November 24, 2020

Discretionary Income: How It Could Impact Student Loan Payments – Forbes

Discretionary Income: How It Could Impact Student Loan Payments - Forbes

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Your discretionary income is how much money you have left after paying for necessities like rent, food and basic clothing. It’s what you use when you meet friends for dinner, upgrade to the latest smartphone or buy a new video game.

If you have student loan debt, you might not have a lot of discretionary income. If you have federal loans and can’t afford your current payments, enrolling in an income-driven repayment plan (IDR) can give you some relief and more breathing room in your budget. With an IDR plan, your loan servicer uses your discretionary income to calculate your monthly payments. Here’s how it works.

What Is Discretionary Income?

When it comes to student loans, discretionary income is treated a bit differently than the standard definition. Instead of looking just at your personal income and expenses, the federal government and your loan servicer will compare your income to the federal poverty guideline for your location and family size.

As of 2020, the following poverty guidelines apply to residents of the 48 contiguous states and the District of Columbia.

Student Loan Payment Plans that Rely on Discretionary Income

If you’re on a 10-year standard repayment plan, you don’t have to worry about your discretionary income affecting your student loan payments; your payment is fixed, and it’s determined by your interest rate and repayment term. Any changes in your income won’t affect your monthly payments.

However, IDR plans are available to federal loan borrowers who are struggling to keep up with their payments. IDR plans determine your monthly payments based on your discretionary income. Depending on your income and family size, you could dramatically reduce your monthly payments by enrolling in an IDR plan.

How your discretionary income is determined varies by IDR plan:

  • Income-based repayment (IBR). Your discretionary income is the difference between your annual income and 150% of the federal poverty guideline. If you took out loans after July 1, 2014, your payment is 10% of your discretionary income, but it will never exceed your monthly payment under a 10-year standard repayment plan.
  • Income-contingent repayment (ICR). Discretionary income for ICR is the difference between your annual income and 100% of the federal poverty guideline for your state and family size. Your payment will be 20% of your discretionary income or a fixed payment with a 12-year term, whichever is less.
  • Pay As You Earn (PAYE): With PAYE, your discretionary income is the difference between your annual income and 150% of the federal poverty guideline for your state and family size. Your monthly payment is 10% of your discretionary income, but it will never exceed your payments under a 10-year standard repayment plan.
  • Revised Pay As You Earn (REPAYE): Your federal loan servicer calculates your discretionary income by looking at the difference between your annual income and 150% of the federal poverty guideline. Under REPAYE, your payment is 10% of your discretionary income.

How to Calculate Discretionary Income

To calculate your discretionary income, compare your annual income to the federal poverty guideline for your state and corresponding family size. Your discretionary income is determined by subtracting a percentage of the federal poverty guideline from your annual income. The percentage is dependent on which IDR plan you choose.

Payment Examples

To show you how your discretionary income affects your payments, consider the following examples. For each, we used a federal student loan balance of $30,000 at 4.53% interest. The borrower earns $35,000 per year, is married, has one child and lives within the contiguous 48 states.

Standard Repayment Plan

Under a 10-year standard repayment plan, the borrower’s monthly payment would be $311 per month, which you can determine using a student loan calculator. Discretionary income does not play a role in determining the monthly payment.

IBR, PAYE, and REPAYE

With IBR, PAYE and REPAYE, the loan servicer calculates the borrower’s monthly payment by subtracting 150% of the federal poverty guideline from their income. Since the borrower has a household size of three people, their guideline is $21,720, and 150% of the guideline is $32,580.

Their discretionary income is the annual income—$35,000—minus $32,580, leaving them with $2,420. To calculate the monthly payment, the loan servicer uses 10% of the discretionary income, and that number is divided by 12.

Under these three repayment plans, the borrower would pay $20.17 per month.

ICR

For ICR, the loan servicer uses 100% of the poverty guideline—$21,720. By subtracting the poverty guideline from their annual income, the borrower finds that their discretionary income is $13,280. Under ICR, their annual payment is 20% of their discretionary income, or $2,656. To find their monthly payment, they divide that number by 12. By enrolling in ICR, the borrower’s monthly payment would drop to $221.33.

Disposable Income vs. Discretionary Income

While disposable and discretionary income are often confused, they’re very different from one another.

Your disposal income is how much money you have left after paying your federal, state and local taxes. You use your disposable income to cover your necessities, like housing and food, as well as any extras you purchase.

Your discretionary income is what you have after paying for your essential expenses. It’s what you use to pay for non-necessities, like entertainment.

What If I’m Not Eligible for an IDR Plan?

Unfortunately, not everyone will qualify for an IDR plan because of their income or loan type. If that’s the case, there are other federal repayment plans you can take advantage of that don’t rely on your discretionary income:

  • Graduated repayment. Under a graduated repayment plan, your loan term is 10 years (up to 30 years for consolidated loans) and your payments start low. Every two years, your payments increase, regardless of your income.
  • Extended repayment. With extended repayment, your repayment term is set to 25 years, and you make either fixed or graduated payments.

Use the Federal Student Aid’s Loan Simulator tool to find the best repayment plan for you.