The Hidden Costs and Complexity of Income Driven Repayment Plans

Written by Geoff Kreller, CRCM, CERP

Income-Driven Repayment (IDR) plans have existed as an education loan option for over three decades.  Historically though, few borrowers used IDR, including some who might have benefitted from reduced payments and eventual forgiveness[1]. Unlike most loans, IDR underwriting does not consider the borrower’s ability to repay the loan from a debt-to-income (DTI) perspective. Instead, payments are calculated based on the student’s prior year annual income, which protects students from financial downturns and partly insures borrowers against a poor return on investment from their educational program.

Especially in light of the difficulty recent graduates are having in finding jobs[2][3], the desire to provide flexible payment and forgiveness options to lower-paying salaried fields such as teaching and social work, and to accommodate fields where higher salaries are likely but not immediate (such as practicing medicine or law), IDR loans can be an advantageous option to these students as long as the loan details and costs are clearly understood.

The Education Department recently finalized guidance for a new income-driven repayment plan –Income-Based Repayment (IBR) – which is set to become the most widely available IDR for federal student loan borrowers[4]. In July 2026, the Education Department will also introduce a new income-driven repayment option, the Repayment Assistance Plan (RAP). These changes come in conjunction with new caps on federal education loans starting July 1, 2026[5], meaning that private loans will play a bigger part in this area of finance.

While private lenders could offer IDR plans, the complexity in marketing, disclosing, and servicing such a loan has deterred most from doing so. The calculations related to payment inflows, delinquency, potential principal forgiveness, and charge-off rates make loss curve projections far more complicated to accurately forecast. By crafting a program that clearly understands and articulates these points, a private lender could potentially unlock a beneficial loan program or modification strategy for their portfolio.

1.       The IDR’s program purpose and scope must be clearly defined.

Because a student always has the “ability to pay” an IDR loan based on its payment calculation, it can lead students to make costly financial decisions where the lender’s role could be interpreted as abusive behavior by a state or federal regulator if the program does not have a defined purpose, scope, and set limitations. Absent robust controls, significant concerns regarding predatory and targeted marketing may arise, and loan officers may steer students who qualify for lower cost options toward IDR if the purpose and scope of this program are not appropriately defined.

Let’s consider a student whose dream it is to study Classical Civilization at Fordham University[6] where 4-year tuition totals $264,000[7]. Fordham accepts the student and gives them a substantial $25,000 scholarship per year, which is on top of the student’s savings (or family gifts) of $50,000. However, the student has difficulty finding a loan to fund the remaining $114,000 (notwithstanding the cost of room, board, and other expenses).

The lender’s model suggests that the predicted salary out of their undergraduate program is $31,000 and within five years, likely increases to $47,000[8]. The lender can’t approve the$114,000 loan application on conventional terms (fixed rate, 10 year repayment) because the resulting amortized payment at 9.99% ($1,500/month) creates a DTI concern based on the predicted salary.

However, the bank could approve the loan under an IDP program since the payments are based on available discretionary income and set over a longer period of time (typically up to 30 years). The interest rate might be higher than a conventional loan (due to the increased risk of default/forgiveness), and the borrower would be required to pay taxes on any forgiven principal balance after the loan’s maturity date, making this an expensive option to consider in pursuit of a Classical Civilization Fordham degree. 

Based on the information available, the applicant might opt to select a different major or a different undergraduate program and take a master’s program in Classical Civilization to pursue their dream in a more economically-feasible way.

There should be program boundaries, including reasonable assumptions and projections about the likelihood of default (and the resultant interest rate), salary, the discretionary income percentage used to calculate payments, and ensuring that the overall sum of projected payments resolves the outstanding principal balance by the maturity date. If the projected payments won’t cover the outstanding balance by that time, it may be prudent to decline the loan on that basis, even if the calculated interest income far exceeds the projected forgiveness at the end of the term.

IDR introduces the possibility of steering customers into sub-optimal, higher-cost loans (or higher cost school programs). Education majors present a potentially vulnerable class of students because they could be approved for conventional loans based on their predicted salary (and/or the possibility of tax-free loan forgiveness after a certain amount of teaching years within a particular US state) depending on the cost of the university program they select.

ZipRecruiter estimates that teachers make about $46,000 on average[9], and Edweek recently noted that master’s graduates of education programs have $72,000 in student debt[10]. Based on that amount, a conventional loan at 9.99% creates a monthly payment obligation of $951 and a total of $42,130 in interest paid over the 10-year term (which equals a 24.81% DTI and might be declined by a private lender). An IDR loan, while having a lower and more flexible payment per month, would be significantly higher in cost over the longer repayment period (and potentially higher interest rate).

While an IDR loan could probably be designed to approve a prospective education major going to Yale for their undergraduate program, the student should be able to see the true cost of that choice in the form of loan disclosures, calculators, and other examples.

2.       Borrowers need clarity on how their monthly payment is actually calculated.

Using the Department of Education’s IDR plans and the section above as examples[11], a lender must define the following variables to calculate a borrower’s monthly payment after graduation:

• The payment amount while the student is still in school (fully deferred, payment option, interest only)

• Whether the unpaid interest at the time of graduation capitalizes into the loan balance

• The repayment period (federal IDR loan programs cover 15-30 years)

• The income on which payments will be based (federal loan programs consider discretionary income, which is the difference between the borrower’s annual income and 150% of the poverty guideline[12], adjusted for family size and the borrower’s state of residence)

• The percentage (i.e., 15%) of that discretionary income that will constitute the set of annual payments owed

• How often the discretionary income will be reconsidered (for federal loans that occurs annually, unless a significant change such as job loss occurs)

• The borrower’s filing status (filing jointly may increase the payment amount owed if their significant other also has a job)

In addition, lenders need to develop assumptions to create a projected APR for the purpose of providing disclosures:

• Estimated time between graduation and securing a job (whether payments be set to $0)

• Predicted entry salary (likely using major, degree, and school as model variables)

• Predicted salary trajectory (projected increase per year)

Under IDR plans, it’s possible for a monthly payment to equal $0, which still counts as a “payment” toward the plan’s maturity date. While IDR plans allow for more flexible payments, they can easily lead to longer repayment periods and more interest paid over the loan’s term when compared to traditional 10-year educational loans.

Because of the infinite outcomes that could result, it’s advisable to provide the prospective borrower several examples (or a calculator capable of providing various scenarios upon graduation) for comparison purposes:

• Where the borrower does not pay off the amount within the loan term (and forgiveness occurs)

• Where the borrower pays off the amount at the loan term

• Where the borrower pays off the amount before the loan term expires

For each example, the calculator should be able to provide (1) the total amount of payments, (2) the amount of interest paid, (3) the amount of interest accrued, and (4) the amount of principal forgiven and/or interest waived at the end of the term.

Lenders and servicers should be clear on when the borrower needs to re-certify their income and family size (noting that family, orientation, and marital status are all sensitive data that should be used for no other purpose outside of this calculation), along with the penalties for not filing their updates timely. For some federal loans, missing the recertification timeline leads to the IDR loan being placed in a standard repayment plan and having the unpaid interest capitalized into the loan balance (“Interest Capitalization”).

3.       Borrowers need to understand why the overall amount owed might increase.

Because payments are not based on an amortization schedule designed to bring the loan balance to zero at the end of the loan term, monthly payments may not cover the interest accrued on the loan even if they are made timely. This effect – called negative amortization - will cause the outstanding principal balance to be unaffected, and for the total amount due and payable to increase over time.

It’s important for lenders to clearly articulate why this is happening, and to regularly provide: (1) the outstanding principal balance, (2) the total (and YTD) accrued interest, (3) the total (and YTD) interest paid, (4) the total (and YTD) unpaid accrued interest, and (5) the total projected loan forgiveness based on the current pattern of payments.

4.       Borrowers must be aware of rules regarding interest and principal forgiveness.

Much like settlements that forgive outstanding principal in part or in full on an education loan, student loan forgiveness under IDR loans will resume counting as taxable income starting January 1, 2026[13]. The amount of outstanding principal forgiven at the end of the loan term will appear as income in a 1099-C statement and be disclosed to the IRS by the end of that tax year. Students should be aware that there is a penalty for failing to pay off the loan by the maturity date, and forgiveness should not be construed as a “gift” or “free money.”

Under some IDR programs, the federal government pays all or part of the accrued but unpaid interest[14]. When outstanding unpaid accrued interest is waived, it is not considered income or incorporated into a 1099-C statement. However, if unpaid interest is capitalized prior to the end of the IDR loan term, it would impact the borrower’s 1099-C statement significantly.

For this reason, it is critical that lenders be upfront about the times and triggers for interest capitalization events if and when they occur during the loan lifecycle (or when they might occur as a result of a proposed refinance).

5.       Life events trigger unexpected payment changes.

Based on the way payments are calculated on most IDRs, significant life events impact an IDR payment stream. Marriage, divorce, having a child, getting a bonus, being laid off, and having an unexpected windfall are just a few cases where borrowers will either face a higher payment than expected or may be in need of a mid-year adjustment based on changed circumstances. Many of these examples involve sensitive family data that should be used for no purpose beyond calculating the borrower’s payment obligation (and kept at a high level of confidentiality).

Your customer service and servicing areas should have clear procedures on the documents required to make mid-year adjustments to payments due to adverse circumstances, proactive communications to address calculated payment spikes, and consideration that may be given when an increased payment is the result of a one-time bonus or windfall.

6.       Accounting, Finance, and Servicing must be programmatically aligned.

Because payments are amortized evenly across the repayment term for traditional education loans, it’s fairly simple to forecast interest revenue and loan principal repayment on traditional education loans and portfolios. IDR loans present an accounting challenge because the borrower may be current and on a payment trajectory that continues to pay interest (booked to interest income), but is clearly not going to pay the full principal by the maturity date (meaning a loan loss provision needs to be booked on a loan that shows current to cover the pending forgiveness).

Delinquencies and defaults still occur on IDR loans – what happens when the borrower fails to make payments should be clear within the loan agreement and to your accounting, financing, and servicing teams. If upon delinquency, the interest is capitalized and/or the IDR loan reverts to a standard amortization loan over the remaining course of the loan term, there should be processes to effectively execute and communicate those changes. The loan’s default may also negate the forgiveness event at the maturity date; however, the loan loss provision may need to be maintained or increased based on the expected loss to the financial institution.

Portfolio models and data need to be consistently up-to-date and tested to ensure monthly financing reports are accurate in respect to actual and forecasted:

• Interest income

• Principal loan balances (reductions, new originations, increases due to interest capitalization)

• Delinquency and default ratios

• Losses and forgiveness

• Required allowance for loan and lease losses (ALLL) on the IDR portfolio

Summary

Income driven repayment plans can be beneficial, though they come with additional financial and operational costs for both the financial institution and consumer. IDR plans are complex and require efficient communication internally and with consumers to ensure consistent execution and clear understanding. Communication should be consistent from marketing to underwriting to loan servicing, all the way through to the loan’s disposition. By effectively managing the risks associated to IDR plans, a financial institution can unlock a beneficial addition to their loan program or modification options.

Follow NAQF and Geoff Kreller on LinkedIn for additional insights. For more information on how NAQF can help your organization with credit policies, loan agreements, or educational loan training, contact us at contact@naqf.org.

Article References

[1] https://www.brookings.edu/articles/income-driven-repayment-of-student-loans-problems-and-options-for-addressing-them/

[2] https://www.cnbc.com/2025/11/23/college-graduates-are-struggling-to-find-jobs-ai-is-partly-to-blame.html

[3] https://www.npr.org/2025/07/13/nx-s1-5462807/college-graduates-jobs-employment-unemployment

[4] https://www.newsweek.com/student-loan-update-new-changes-borrowers-in-december-11149428

[5] https://www.cnbc.com/2025/07/16/trump-big-beautiful-bill-student-loan-cap.html

[6] https://www.fordham.edu/undergraduate-admission/majors-and-minors/

[7] https://www.fordham.edu/student-financial-services/tuition-and-payments/undergraduate-tuition/fordham-college-at-lincoln-center/

[8] https://www.careerexplorer.com/degrees/classical-and-ancient-studies-category/salary/

[9] https://www.ziprecruiter.com/Salaries/What-Is-the-Average-Teacher-Salary-by-State

[10] https://www.edweek.org/teaching-learning/opinion-student-loan-debt-is-an-overlooked-crisis-in-teacher-education/2024/12

[11] https://www.salliemae.com/blog/income-driven-repayment-pros-cons/

[12] https://povertylevelcalculator.com/poverty-level-calculation-tables/

[13] https://www.newsweek.com/student-loan-update-new-changes-borrowers-in-december-11149428

[14] https://www.savingforcollege.com/article/pros-and-cons-of-income-driven-repayment-plans-for-student-loans