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The Income-Based Repayment (IBR) plan was proposed as part of the College Cost Reduction and Access Act of 2007 and will become available on July 1, 2009.

Income-based repayment is intended as an alternative to income sensitive repayment (ISR) and income contingent repayment (ICR). (Both ISR and ICR plans will continue to exist.) It is designed to make repaying education loans easier for students who intend to pursue jobs with lower salaries, such as careers in public service. It does this by capping the monthly payments at a percentage of the borrower's discretionary income, which is based on the borrower's income, family size, and total amount borrowed. The monthly payment amount is adjusted annually, based on changes in annual income and family size.

Income-based repayment is only available for federal student loans, such as the Stafford, Grad PLUS and consolidation loans. It is not available for Parent PLUS loans or for consolidation loans that include Parent PLUS loans. (IBR is not available for Perkins loans, but it is available for consolidation loans that include Perkins loans.) It is also not available for private student loans.

Income-based repayment is similar to income-contingent repayment. Both cap the monthly payments at a percentage of your discretionary income, albeit with different percentages and different definitions of discretionary income. Income-based repayment caps monthly payments at 15% of your monthly discretionary income, where discretionary income is the difference between adjusted gross income (AGI) and 150% of the federal poverty line that corresponds to your family size and the state in which you reside. There is no minimum monthly payment.

(Overall, income-based repayment is probably a bit better for borrowers than income-contingent repayment, especially if the borrower's financial circumstances improve. Income-contigent repayment caps monthly payments at 20% of the difference between AGI and 100% of the federal poverty line. Income-based repayment is clearly more generous than this aspect of income-contingent repayment, since it assesses a lower percentage, 15%, of a smaller definition of discretionary income, the excess of income over 150% of the poverty line. Income-contingent repayment also capped monthly payments at the 12-year extended repayment plan monthly payment multiplied by an income percentage factor of 50% or more based on income and marital status. However, few borrowers would trigger the income percentage factor caps.)

The maximum repayment period is 25 years. After 25 years, any remaining debt will be discharged (forgiven). Under current law, the amount of debt discharged is treated as taxable income, so you will have to pay income taxes 25 years from now on the amount discharged that year. But the savings can be significant for students who wish to pursue careers in public service. And because you will be paying the tax so long from now, the net present value of the tax you will have to pay is small.

A new public service loan forgiveness program will discharge the remaining debt after 10 years of full-time employment in public service. The borrower must have made 120 payments as part of the Direct Loan program in order to obtain this benefit. Only payments made on or after October 1, 2007 count toward the required 120 monthly payments. (Borrowers may consolidate into Direct Lending in order to qualify for this loan forgiveness program starting July 1, 2008.)

In addition to discharging the remaining balance at the end of 25 years (10 years for public service), the IBR program also includes a limited interest subsidy benefit. If your payments don't cover the interest that accrues, the government pays or waives the unpaid interest (the difference between your monthly payment and the interest that accrued) on subsidized Stafford loans for the first three years of income-based repayment.

The IBR program is best for students who will be pursuing public service careers and borrowers with high debt and low income. Having a large household size also helps. Borrowers who have only a temporary income shortfall may be better off seeking an economic hardship deferment.

Students who are not pursuing careers in public service may be intimidated by the through of a 25-year repayment term. However, it is worth careful consideration, especially by students who might be considering using an extended or graduated repayment plan. IBR will likely provide the lowest monthly payment for many low income borrowers and certainly is a reasonable alternative to defaulting on the loans.

Calculating the cost of a loan in the IBR program can be somewhat complex, in part due to the need to make assumptions about future income and inflation increases. FinAid provides a powerful Income-Based Repayment Calculator that lets you compare the IBR program with standard and extended repayment. You can compare the costs under a variety of scenarios, including the possibility of starting off with a lower income and later switching to job with a higher salary.

FinAid's IBR calculator also computes the net present value of the total payments, telling you how much they would cost in constant dollars. The idea is that a dollar ten years from now will have less buying power than a dollar today, due to inflation. Net present value tells you how much that dollar would be worth today, under certain assumptions. Comparing different loans using constant dollars can provide a more realistic analysis of the difference in real cost.

When comparing the IBR program with the standard and extended repayment programs, it is important to recognize that the loan term has a significant impact on loan cost. Although net present value figures allow you to compare costs on a constant dollar basis, comparing the cost of a 10 year loan with a 25 year loan is like comparing apples and oranges. A 10 year loan will likely have a lower overall cost than a 25 year loan, primarily because of the shorter loan term. For example, consider a student with a $72,000 loan and an AGI of $40,000. Under the IBR program, the net present value is $77,940.78. Under the standard repayment program, the net present value is $76,074.74. So the standard repayment program is slightly less expensive than the IBR program. However, it would be a mistake to conclude from this that the extended repayment program with a 25 year loan term is better than the IBR program, because the relative costs change as the loan term increases. The 25-year extended repayment program turns out to have a net present value of $80,743.06, more expensive than the IBR program.

The marriage penalty inherent in the IBR formula was corrected by Congress (P.L. 110-153, December 21, 2007) by allowing a married borrower who files income tax returns as "married filing separately" to count only the borrower's adjusted gross income and student loan debt. This lets a borrower exclude the (higher) income of his/her spouse when calculating the cap on monthly payments under income-based repayment instead of combining the income as under the original legislation.

An important feature of the government's IBR program is that although you must initially sign up for 25-year income-contingent repayment, you are not locked into this payment plan. If your circumstances change or if you just decide that you want to pay off your loan more rapidly, you may do so. (Borrowers who switch into Direct Lending in order to obtain public service loan forgiveness are limited to the IBR, ICR and standard repayment plans.)

Additional Information

Prof. Phil Schrag, a law professor at Georgetown University Law Center has written a 21-page law review article concerning income-based repayment and public service loan forgiveness: Schrag, Philip G., Federal Student Loan Repayment Assistance for Public Interest Lawyers and Other Employees of Governments and Nonprofit Organizations, Hofstra Law Review 36(1), September 2007. The article includes practical advice concerning the two programs, as well as detailed examples. The article can be found at the Social Science Research Network, the NELLCO Legal Scholarship Repository and on the Georgetown University Law Center web site.