In this article from Yahoo! Finance, Laura is asking about her student loan debt and whether or not IBR is the best way for her to pay off her debt.
For those of you who are not aware, Income-Based Repayment (IBR) is a federal program for paying off federal student loans. Payments are capped based on income and family size, however the repayment period is extended. Along with reduced monthly payments, borrowers are granted forgiveness on any remaining balance after the repayment period has been satisfied. I have created A LOT of content of income-driven repayment plans (IBR is just one of a few of these). These programs are constantly changing, but the general idea remains the same.
There are many issues with income-driven repayment plans, which is rather unfortunate as these were designed to “help” young adults who are shackled with student loans. Among the drawbacks are…
- The repayment period is extended
- Even though monthly payments are reduced, borrowers often end up paying more in the long-run
- Student loan forgiveness after the repayment period is a taxable event
- Negative amortization can cause the debt amount to balloon, generating a much larger taxable event
- There is a disincentive to earn more money
I have written a lot on these repayment plans, and I have a lot of “beefs” with them. My biggest beef is that there is a disincentive to earn more money. As the borrower earns more money, the payment under the income-driven repayment plan gets larger. If it gets too large, they no longer qualify for income-driven repayment, revert back to the standard 10 year plan, and lose the protections under income-driven repayment, including but not limited to forgiveness.
In the Yahoo! Finance article, Laura gets a new job with a larger income. How dare her, right? And now that she has a larger income, her payment under IBR is larger.
Laura is absolutely right to ask whether or not IBR is the best option for her now. Without knowing more about her situation, it is not really possible to make a mathematical assessment. However, I can still say with complete confidence that IBR is not the best option for her. There are far too many drawbacks.
I have said before, and I will say again, that income-driven repayment plans may be a good short-term plan. When the borrower has a lower income and cannot possibly meet the payment on the standard 10 year repayment plan, going to an income-driven plan for the short-term can be a good idea. However, it needs to be part of a larger financial plan.
The overall financial plan needs to include increasing income, in spite of the disincentives to do so. The overall financial plan needs to include a balanced budget that prioritizes debt repayment over things like vacations and extravagant dinners.
Am I saying that the borrower should not have any fun with their money while paying off debt? Absolutely not! I am a huge advocate of enjoying your money, even while paying off debt. After all, fun is a good motivational tool.
Am I saying that the borrower should not save or invest while paying off debt? Of course not. I have been very consistent in saying that people should try to save and invest even a little bit of money while paying off debt. Investing for the future is all about establishing good habits.
What I am saying is that the borrower’s budget should put an extra emphasis on debt repayment.
What I want readers to get out of this post is this…
Income-driven repayment plans should not be seen as long-term solutions. There are many issues with them, and let’s face the 10,000 lb elephant in the room – your financial plans should NOT revolve around the government. All it takes is one well-hidden clause in one bill to pull the plug on income-driven repayment plans and the forgiveness that comes with them.
Do not put your faith in a government problem. Put your faith in yourself. Get out of that program as soon as you possibly can. Mathematically and psychologically, it will benefit you.