The Income-Based Repayment plan (IBR) officially opened for business on July 1st. Signed into law as part of the College Cost Reduction and Access Act of 2007, this new repayment option doesn't replace the Income-Sensitive or Income-Contingent Repayment plans. Rather this plan provides yet another option to manage and pay back your student loans.

How Does Income-Based Repayment Work

The IBR provides a monthly payment amount that tries to be affordable for your life situation by capping your monthly payment based on income, location, and family size.

Payments under the IBR are capped at 15% of monthly discretionary income, which is defined as the difference in you income and 150% of the Federal Poverty Guidelines for your family size.

Each year, the government will recalculate your payment amount based on last year's tax returns. In certain instances, you may be required to furnish alternate documents for the calculations to take place.

Eligibility

Unlike the ICR plan, which is limited to Direct Loan borrowers, the IBR also includes Grad PLUS and Stafford loans as well as consolidation loans. Parent PLUS and consolidation loans that include Parent PLUS loans are not eligible for repayment.

Income limits are $50,000 for single borrowers and $100,000 for married borrowers.

Loans must not be in default.

Advantages of Income-Based Repayment

• Scalable Payments - Your payments are tied to your income, so as your yearly income fluctuates, your payments follow it. For most people, this means lower payments when compared to the standard ten-year repayment.
• Interest Payment - For Stafford loan borrowers, if your IBR payment amount isn't sufficient to pick up the tab Uncle Sam will pay it for you. This only lasts for the first three years of repayment and isn't available for the other loan types.
• Public Service Forgiveness - Certain public service and non-profit careers may allow you to have the balance of your loan forgiven after ten years of repayment.
• 25 Year Pay Off - 25 years is a long way down the road, but if you have made all of your payments under the IBR for that time, the government will forgive any remaining loan balance.
• Peace Of Mind - Ok, this one isn't an official advantage to the program, but knowing that you can make your monthly payment without breaking the bank can make for some sleep filled nights

Draw Backs to IBR

• Scalable Payments - Your payments are tied to your income, which can help when money is tight, but can also extend your repayment term well beyond the standard ten years.
• More Interest - Longer repayment terms lead to a larger amount of interest repaid, which leaves less money in your pocket over the long haul.

Comparisons Between IBR, ICR and Standard Plans

Standard plans require a fixed monthly payment for 120 months and the plan is paid off at the end of the ten-year term. The payment doesn't vary regardless of family size or ability to pay. This plan provides the largest monthly payment and the fastest pay-off time as well as the smallest amount of interest paid over the life of the loan.

Income-contingent plans figures your monthly payments based on the lower of two figures:

• 20% of discretionary income
• monthly payment for a 12 year loan term (adjusted by some magical formula determined at least in part by your income and family size).

They also offer no automatic interest forgivement option but do cap interest capitalization (the process of adding unpaid interest to the principal of the loan) at 10% of the principal balance when you started repaying your loan. This plan provides for a lower payment than the standard plan, with a longer pay back term.

Income-based plans use a more favorable discretionary income calculation than the ICR plan and do provide for some interest forgiveness if your new payment amount doesn't cover all of the interest owed each month. This plan provides for the smallest monthly payment of the three, but also the longest pay back period and the longer the pay back the greater the interest paid.

Now let's take a look at a hypothetical situation to compare the three repayment plans and think about an individual in the continental US with an AGI of 48,000, a spouse and two children, and a loan amount of $21,500 at a 6.3% interest rate.

Standard Repayment Plan $241.95
Income-Contingent Plan $212.70
Income-Based Plan $185.00

As you can see, the IBR provides for a payment that is $56 less than the standard plan and $27 less than the ICR.

The second hypothetical situation is a single individual who has an AGI of 43,000 and a loan of $14,000 at a rate of 6.3%.

Standard Repayment Plan $157.55
Income-Contingent Plan $130.54
Income-Based Plan $N/A

In this scenario, the borrower would not be eligible for the IBR, but would still be able to take advantage of the ICR plan.

You can perform your own calculation using the IBR and ICR/standard pament calculators to determine which one is right for you.

Is It Worth It

The IBR is worth it if you are struggling to meet your repayment obligations under the standard repayment plan. If you are meeting them with no or little problem, stick to the standard plan. You'll pay it off sooner, and at the least overall cost to yourself.

Failing that, consider the ICR plan first, as it may lower the payments enough for you to survive but it won't extend the repayment terms as long as the IBR.

Only consider an IBR plan as a last resort and be sure to change it to another plan when you can afford it in order to avoid a lengthened repayment term and corresponding higher overall loan costs.