Student Loans

What Is The Best Student Loan Repayment Plan

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 12 minute read

Mortgage, child care, and grocery bills have depleted your savings. You still need to find a way to come up with the money each month to pay down your student loans. Yes, I see what you mean. I’ve really been there before!

In case you’re wondering what to do with your federal student loans, you do have choices. Income-based repayment plans are just one of several available possibilities.

Unfortunately, picking the one with the cheapest monthly price isn’t always the best option. Selecting the most suitable repayment plan for your student loans requires some basic but essential considerations.

How to Pick Your Ideal Student Loan Repayment Plan

Which federal student loan repayment arrangement is ideal for you will depend on your unique financial status and desired outcomes. The best plan for you can be found by following these simple steps.

1. Be Aware of Your Options

You need to learn about your choices before you can pick the right plan. There is a wide range of options for paying back federal student loans.

Regular Repayment Schedule

Every student’s loan payback will begin according to the standard, as that is the default plan. The loan has a fixed interest rate of 6% and fixed monthly installments of $1000 for 10 years.

Gradual Repayment Schedule

The graded plan offers the same 10-year grace period as the ordinary plan. Though initial installments are lower, they double in size every two years.

Longer Repayment Schedule

Repaying the loan over a longer period of time (up to 25 years) reduces the monthly cost. Your payment schedule might be either consistent or variable.

Plans for Repayment Based on Income

The amount you owe each month will be directly proportional to your monthly income in income-based plans. There are four income-based programs available, each with its own set of restrictions and perks.

All but one of these plans limit your monthly contribution to no more than 10% of your discretionary income. While they are comparable in that respect, certain borrowers may place greater weight on tiny variances.

  • Wage-Based Payments. To qualify, you must show that you are experiencing significant financial difficulty. If so, for the first three years after taking out a subsidized loan, the government will pay the interest for you. Plus, even if your salary increases, your payments won’t go above what they would be under a typical 10-year plan.
  • Revised Wage-Based Payments. This option is available to borrowers of all means. For the first three years of a federal loan’s life, the government will pay the interest on your behalf, with no maximum amount required.
  • Repayment Scheduled According to One’s Income. This one has a minimum income requirement. However, the size of payments is capped so long as you are enrolled, regardless of how much money you make.
  • Income-Based Repayment. With this least desirable income-driven plan, payments are determined by taking 20% of your take-home earnings. However, it is the only option for parents who wish to apply for a PLUS loan at this time.

Except for the income-contingent plan, discretionary income is determined by the ED by subtracting your adjusted gross income from 150% of the federal poverty level as determined by your family size and state of residence.

In addition, if you are unemployed or have a low enough income, your monthly payment may be zero dollars and you would still qualify for any forgiveness programs. Despite the fact that income-driven programs might dramatically lower your monthly cost, they are not without their drawbacks. See our income-based repayment guide for details on each option.

Consolidation

Getting a consolidation loan means getting a new loan to pay off your existing debts. Since there will be only one loan to pay back each month, you’ll only have to deal with one loan servicer.

The ability to prolong your payback period for up to 30 years may help you reduce your monthly payments, but it is not a repayment plan in and of itself. It’s possible that loan consolidation will be required before you qualify for some assistance programs.

In order to be eligible for income-driven repayment schemes, borrowers with several federal student loans (such as Perkins or FFEL) must consolidate their debt. This is due to the fact that only direct loans, such as consolidation loans, are considered to be eligible, and the loans that were previously offered are not.

2. Build Your Financial Capability

Once you know what you have to pick from, the next question is how to decide. A closer examination of your financial situation is the first step.

Start keeping tabs on your monthly outlays and inflows of cash with a budgeting program like Mint or Personal Capital, or a spreadsheet like Excel or Google Sheets. Keep track of every penny you spend. If at all possible, it’s best to keep tabs on your expenditures for a few months to acquire an average.

Find out how much of your monthly income is left over after paying all of your monthly bills to calculate the amount you may put toward your student loans. Reducing your monthly payment on your student loans is a good idea if you’re finding yourself strapped for cash.

If you are fortunate enough to have a surplus, though, you may want to redirect your resources toward other objectives.

3. Determine Your Goal for Repayment

Understanding your monthly cash flow will help you decide whether meeting your basic needs or saving for a specific goal is more important to you. Which repayment strategy is suitable for you depends on your end aim.

Income-Driven Repayment is the Best Plan to Lower Your Monthly Payment Amount.

Applying for an income-based repayment plan is your best bet if you’re having trouble making your monthly payment and need to reduce it.

A person’s monthly contribution to one of these programs is determined by their discretionary income and the size of their household. Your spouse’s student loan debt may be taken into account by some programs.

However, if you file jointly or separately, your spouse’s income may be factored into the calculation of your benefits under such schemes. Before deciding whether to file jointly or individually, you should talk to a tax expert.

You should know that, while income-based repayment plans may be a lifesaver if you’re struggling to make ends meet, they will ultimately increase the cost of your loans because interest will accrue at a higher rate over a longer period of time.

You will also be in repayment for a much longer period of time, especially if you took out loans to pay for graduate school, as income-driven repayment plans extend the repayment period for such loans by an additional five years.

Don’t automatically choose the plan with the lowest monthly payment if you’re interested in income-driven payback. Instead, if you’re in a position to do so, select the one that would get you debt-free the quickest, and for the least amount of money.

Find out how much you’ll owe, how much you can afford, and whether or not any of your loans will be forgiven by using the loan calculator on StudentAid.gov.

If the monthly payment is still too high after using the income-driven repayment plan, the only alternative options are the extended repayment plan or loan consolidation with a longer loan term, neither of which is ideal.

Most Effective Strategy to Reduce Your Total Repayment Cost: Repayment Schedule

Interest costs more money every month if you don’t pay off your loan. For illustration’s sake, let’s say you borrow $30,000 at 3% interest and pay it back over 10 years. The interest you pay amounts to around $4,300. If you extend the loan over 20 years, though, the interest you pay will nearly quadruple, to nearly $9,000.

However, not all borrowers can benefit from the lower monthly payments and potential loan forgiveness offered by income-driven repayment plans.

After 20 years of payments, even if you only owe $27,000 but make more than $30,000 annually, you won’t have any debt left to forgive. However, the interest you pay on your loan throughout the course of a repayment plan based on your income would be significantly higher than it would be if you just made monthly payments on time every month.

As debt levels increase, the outlook worsens. In most cases, debtors with a large amount of debt will spend more on interest on an income-driven repayment plan than they borrowed. Therefore, it is possible that you will have to pay back two or more times the amount you borrowed.

Therefore, if an income-driven plan is not necessary, the regular 10-year payback schedule should be used. That way, you can minimize the cost of your loan to a minimum. More interest savings will be yours to enjoy if you are able to pay off your loan sooner than 10 years.

Choose the graduated plan instead if you work in a field where your salary is likely to increase regularly over the following decade.

You can start out by making lesser payments. To keep you on a 10-year repayment schedule, your payments will grow every two years, but they will never be more than three times what they were before.

This strategy makes sense for recent college grads whose salaries are low, to begin with, but are expected to soar in the future, such as lawyers and doctors.

However, if things don’t go as planned, the strategy can become complicated. It’s likely that you won’t be able to make those larger payments in the future, even if your salary increases. Understand that this is a risk if you choose this path.

Standard Repayment Plan Is the Best Way to Pay Off Your Loans Quicker

Paying off college loans can take a very long time. However, this can be avoided if you stick to the conventional 10-year payback plan.

The best part is that you’ll save money on interest by paying off the loan sooner. Therefore, you should expect a lower overall loan cost. Moreover, if you want to get rid of your student loans sooner, you should put aside any additional money you come into whenever you can.

Use a micro-savings app that automatically rounds up your purchases and transfers the extra money to a linked savings account to make this process even simpler. Even better, there are a number of apps that facilitate the repayment of student loans by directing your micro-savings to your loan payments.

A Graduated Repayment Plan is the Best Option for Juggling Savings and Debt Repayment.

You won’t be able to save for things like an emergency fund, a down payment on a house, or retirement if you’re always putting your spare change toward other expenses. You can lose thousands of dollars in compound interest if you wait to start saving for retirement until you’ve paid off your student debts.

As a result, it’s wise to strike a balance between making investments and eliminating debt. Having a reduced monthly payment under the graduated plan is one way to do this, especially if your salary is modest right after graduation.

After then, payments increase every 24 months, hopefully in line with your rising standard of living. In order to keep you from feeling overwhelmed. You also commit to a 10-year repayment plan to avoid paying more in interest over the long run.

Using the normal plan of repayment as an example, the monthly payment on a $27,000 loan would be $258. If you chose the progressive plan instead, your first payment would be $142.

The difference between the monthly payments required under the ordinary repayment plan and the graded plan would grow to slightly over $6,100 after six years if invested and the market returned its historical average of 7.08%.

Payments under the graduated plan are, of course, significantly larger than they would have been under the ordinary plan by this time. Therefore, for the next four years, you must let that sit in the market while you make payments on your school loans.

Your retirement account has grown to over $8,000 while you focused on making the larger payments required by the graded plan, so it’s all OK.

It’s even more striking to consider how far ahead you are of those who waited to begin until they had paid off their college loans. Imagine you start investing the $258 basic plan payment each month once the repayment period ends. That’s far less than what you paid at the peak of your graded plan, so you’d still have some savings left over.

If you wait another 20 years, you will have nearly $160,000. If you invested the final amount of your monthly graded plan payment, the return you received would be considerably higher.

After 20 years of investing a zero-balance borrower’s proceeds from the loan’s repayment will amount to little more than $128,000. Initially, the disparity was about $8,000. Now, it’s more than $30,000.

Best for Making Monthly Payments Easier: Consolidation

Consolidating your student loans can make repayment easier and less likely to result in missed payments if you are currently making payments on several loans with different due dates to different services each month.

Remember, though, that consolidating student loans won’t lower your interest rate. This is a widespread misconception about consolidating student loans.

On the contrary, you might pay more interest overall if you consolidate your debts. A payback period of up to 30 years is available. As a result, the total amount of interest you pay will rise dramatically due to the compounding effect of a longer repayment period.

The advantages of income-driven repayment plans, such as interest subsidies and student loan forgiveness, make them preferable to just extending the repayment term if you need a lower monthly payment.

If you’re considering consolidating your student loans but aren’t sure if you should, check out our post first.

Income-Driven Repayment is the Best Plan to Be Eligible for Loan Forgiveness

After enrolling in an income-driven repayment plan and making the necessary installments, the remaining balance of your loans may be forgiven.

After 20–25 years of qualifying payments, all income-driven programs cancel any outstanding balance. However, if they enter a qualifying public service occupation, some borrowers may be able to have their loans erased in as little as ten years.

Best Strategy for Lowering Interest Rates: None

Interest rates on federal student loans are not eligible for any of the available repayment plans. Interest rates on federal student loans fluctuate annually; nonetheless, borrowers are locked into the interest rate in effect during the academic year in which they took out their loans. This is due to the fact that by law, the interest rate on all federal student loans must be fixed.

You might consider refinancing your student loans with a private refinance business if you want to considerably reduce your interest rate. Once you refinance, though, it’s too late to change your mind. A commercial bank will take over your government student loan, making you responsible for repayment.

In other words, you will no longer be eligible for government repayment programs like forbearance, deferment, income-driven repayment, or forgiveness for public service.

You might not believe you’ll ever need these choices, but life is full of surprises. To sum up, if you want to refinance your federal student loans, you should only do so if you have a high-paying job in a secure industry, a strategy to pay off the loans soon, and outstanding credit that will get you a big interest rate discount.

4. Perform the Math

Do the arithmetic to understand what each strategy will entail for you once you’ve established your budget and set your objectives. Get your feet wet with the help of the loan calculator on StudentAid.gov. 

A more accurate projection can be obtained by signing in with your existing student account information or creating a new one. A series of questions about your present circumstances and future aspirations are posed by the simulator.

You can also experiment with other different student loan calculators. These can provide more insight into how certain outcomes play out. If you know you want to get rid of your debt as soon as possible, a prepayment calculator will show you how adding $25 to your monthly payment will get you out of debt a full year sooner.

The impact of a reduced monthly payment can also be modeled using the calculator. An income-based repayment calculator, for instance, can give you an idea of what your monthly payments under this type of income-driven plan will look like both now and at the end of your repayment period.

Find out how much interest you’ll pay, how much may have been forgiven, and how much the whole loan can end up costing you. However, many online calculators allow you to choose the annual income increase percentage, which affects the resulting figures. 

Therefore, some income-based plans may result in significantly higher payments if your salary increases by a large amount. If your circumstances change after utilizing a student loan calculator, such as the one on StudentAid.gov, the results may no longer apply.

Bottom Line

Forbearance and deferment are possibilities if you are unable to make payments on your federal student loans. However, a repayment plan benefits the vast majority of debtors. The good thing is that you can change your payment schedule whenever you choose.

The only truly irreversible steps are consolidation and refinancing. This gives you the flexibility to adjust your goals and your repayment schedule if life throws a wrench into your plans.

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