside: Paying back the loan over a longer period means the borrower will pay more interest.

All IDR plans have the following aspects in common:

• They can be used by borrowers who have a financial hardship. This is determined based on the size of the standard student loan payment as a percentage of the borrower’s discretionary income. Discretionary income is calculated by a formula taking into account family size, household income, and size of the loan compared to 150% of the federal poverty level. It is used to determine both qualification for a loan and the size of the monthly loan payments during the 12-month period during which a borrower is qualified. (See questions 16, 17, and 18 of studentaid.ed.gov’s Q&A “Income-Driven Repayment Plans: Questions and Answers” for more information.)
• They require annual recertification. The borrower must reapply every 12 months.
• They offer loan forgiveness of any remaining student loan debt not paid after 20 to 25 years.
• The federal government may provide a subsidy on interest accrual if the monthly IDR payment does not cover the total amount of interest. In most cases, the subsidy is only given for a limited period (e.g., three years).

However, in other respects the types of IDR plans differ. It is difficult to determine which IDR plan is the right one for your client’s child unless he or she carefully considers each.

With that, let’s look at the particular requirements of each IDR plan:

* For the purposes of this chart, the term “Direct Loans” refers to all types of Direct Loans, including Direct Subsidized Loans, Direct Unsubsidized Loans, Direct PLUS Loans, and Direct Consolidated Loans.

* FFELs can be eligible for REPAY, PAYE, and ICR if they are consolidated into Direct Loans first. Federal Perkins loans can be eligible for all IDR plans if they are consolidated into Direct Loans. In most cases, loans made to parents are only eligible for ICR. See the Federal Student Aid website for full details.

The IBR plan has been the most popular IDR plan because of its simplicity and the flexibility it gives borrowers to decide which loans will be included. The REPAYE plan may become more popular as borrowers learn more about it. It has broader eligibility and lower monthly payments. However, each IDR plan has several pros and cons, and all factors need to be considered when looking at which plan is right.

Below is a comparison chart showing estimated payments due under each IDR compared with payments due under a standard 10-year student loan. Note the substantial reduction in the monthly payment along with the increase in the repayment period.

Total Student Loan Debt Balance: $30,000

Interest rate: 6.8%

Adjusted Gross Income: $20,000

Family Size: 1

* Initial payment; future payments assumed to increase by 5% per year as borrower’s income increases. Generated by Student Debt Manager® software.

Does an IDR plan make sense?

Before borrowers struggling with making student loan payments consider an IDR, they may want to review their entire financial situation and look at all other options for easing their student loan debt (e.g., cancellation, forgiveness, and postponements). In addition, a certified credit counselor trained in debt management may be able to recommend other ways to free up cash flow to make all monthly payments, such as creating a debt management plan to reduce credit card debt. After other options have been considered, looking at IDR plans may make sense.

A CPA with a basic knowledge of student loans can provide real value to their clients (and their children) by pointing out how IDRs work and how selecting the right one just may make it affordable for their grown kids to finally move out of their house. If the CPA is uncomfortable getting into much detail, he or she can refer the client to a knowledgeable student loan counselor. Many not-for-profit credit counseling agencies now provide student loan counseling services. Finding a local agency that is a member of the Financial Counseling Association of America or the National Foundation for Credit Counseling is a good place to start.

James Sullivan, CPA/PFS, is a board member of Consumer Debt Counselors Inc., a not-for-profit debt counseling agency. Melissa Towell is a student loan counselor for Consumer Debt Counselors Inc. To comment on this article, email associate editor Courtney Vien.