Question

Sarah looks at these results and realizes her monthly payment would be lower with most of the income-based repayment plans. But then, she looks at the Total Amount Paid and realizes that the loan price increases when she chooses these plans. How is this possible -- that her monthly payment is lower but her total payments are higher?

Answer 1

Answer: Interest accrues given more time

Explanation:

Income-based repayment plans are usually for those who don't make a lot of money and so would like to pay smaller instalments towards debt repayments. These plans will cap the monthly instalments to between 10% - 20% of her income.

The problem with these however is that with lower monthly/periodic payments, the debt will take longer to be paid off. This will give interest more time to accrue on the debt and will ultimately result in her paying more than she would have if she doesn't use income-based repayment plans.