When it comes to taking out student loans for college, a common rule of thumb is not to borrow more than your starting salary will be after graduation. Of course, many students are not aware of this, and even for those that stay within this guideline, paying off student loans can be quite a headache. While experts often consider student loans to be good debt, owing money is stressful for many borrowers. An amount that seems reasonable to an 18 year-old college freshman doesn’t seem quite so reasonable when that person is 25, or 35, and still making a monthly payment.
With the total student loan debt recently surpassing one trillion dollars, there has been a lot of buzz around the subject lately. President Obama’s “Pay As You Earn” updates to the Income Based Repayment (IBR) plans have shed light on the fact that few federal student loan borrowers understand the option and whether it’s right for their situation. If you’re struggling to strike a balance between your living expenses, future goals and debt payments, IBR may be just the solution you’ve been looking for.
Understanding the Income Based Repayment Plan
For those that have heavy student loan debt relative to the amount of money they earn each year, Income Based Repayment eases the monthly payments. IBR ties the amount you owe each month for your federal student loans to your income, rather than your total amount of debt. Not all borrowers will qualify, but there are calculatorsto help you determine if you do.
Most people pay off student loans over a 10-year period, but IBR extends that period to 25 years. After 25 years of on-time payments, the remaining balance of your loan is forgiven. If you work at a non-profit, your balance could be forgiven after only 10 years through a program called Public Service Loan Forgiveness.
Weighing the Pros and Cons
The best thing about IBR is that it will make your monthly payments more affordable today. For some people, that’s an absolute necessity. But, there is a catch. Since IBR lowers your monthly payments by extending the amount of time you’ll be repaying your loan, you’ll ultimately pay more in interest over time. So, the trade off for lowering your payments now is that you make your loan more expensive in the long run.
That said, if you’re buying groceries with your credit card because you don’t have any money leftover after your loan payments each month, IBR is a good option. If you’re making do for now (even if that means that you’re still living like a poor college student), then sticking to the standard repayment plan is the best choice.
IBR Is Intended to Help, Not Hurt
A basic financial foundation includes paying off debt, establishing an emergency fund and saving for retirement. If paying off student loans is preventing you from tackling credit card debt or saving for the future, then IBR can help you start working toward reaching those goals sooner rather than later. For example, if your monthly student loan payment is $800, but IBR will lower it to $500, you can use that extra $300 for credit card payments or contribute it to a retirement account. IBR should not be used to increase your shopping budget, help you afford a new iPad or a tropical vacation (sorry).
Keep in mind; you can always switch between payment plans. Needing to use IBR today doesn’t mean you’ll have to use it forever. It may help get your credit card debt under control, or allow you to live within your means until you can find a better paying job. IBR is simply an option, and it’s designed to help—not hurt. Consider it another tool in your financial toolbox.