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Student Loans: Decide Whether to Refinance or Keep the Graduated Plan

Nov. 6, 2015
Loans, Student Loans
Decide Whether to Keep Your Graduated Student Loan Payment Plan or Refinance
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Your first job after graduation probably won’t make you a millionaire. For some grads, that makes the federal government’s 10-year graduated student loan repayment plan sound ideal: Your monthly student loan payments increase every two years, so you pay less as you’re starting out and more as time goes on and your career progresses.

In most cases, though, you’ll pay more in interest over time on the graduated repayment plan than if you chose other repayment options, including refinancing. So if you picked the graduated plan, stay on it if you really need to pay less now because of your income. Consider refinancing your student loans instead if you have a high credit score and might want to pay off your loans in less than 10 years.

We’ll lay out the differences between the plans so if you’ve narrowed your options down to these two plans, you can decide which is best for you.

Table of contents

The basics: Graduated repayment plan

How it works

Remember that student loan exit counseling session you had to complete online when you graduated from college? That’s when you signed up for a plan to pay back your federal loans. You also have the opportunity to choose a repayment plan when you consolidate your student loans.

The graduated plan is one of your repayment options. You pay less initially than what you’d owe on the default 10-year standard plan, which breaks up your loan balance into 10 years’ worth of fixed payments. Graduated repayment is helpful if you’re on a tight budget right out of school. On a $10,000 direct unsubsidized loan with an interest rate of 4.29%, for instance, you’ll pay $58 a month at first on the graduated plan. You’ll pay $103 a month on the standard plan.

Graduated repayment is less popular than standard repayment, though. Only 12% of the 20.3 million direct loan borrowers are on the 10-year graduated plan, while nearly 56% of direct loans are in repayment under the standard plan.

The benefits

Along with a lower monthly payment to start, the graduated plan gives you access to federal loan benefits you’ll lose if you refinance. You can temporarily suspend or reduce your federal loan payments when you can’t afford them, and you won’t pay interest on your subsidized loans during periods of deferment. Public service employees can get the remaining balance of their loans forgiven through the Public Service Loan Forgiveness program after they make 120 eligible payments.

The drawbacks

Not all borrowers can count on their incomes increasing every two years, so you might reach a point at which the graduated plan is unaffordable for you. For example, your initial payment on a $10,000 direct unsubsidized loan might be $58 a month, but that would rise to $173 a month later in your repayment term. That’s $70 more than what you’d pay on the standard plan.

You’ll also pay more in interest overall than you would on a plan with fixed payments, since you’re accruing interest on a larger unpaid balance early in the plan. On that $10,000 direct unsubsidized loan, you’ll pay $2,321 in interest and $12,321 total through standard repayment. You’ll pay $2,904 in interest and $12,904 total — almost $600 more — through graduated repayment.

The basics: Refinancing

How it works

During the refinancing process, a private lender takes over your loans, so they’re no longer owned by the federal government. The lender will pay off the federal loans you choose to refinance and replace them with a new private loan.

Unlike federal loans, refinanced loans are credit-based. Your new interest rate will depend on your credit score and other financial factors, which vary from lender to lender. Some require you to earn a certain income, while others have minimum or maximum loan balances you must meet in order to refinance.

When you refinance, you’ll often have the opportunity to choose between a fixed interest rate and a variable interest rate, which fluctuates according to market conditions. Variable rates generally start out lower, but they’re riskier; fixed rates might cost you more money, at least initially, but they give you the certainty you’ll never pay a higher interest rate than what you start with.

The benefits

Congress resets interest rates on federal loans every year, so your loan might carry a higher rate than what you’d get if you applied today. Since the federal government doesn’t allow borrowers to refinance their loans to current interest rates, refinancing with a private company is the only way you’ll potentially receive a lower rate on the loans you have.

To get an idea of the interest rate you might get if you were to refinance, you could look to NerdWallet’s partner Credible. It’s a refinancing marketplace that gives borrowers loan offers from up to nine lenders at a time. The lenders that work with Credible offer fixed rates on refinanced loans starting at 3.74% and variable rates starting at 1.92%. (Remember that you’ll get the best deal with a strong credit score.) Interest rates on federal loans are currently between 4.29% and 6.84%.

A lower interest rate also means a lower monthly payment. Remember that when you repay a $10,000 direct unsubsidized loan with a 4.29% interest rate on the graduated plan, your monthly payment increases from $58 a month to $173 a month over 10 years. Let’s say you refinance when you have $8,000 in principal left to repay: A refinanced loan with a five-year repayment term and a 3.5% interest rate gives you a flat payment of $145.53 a month. You’ll save nearly $30 a month by refinancing compared with what you’d owe during your final two years on graduated repayment — and you’ll pay off the loan sooner.

The drawbacks

Not everyone is a good candidate for refinancing. The government gives all borrowers the same interest rate depending on the year and the type of loan they take out. Private lenders, on the other hand, take your credit history and other financial circumstances into account. You’ll receive a lower interest rate if you have a high credit score, solid employment history and a steady income.

Taking your loans private also means they’ll no longer come with the protections the federal government provides. You won’t be able to utilize loan forgiveness programs or interest-free payment postponement, and you won’t have the opportunity to switch to a different repayment plan; the amount you pay from the beginning most likely won’t change.

Which is best for you?

New Grads Might Not Retire Until 75, Study FindsStay on the graduated plan if you’d only be able to afford your loans by paying the lower amount you currently owe each month. The graduated plan is best in those early years after graduation, when your income and job aren’t as stable as they’ll eventually be.

But as you progress in your career, the graduated plan will end up costing you money in interest. If you’re having no trouble affording your rising payments, you might be a good fit for refinancing. You’ll save money and have the option to choose a shorter repayment plan than 10 years, which would help you get rid of your loans faster.

Refinanced loans are best suited to borrowers who can count on a secure income and who don’t qualify for Public Service Loan Forgiveness or other loan cancellation options. If you think you might take advantage of federal loan protections, consider refinancing your private loans only, if you have them.

You also have the option to switch from the graduated plan to the standard plan if you can afford the fixed monthly payments, or an income-driven plan if you need more flexibility. The standard plan will save you money in interest and income-driven plans will keep your monthly payments low.

How to take action

If you want to switch repayment plans, call your federal loan servicer. A representative from the company will walk you through how to do it, what you’ll owe each month, and how the change will affect your loan balance. Check out NerdWallet’s advice on how refinancing stacks up to the standard student loan repayment plan and consolidation, too.

If refinancing is best for you, Credible will let you you compare offers from multiple lenders at once.

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