Federal student loans come with lots of benefits that private loans don’t, and one of their most valuable perks is the range of repayment options you can choose from. Besides the standard repayment plan, which breaks up your debt into 10 years’ worth of payments, the government offers five other options. You may even qualify for an income-driven plan, which bases the amount you owe each month on your income — so you’re never charged more than what you can afford.
But a lot of borrowers don’t know these choices are available to them. The U.S. Department of Education is trying to spread the word that grads can change their monthly payments — for free — through their loan servicers, says Ted Mitchell, under secretary of education at the U.S. Department of Education.
“It’s an ongoing effort,” he says. “We’re not going to slack off. We’re going to continue to get the word out through every means possible.”
Whether you’re picking a repayment plan for the first time or switching to a new one, knowing your options is the first step. It’s key to consider not only how much your monthly bill will cost on a different plan, but also how much extra you’ll pay in interest if you extend your repayment term beyond the standard 10 years, Mitchell says.“It’s balancing those two things that’s really the most important thing a borrower can do.”
If you can afford your basic expenses while on the standard repayment plan, it’s best to stick with it for as long as you can. You’ll pay off your loans faster and accumulate fewer interest charges, which will save you money in the long run.
But if you have a large loan balance and find that monthly payment tough to make, it’s possible you’ll qualify for an income-driven repayment plan. Look into these options first, since they’ll not only save you money — they’ll also allow you to cancel your loans after 20 to 25 years of on-time payments. Extended and graduated plans are other options to consider if you want to pay less per month, but don’t qualify for the income-driven options.
If you’re considering a switch, these questions can help you decide which repayment plan is best for you:
- Does your income qualify you for a partial financial hardship?
- When did you take out your first loan?
- What types of loans do you have?
- Do you work full-time in a public interest job?
- Are you willing to potentially pay taxes on your forgiven loans?
- Can you count on a steady increase in income over the next 10 years?
- Do you have more than $30,000 in federal Direct Loans?
- Are you willing to pay more in interest to have lower monthly payments and a longer repayment term?
You may qualify for an income-driven plan
1. Does your income qualify you for a partial financial hardship?
The government offers three income-driven repayment plans: income-based repayment (IBR), Pay As You Earn (PAYE) and income-contingent repayment (ICR). Each limits your monthly payment to a percentage of your income, and cancels your remaining balance after you’ve paid down your loans for a certain number of years.
Anyone can sign up for ICR, but it’s not as generous as the other plans. To participate in IBR or PAYE, you first need to demonstrate that you have a partial financial hardship. The specific plan you’re able to participate in will also depend on the year you borrowed your first loan (see below).
If your monthly payment on the standard plan is or would be more than 10% of your discretionary income, you qualify for a partial financial hardship under the most recent version of IBR and PAYE. Under the original version of IBR, borrowers must show that their payment on the standard plan is or would be more than 15% of their discretionary income.
If you meet the financial hardship requirement, you can sign up for IBR or PAYE through your loan servicer.
If yes, keep reading: You may qualify for an income-driven repayment plan. If not, skip to question 6.
2. When did you take out your first loan?
The year you first took out federal loans will dictate which income-driven plan you can choose. The original version of IBR is available if you took out loans before July 1, 2014. The newer version of IBR is available if you took out loans after July 1, 2014. PAYE is only open to graduates who took out their first loan on or after October 1, 2007 and at least one more loan on or after October 1, 2011.
But the Department of Education has been developing a new income-driven plan, called REPAYE, which will extend PAYE to all student loan borrowers, regardless of the year they took out their loans or whether they have a partial financial hardship. REPAYE will be available by the end of 2015, says Under Secretary Mitchell.
3. What types of loans do you have?
Some loans don’t qualify for income-driven repayment plans. Depending on types of loans you have, your servicer may suggest you consolidate them into a Direct Consolidation Loan first. Only Direct Loans can be repaid through PAYE, for instance. So let’s say you took out Stafford Loans; you would have to consolidate them into a Direct Consolidation Loan before they could be included in your monthly payment under PAYE.
Your servicer can guide you through the process of applying for a Direct Consolidation Loan and picking a repayment plan for your new loan, which would cover the balances of your previous loans. If you opt for an income-driven plan, you’ll fill out an Income-Driven Repayment Plan Request Form. It can be a confusing process, so your best bet is to your call your student loan servicer and ask which plan you qualify for that will give you the lowest monthly payment.
4. Do you work full time in a public interest job?
The Public Service Loan Forgiveness program allows grads who work at least 30 hours a week in a public interest job to cancel their federal loans after 10 years of on-time payments. You must work in a qualifying job the entire time it takes you to make 120 loan payments, and you must certify your employment status every year you take part in the program.
You’ll save the most money on PSLF if you repay your loans on an income-driven repayment plan, which will keep your monthly payments low and leave a larger balance at the end of your loan term to be forgiven.
5. Are you willing to pay taxes on your forgiven loans?
Any loans forgiven under PSLF won’t be taxed. But according to current IRS rules, loans forgiven under the income-driven repayment plans will most likely be considered taxable income for the year they’re canceled, which could mean a high tax bill in the future.
When deciding whether to switch to an income-driven plan, consider how much of your loans will be forgiven at the end of your repayment term and what you could owe in taxes down the road. If signing up for an income-driven plan helps you avoid default, your potential tax bill may be worth it.
If you want to pay less per month, but don’t qualify for an income-driven plan
6. Can you count on a steady increase in income over the next 10 years?
Say you’re not eligible for income-driven repayment, but you’d like to pay less toward your loans each month while you get settled after graduation. The 10-year graduated repayment plan will charge you a lower amount at first and increase your payments every two years.
It’s worth considering if you can’t afford their payments on the standard plan now, but expect to consistently make more money as you establish your career. While your payment will initially be lower, it will most likely be higher than what you’d pay on the standard plan by the end of your repayment term.
Your monthly payment on a $10,000 Unsubsidized Direct Loan with a 4.29% interest rate, for instance, will start out at $58 and will grow to $173 over 10 years. You’ll also pay $583 more in interest than you would have if you’d stuck with the standard plan.
7. Do you have more than $30,000 in federal Direct Loans?
If you’re not sure you’ll be able to keep up with a higher monthly payment every two years, the extended repayment plan gives you the option to make lower payments for a longer period of time. Only borrowers who owe more than $30,000 in Direct Loans are eligible. You can choose to pay a fixed or graduated amount for up to 25 years.
But if you have trouble making payments on your income, it’s possible that you qualify for an income-driven plan. Be sure to look into those options first. Your best bet is to ask your loan servicer how you can sign up for the plan that gives you the lowest monthly payment you’re eligible for.
8. Are you willing to pay more in interest to have lower monthly payments and a longer repayment term?
If you decide to go with extended repayment, be aware that you’ll pay more in interest over time. That’s because interest accrues daily, and the longer it takes you to pay off your loans, the more interest you’ll accumulate. You’ll also pay more in interest on the graduated plan than you would on the standard plan, even though they both break up your payments into a maximum of 10 years. You’ll carry a higher balance for a longer time as your payments increase.
Start your research into alternative repayment plans by entering your individual loan balances and interest rates, plus your annual income and family size, into Federal Student Aid’s Repayment Estimator tool. You can view how much you’re likely to pay on each plan the government offers.
You made a good choice by taking out federal loans; once you graduate, make sure you take advantage of the flexible repayment options available to you.
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Graphic by Dora Pintek
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