Income-driven repayment plans can seem like a godsend for people who are saddled with big debts. This type of payment plan is most commonly available for federally-administered student loans. Recent graduates in their 20s often aren’t making enough money to pay $600 or $800 monthly on their loans. That eats into their rent and car payments. Are income-driven plans a good idea for them?
Who Are These Plans For?
The answer is complex. Income-driven repayment plans are designed to help borrowers make more manageable payments. Because of this, they can seem like a lifesaver in the short term. However, some payers are frustrated by them. How can that be? Isn’t an income-driven plan supposed to help people?
Yes, these plans are designed to make payments more manageable. However, people can quickly end up underwater when using the income-driven repayment option. That’s because minimum payments under these plans often don’t even cover the interest that is continuing to accrue. This is called negative amortization. For some people, then, income-driven repayment plans become a trap.
When Is Negative Amortization Okay?
Negative amortization can be extremely frustrating. People continue to make payments representing a substantial chunk of their income. Yet, instead of decreasing, the total of their debt goes up. However, it’s important to take the long view. Depending on the borrower, negative amortization may not be a bad idea.
For example, doctors make little money as residents. They know that in four or five years, they will be making several times more. For them, it’s a matter of just sitting tight and getting through the lean years. For others, it may not be such a great deal. It’s important to make extra payments where possible. Even getting a second job can be an appropriate idea.
Apart from that, refinancing through a private lender can actually be a good idea, for people who are underwater on their student loans. Looking at loan forgiveness plans can also be a viable option.