In March, 2019 it was reported that Americans owed about $1.5 trillion in student loan debt. With these numbers, I’m going to assume you or a loved one has student loans and a repayment plan of some sort. But how confident are you that the repayment plan you’re on is the best one for you?
The number of repayment options available means you can tailor a plan that’s right for you. However, it also amplifies confusion for borrowers. This post isn’t meant to be an exhaustive list of every repayment choice, but it should give you a good idea of how to think through what’s available.
Your first decision in loan repayment is to determine your goal:
- Minimize interest: you can accomplish this by enrolling in a shorter-duration repayment plan. Your monthly payments will be higher, but the debt will be paid off sooner.
- Minimize monthly payment: if your expected payments are too high for your income, you can get on a longer repayment plan or a repayment plan that determines your payment based on your income.
Plans to pay off your loans and minimize interest
If you have a good income and would like to pay off your student loans in a timely manner, consider the following repayment programs:
Standard Repayment Plan
This is the “default” repayment plan. Standard Repayment Plan payments will be amortized over 10 years. This option means you will pay the least amount over time. Because of this, this option typically has the highest monthly payment.
Graduated Repayment Plan
Just like the Standard Repayment Plan, the Graduated Repayment Plan is 10 years. The difference is the payments start out lower and increase every two years. This sounds appealing since your income at the start of your career is likely to be lower and will increase over time. However, you’ll pay more in interest than a Standard Repayment Plan and the automatic increases can grow at a faster rate than your income.
Direct Consolidation Loan
If you have multiple federal loans, you apply for consolidation into one single loan. This is especially convenient if you have federal loans at different servicers. The interest rate is an average of the rates on your existing loans. In addition, your repayment term can be lengthened depending on your loan balance.
Private Loan Refinance
All the repayment plans mentioned here are federal loan programs. Refinancing through a private lender falls outside of the federal programs and should be considered carefully. If you choose this option, you no longer have federal loans and cannot change to an Income-Driven Repayment Plan or seek loan forgiveness. However, if you have good credit and income and are planning on paying off your loans, you may be able to get a better rate with a private lender.
Plans to minimize monthly payments
Extended Repayment Plan
An Extended Repayment Plan increases your repayment from 10 to 25 years. You can consider this option if your loan balance is over $30,000. Payments can be fixed or graduated (increasing).
Since your payments will be lower, you’ll pay more in interest over the life of the loan. If you are leaning towards this option, you may also want to consider an Income-Driven Repayment Plan, as the term of the loan may be similar with the added bonus of possible loan forgiveness.
Income-Driven Repayment Plans
Income-Driven Repayment (IDR) Plans base your monthly payment on your income. The formula involves looking at the difference between your adjusted gross income and the federal poverty guidelines for your family size (this is called your discretionary income).
Besides keeping your payments low, a benefit of IDR Plans is that any balance at the end of the repayment term can be forgiven!
There are four IDR Plans, but here is an overview of two popular options:
1. Pay As You Earn (PAYE)
In this plan, your monthly payment is calculated as 10% of your discretionary income. Because you are required to recertify annually, your payment will change with your income. However, under PAYE, your monthly payment will not go higher than the payment you would have had under the 10-year Standard Repayment Plan when you first entered PAYE. This is a good guardrail!
After 20 years of being on PAYE, any loan balance that remains will be forgiven. The amount forgiven will be added as taxable income in the year this occurs.
2. Revised Pay As You Earn (REPAYE)
REPAYE shares similarities with PAYE (payments calculated at 10% of your discretionary income, forgiveness after 20 years). However, REPAYE is available to all borrowers, while PAYE was reserved for borrowers after October 1, 2011.
REPAYE has the best interest subsidies but has some drawbacks. There are no caps on payment increases, making this a danger if your income increases significantly over the life of the loan. Finally, your discretionary income calculation includes your spouse’s income, even if you file taxes separately.
If you pursue an Income-Driven Repayment Plan with loan forgiveness, you must realize that your loan balance might not go down prior to being forgiven, depending on your monthly payment. This can be unsettling if you don’t have confidence that you are in the right repayment plan.
Don’t just choose a plan—make a plan!
It’s common to see student loan borrowers enrolled in a repayment plan without knowing what it is or why they are enrolled. This can create frustration, especially if you struggle to make your monthly payments or if you’re enrolled in an IDR and don’t see any progress on your loan balance.
I get it—the options can be overwhelming! As a financial planner, I know choosing the right student loan repayment plan can affect your ability to thrive in other areas of your finances.
Choosing the wrong plan can cost you anxiety and frustration. The solution is to work with Stewardship to make a plan for your student loans! We can help you determine which repayment plans will save you money and allow you to thrive.