By Mike Brown
Special to Campus News
If you are one of the more than one million students who will be graduating from college with federal student loan debt in 2017, you have a lot to think about. Your first loan payments will begin six months from the date of your graduation, but before then you need to decide which student loan repayment plan will best serve your needs for the next 10 or 20 years or so. So, it is important to really understand your options and how they might apply in your particular situation.
Basic Federal Repayment Plans
Unless you choose another repayment plan, you are automatically enrolled in the standard repayment plan with 120 equal monthly payments (10 years). If you can afford it, the standard plan is the least costly in terms of total interest paid. The way to determine if you can afford it is to do a quick budget calculation. Say your salary is going to be $40,000 a year. Then add your monthly student loan payment to your other debt obligations (credit cards, car payments, etc.). If your total debt obligations exceed 10% of your pre-tax income, it might not be so affordable.
You could opt for the graduated repayment plan. It is also a 10-year plan, but it starts your monthly payments low and increases it every two years. Because you’re not paying all of the interest due in the earlier payments, it accrues to the back end, so you will pay more total interest on the loan. This would be a good plan if you expect your income to increase over time or your other debt payments to decrease.
You could lower your payments permanently through the extended repayment plan, which stretches your loan out to 25 years. Of course, you will pay much more interest over the course of this plan. An extended repayment plan may require you to consolidate all your federal loans into one new one. The new interest rate on the loan is based on the weighted average of all your existing loans and it is fixed for the life of the loan.
If lowering your payment is your biggest concern, you might be better off with the income-driven plans discussed below. However, if you want to avoid having to reapply each year, which is required of income-driven plans, the graduated or extended plans can do the trick.
In an effort to assist student borrowers who are experiencing a financial hardship, the federal government has come up with four different plans designed to lower their monthly payment. Income-driven plans extend the loan term to 20 or 25 years. Then, using a formula that takes into account the amount of your take home pay and your outstanding debt obligations, it caps your monthly payment between 10% and 20% of your pay. To remain eligible for the plan, you have to reapply each year, submitting updated information on your income and your debt obligations. So, your payment amount can change if your income increases and/or your debt obligations decrease.
To qualify for the income-based repayment plan (IBR), you have to show that your monthly payment on the standard plan is higher than what you would pay on the income-based plan. If you took your loan out after July 1, 2014, your loan payments are capped at 10% of your discretionary income. The cap for loans originated before that are capped at 15%. The plan accepts direct loans and Federal Family Education Loans (FFEL). Parent PLUS loans are not eligible.
Borrowers who took out loans after July 1, 2014 can have their loans forgiven after 20 years. Those with loans older than July 1, 2014 have to make payments for 25 years before their loan is forgiven. It is important to note that you will be taxed on the forgiven amount.
While the other plans can lower your payment more than an income-contingent repayment plan (ICR), it may be the best option under certain circumstances. ICR is the only option available for Parent Plus loans. However, to qualify Parent Plus borrowers are required to consolidate into a federal direct consolidation loan. An ICR plan would be a good option for borrowers who can’t afford a standard payment but are able to pay more than on an IBR. The cap on ICR is 20%, so, while the payment reduction isn’t as much, you can save more on interest over an IBR.
Pay As You Earn
If you can meet the more stringent requirements of the Pay As You Earn (PAYE) plan, it does offer the most generous benefits. The first qualification is the timing of your loan. Only borrowers who first took out a direct loan or a FFEL loan after Sep 30, 2007, and then again after Sep 30, 2011, may qualify. To qualify financially, your monthly payment on PAYE must be less than what you would owe on the standard plan. Your payment will then be capped at 10% of your discretionary income.
Revised Pay As You Earn
The Revised Pay As You Earn (REPAYE) plan is the only plan that doesn’t require you to demonstrate that your payment on the standard plan is unaffordable. It also doesn’t have any timing requirements like PAYE or IBR. Regardless of how much you make and when you took out the loan, you can be eligible for REPAYE’s 10% cap. However, it does include your spouse’s income in determining what is capped. REPAYE will forgive your undergrad loans after 20 years. If you took out any grad school loans, they will be forgiven after 25 years.
The best way to simply lower your payment while paying your loan off faster is by refinancing it through a private bank. Research has shown that the average refinancing candidate saves about 2.25% through refinancing, it could save you money without extending the loan term. There are four big caveats with refinancing:
- You need a very good credit score to qualify for the best rate.
- When you refinance, you will lose the option of switching to an income-driven plan.
- You’ll lose federal protections such as forbearance and deferment that can be used in times of hardship.
- Your loan will no longer be eligible for forgiveness. While it does offer the opportunity to significantly lower your loan costs, it comes at a potentially big price.
Student loan debt is beatable. But first, make sure that you have the right repayment plan and strategy in place.
Mike Brown is a Research Analyst at LendEDU.