Is income-based student loan repayment right for you?

By Georgie Miller

According to a popular estimate, more than 40 million Americans now owe a combined $1.2 trillion in student loans. That's made the issues surrounding these loans -- including income-based loan repayment plans -- a hot topic lately.

Income-based repayment plans may lower your monthly payments and, over time, even eliminate some of your student debt. But not every borrower is eligible for an income-driven plan, and if you are eligible, there's lots to consider when deciding if it's the right choice for you.

Income-based repayment options

The standard repayment plan for a federal student loan is 10 years. However, as you will learn about money after graduation, your grown-up salary may not be as big as you think it is. You will also have other priorities, including savings and retirement, and maybe even an occasional vacation.

According to the Federal Student Aid website, an income-driven plan is worth considering "if your outstanding federal student loan debt is higher than your annual income or if it represents a significant portion of your annual income."

There are three main types of federally available income-driven plans:

• Income-Based Repayment (IBR)

• Pay As You Earn (PAYE)

• Income-Contingent Repayment (ICR)

Private loans are not eligible for these plans. If you have private loans, contact your lender or loan servicer directly to find out what kind of repayment plans they have available. If you have federal loans, the Federal Student Aid Repayment Estimator can help you determine which plan or plans you are eligible for and what your monthly payment would be under each.

Pros and cons of income-driven plans

Once you've determined that you're eligible for an income-driven plan, it's time to consider the benefits and drawbacks of switching. For example:

• Pro: Your monthly payment may decrease. While your monthly payment may fluctuate during repayment, it will never exceed the amount under the standard 10-year plan, and is often less.
• Con: Your balance may increase. Since your interest rate on the loans doesn't change, your new payments may not cover the interest as it accrues. It can be frustrating to make payments, yet watch your account balance grow.
• Con: Your repayment term may increase. If you're currently on the standard 10-year plan, switching to an income-driven plan may extend the amount of time you are shackled to your student loan payments by a decade or more.
• Pro: After 20-25 years, any remaining balance may be forgiven. Depending on your starting balance and income, you may or may not pay off your loan by the end of the repayment term. If you don't, any remaining balance may be forgiven.
• Con: The forgiven balance will be taxed as income. Depending on the amount of the balance that is forgiven, this can mean a hefty tax bill. What's the point of lowering your monthly payments for 20 years, only to potentially owe thousands of dollars to the IRS?

Your tax filing status may also impact your repayment amount under income-driven plans. If you're married, you'll have to decide whether filing separately or jointly is the right move for your circumstances.

An income-driven plan plus extra payments: the best of both worlds?

Just because your minimum payment is set at a certain amount doesn't mean you can't pay more each month. Extra payments may help you pay off your student loans faster and reduce the amount of interest you pay. Try these student loan payback tips for more helpful strategies.

Additionally, most people's income increases over time. If you wait too long, you may find you're no longer eligible. Locking in an income-driven repayment plan soon after graduation may take the pressure off when money's tight. You can always make extra payments later, after your income rises.

And don't forget non-student loan related strategies. Regardless of whether you have student loan debt, you can use high-interest savings accounts to boost your bank balance or a rewards credit card to earn cash back on your spending. The money you save in other areas of your budget can help free up funds for extra payments and bring you that much closer to a life free of student debt.