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It should be noted that the government has suspended all repayment on federally held student loans until the end of 2022, during which time no interest will be charged and no loans will be considered past due or in default.
Income-driven repayment plans can reduce your student loan payments, as you probably know, but you may not be aware that some of them also include an interest subsidy.
A benefit that the government offers by paying off some or all of your student loan interest is known as an interest subsidy.
The government may pay a portion of the interest that accrues if your loans are on an income-driven repayment schedule. However, the availability of this student loan interest subsidy does not last the entire repayment period.
What the student loan interest subsidy is
Your monthly payment under an IDR plan might not be sufficient to pay off the accumulated interest depending on your income. This is called “negative amortization. ”.
In this situation, the government may pay some or all of your interest for a set amount of time.
Role of IDR plans
A 10-year standard repayment plan for federal student loans may be unaffordable for you; however, an income-driven repayment strategy might be an option. Your monthly payment for IDR is determined by the government based on your discretionary income and the size of your family. Depending on the loan you have, you have a 20- or 25-year repayment period. If you are eligible, it may lead to a noticeably lower monthly payment.
However, under an IDR plan, interest continues to accrue. Additionally, since the loan’s repayment period is longer, interest accrues over time and could cost you thousands more overall. Furthermore, because these plans forgive debt at the end of the term, if you still owe money, you might have to pay taxes on the amount that was forgiven.
Which loans are eligible?
The interest subsidy and income-driven repayment plans are only available for certain types of student loans.
The following loan types are eligible:
If you combine your direct PLUS loans for parents into a direct consolidation loan, you’ll be able to use the income-contingent repayment plan.
For information on federal Stafford loans from the Federal Family Education Loans (FFEL) program, as well as FFEL PLUS loans, FFEL consolidation loans, and federal Perkins loans, contact Federal Student Aid.
If you have private student loans, you are not eligible for the interest subsidy.
Which IDR plans get the student loan interest subsidy
Three of the four IDR plans’ participants are qualified for a student loan interest subsidy:
How much interest the government covers varies by plan.
The government will cover all of the interest on your subsidized loans, including the subsidized portion of a direct consolidation loan, for up to three years in a row if your monthly payment is insufficient to cover it. Afterward, it will pay for half the interest for the remainder of your term.
For instance, if your payment only covers $25 each month and your interest charges total $40 per month, the government will cover the $15 difference for the first three years. After that, it will pay $7. 50 (half).
If you have loans that aren’t subsidized, the government will cover half of the interest that accrues after your loan term.
Any borrower with eligible federal loans can qualify for REPAYE. Undergraduates receive a 20-year repayment period, while graduate students receive a 25-year repayment period. You’ll generally pay 10% of your discretionary income.
The student loan interest subsidy operates in a different manner if you have loans in a PAYE or IBR plan.
When the interest on your subsidized loans is not covered by your monthly payment, the government will cover the balance for up to three years in a row. After those three years, you’ll be responsible for paying any interest that accumulates.
The government will not pay any of the interest on unsubsidized loans. Your interest will capitalize if you withdraw from either plan or are no longer eligible to receive income-based payments.
You get a 20-year repayment term under the PAYE plan. Depending on when you took out your loans, the IBR term ranges from 20 to 25 years. You typically pay 10% of your discretionary income into either plan, though if your loans were disbursed before July 2014, you could pay 15% into an IBR plan. However, you’ll never pay more than what you would under a regular repayment plan with either PAYE or IBR.
Your loans are not qualified for the student loan interest subsidy if you are a borrower on an income-contingent repayment schedule.
With ICR, your repayment plan term is 25 years. You will make payments equal to no more than 20% of your discretionary income or what you would pay over 12 years under a fixed repayment schedule (adjusted for income).
How to apply for an IDR plan
To obtain an IDR plan, just like with most other financial assistance programs, you must apply.
Borrowers can apply through Federal Student Aid for free. Private companies can help, but they may charge a fee.
After your initial application, your work isn’t done. Every year, participants must recertify and provide updated information on their family and income. If you don’t, you risk losing your benefits and having to pay back the full amount of your debt according to the 10-year repayment plan, which could end up costing you a lot of money.
Set a calendar or phone reminder to let you know when it’s time to recertify.
Why understanding your IDR plan terms is important
It can be challenging and overwhelming to manage your student loans, particularly if you’re on an IDR plan. Paying off your debt requires understanding the terms of your loan and repayment strategy, including how the interest subsidy operates. A mistake could cause you to pay more than you should or prolong the repayment period for your debt.
The student loan interest subsidy can help those who are having trouble making their repayments. Borrowers can save money and free up some much-needed cash flow when the government contributes to interest costs.
Consider all of your repayment options before deciding on an IDR plan, then pick the one that best suits your financial situation.
Rebecca Safier and Alli Romano contributed to this report.
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FAQ
Are Subsidised or unsubsidized loans better?
Direct Subsidized Loans have slightly better terms to assist students in need, which is the main distinction between them and Direct Unsubsidized Loans.
What is an interest subsidy?
Grantees may offer a discount on the interest rate to make the payments more manageable. For instance, a bank might offer a couple a home loan with an interest rate of 5%. The grantee may provide subsidies to reduce the interest rate from 5% to 3%, lowering the monthly mortgage payment.
Do subsidized and unsubsidized loans have interest?
Direct loans, both subsidized and unsubsidized, can help with college costs. Just keep in mind that all loans must be paid back eventually, plus interest.
What are subsidized loans called?
Subsidized vs. Loans that cannot be subsidized include those made through Direct Stafford Loans or FFELP. When a student takes out a “subsidized” FFELP or Direct Stafford Loan, the federal government pays the lender the interest that accrues while they are enrolled at least half-time in school, as well as during grace and deferment periods.