Student Loans: How Income-Based Repayment Will Make You Poorer

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Income-Based Repayment, or IBR, is intended to help struggling federal student loan borrowers The federal government introduced Income-Based Repayment, or IBR, last year to provide relief to federal student loan borrowers who are struggling to manage their loan payments.

IBR provides a formula that caps monthly payments at 15% of discretionary income. Borrowers who make all their income-based payments for 25 years have the balance of their federal student loan debt forgiven at the end of that period. To find out how that would work for you, use this calculator.

Education lender Sallie Mae recently noted in a press release that "Since IBR was introduced last July, approximately 23,000 Sallie Mae customers have enrolled in the plan. Under IBR, in addition to paying a lower amount each month, eligible customers can extend their payment term from the standard 10-year term up to 25 years."

How to Dramatically Increase the Cost of Student Loans

The problem for borrowers is that extending your repayment term will dramatically increase the amount of interest you'll pay over the life of the loan -- and, if you take the full 25 years to repay your debt, you'll be around 46 by the time you're debt-free. That's a very, very hard way to establish a solid financial life. Let's look at how this works with real numbers using this handy calculator from
  • Student A borrows $30,000 with a Federal Stafford Loan at 6.8% and opts for the standard 10-year repayment plan. He'll make 120 payments of $345.24 before he is debt-free, having paid back a total of $41,428.97; $11,428.97 of that amount will consist of interest.
  • Student B borrows $30,000 with a Federal Stafford Loan at 6.8% and stretches his repayment out over 25 years. His monthly payment will be $208.22 and he'll make that payment for 301 months. He'll pay back a total of $62,467.29, of which $32,467.29 will be interest.
(I'm assuming, for simplicity, that after 25 years, you will have paid off your loan in full, which will likely be the result for most borrowers; I'm also making the payments the same each year because there's no way to actually incorporate changing payments from changing incomes into this equation.)

Now That's Just Dumb

Here's the problem with this scenario: In order to reduce your monthly payments by 40%, you'll have to increase the number of payments you make by 150%. That's dumb!

The single most powerful thing you can do to improve your financial life is to get out of debt. The sooner you do that, the better -- and healthier! -- you'll be.

IBR is a valuable tool if you literally can't afford to make your payments and put food on the table. But if there's any way that you can possibly scrimp together the cash to make your loan payments, it'll be a lot better for your total cost and financial health. My concern is that too many borrowers are opting for IBR as a way to lower the monthly student loan expenses even when they could find a way to make the full payments. If you can afford to eat out or go see movies, you should skip IBR and opt for a standard repayment plan.
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