Discretionary Income and Student Loans: What Does It Mean?

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Have you ever heard of “discretionary income” but felt unsure about exactly what it means? You’re not alone. Many people are aware of what they spend, but not the financial lingo behind it.

Discretionary income refers to the remaining funds you have after you pay for necessities, like rent, food, and car insurance. Some people spend their discretionary income on entertainment or a new pair of shoes. Others spend it on building an emergency fund or paying off debt. For many, it’s hard to balance regular expenses and pay off student loans.

Luckily, based on your discretionary income, you may be eligible for reduced student loan payments. By understanding discretionary income, you can better manage your budget and still enjoy what life has to offer.

What is Discretionary Income?

Discretionary income is the money remaining after paying for living expenses such as rent and food. Put a different way, it’s the leftover funds after you’ve paid your necessary bills.

What you spend each month after your necessities is your discretionary spending. Some people put these funds toward a vacation, a night out with friends, or a gym membership. Your discretionary spending is different than buying on credit. When you buy things on credit, the funds might not be available. For example, you might buy a new couch, even if you don’t have the full amount right away. Discretionary income refers to the amount of money you have available for extra purchases and expenses. 

How Do You Calculate Your Discretionary Income?

As a general rule, you can calculate your discretionary income by subtracting your living expenses from your after-tax income. 

Let’s look at an example with a monthly take-home pay of $3,000 after taxes. If rent and utilities are $950, groceries cost $300, your car expenses total $200 and you pay $100 for health care, your living expenses equal $1,550. Subtract these necessary expenses from $3,000, and your discretionary income is $1,450.

How Should You Spend Your Discretionary Income?

How you budget is a decision for you and your family. In general, financial experts recommend the 50/30/20 rule. This means you should spend 50% of your take-home income on living expenses, 30% on personal expenses like entertainment and dining out, and 20% on long-term goals like paying off debt or saving for a down payment. In this model, that means 50% of your income is discretionary, and that 2/5ths of it should be put toward the future or paying off debt. 

Putting approximately 40% of your discretionary income toward paying off debts and savings is a good goal to aim for. For example, if your discretionary income is $1,000, consider putting $400 toward your student loans and some investments. If you’re unable to do that now, take small steps until you’re able to.

Discretionary Income and Student Loans

Determining your discretionary income looks a little different when it comes to your student loans. The government or your loan provider may calculate discretionary income for repayment plan purposes. In these cases, your discretionary income is the difference between your annual income and 150% of the poverty line. Each state defines poverty guidelines differently. The guidelines are also based on family size. 

Here’s an example of Rita, who lives in Texas with her two children. She makes $40,000 a year. If the poverty line for a household of three is $30,000, she would multiply that by 1.5 (or 150%), equaling $45,000. With her income of $40,000, her discretionary income is $5,000.

When looking at the poverty line, remember that your annual income includes more than your base salary. You should include tips, commissions, side hustles, freelancing, social security, and retirement income. In other words, it’s the total amount of money you make in a year—no matter the source.

What is Income-Driven Repayment?

Income-driven repayment (IDR) plans adjust your student loan repayments based on income, family size and state. For example, if your state’s cost of living is high and you have a moderate income, you might be eligible for a reduced monthly payment.

There are several types of IDRs. The main options include Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Contingent Repayment (ICR), and Income-Based Repayment (IBR). Each type uses a different formula to determine how much you’ll pay. Based on your income and situation, like if you pay child support or attend school part-time, a certain plan might offer a lower repayment option. You can apply for an IDR to make your loan repayments and other expenses more manageable.

On the application, IDR plans help you calculate your discretionary income, so you have an accurate number. From there, you can make the decision on whether you want to sign up for their repayment schedule. 

Your loan provider won’t have you spend all your discretionary income on your loans, just a part of it. While having lower monthly payments might seem ideal, it can also mean that you’re paying on your loans for longer. For example, instead of paying off your student debt in 10 years, you may have to make payments for 15 years due to the smaller monthly payments. The longer payment schedule results in paying more interest—and more for your loan overall. That’s why it’s important to review the terms of the IDR before signing up.

What is Disposable Income?

Discretionary income and disposable income are often confused but mean different things. 

Disposable income is the amount you take home after taxes. Disposable income is the total amount you have available to pay for living expenses, personal expenses, debt repayment, and savings. Discretionary income, on the other hand, is the amount of money left after you’ve paid for living expenses.

Let’s look at an example. Malorie’s salary pays $3,500 a month, but $500 of taxes gets taken out. The remaining $3,000 is her disposable income. This disposable income is available to cover her living expenses, personal expenses and savings. If her living expenses cost $2,000—such as for rent, groceries and health care—her discretionary income is $1,000. In other words, she has $1,000 of her $3,000 to truly decide where it goes.

Repaying your student loans can be difficult, especially as you balance your other expenses. An income-driven repayment plan based on your discretionary income might give you the relief you need. It might help you make payments on-time while still maintaining the lifestyle you want. Overall, a budget can help you pay off debt and offer a guide for achieving your financial goals.

 

Sources  

Federal Student Aid | Great Lakes Educational Loan Services | Intuit Turbo | Investopedia | Saving for College | Student Loan Hero | Student Loan Planner 

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