Student Loan Repayment Options – Pros and Cons

So you have taken the advice of your parents and others, completed college, obtained a bachelor’s degree, and if you took out a loan to pay for this expenses, now have over $25,000 in debt.

Great.

Oh, and to make matters worse, the unemployment rate for anyone under the age of 24 currently sits at close to 50%, and it isn’t much better for those under the age of 35, where the rate currently sits at about 25%.

If you lie awake at night, wondering how you are going to pay back these loans (which usually require payments to begin within six months of graduation, if not sooner), relax. There are a number of different options available to you to help alleviate this burden.

Note that the loan repayment options discussed below apply only to federal loans. Private loan repayment options must be negotiated on an individual basis with the organization that issued the loan.

1. Standard Loan Repayment Plan

   As the name implies, this is the standard repayment plan that applies to all federal loans by default. If you do not elect another repayment option, this will automatically be applied to your loan.

   Defined

   Under this repayment option, your loan is amortized over a period of 10 years. What this means is that your monthly payment is set at a figure that ensures the entire loan will be paid off within 10 years (similar to making a mortgage payment). Each payment will include principal and interest.

   Notes

   There are two important points to make. One, your payment can never be below $50 per month, regardless of employment or income. Two, you have the option of paying more than the minimum amount or stated amount, which will lead to the loan being paid off before the ten year period is up.

   This option carries with it the highest monthly payment of all options, but in return, ultimately ends up with the lowest total payments, due primarily to the decreased interest payments you make.

   Recommendation

   If you are employed, expect to be in the future, and have disposable income, this may be a good option for you. If you are unemployed, or have little or no disposable income, an extended repayment option may be better.

2. Extended Repayment Plan

   The extended repayment option is similar to the standard option in that minimum payments of $50 per month are required.

   Defined

   It differs in that the repayment term is set at a period longer than 10 years. Typically, payoff periods can be anywhere from 12 to 30 years. Because the repayment term can be much longer, the monthly payments are typically lower than they would be under the standard option.

   Notes

   Because you are paying off the loan over a longer period of time, total interest payments will be higher than they would have been under the standard option, where you are paying off your loan in 10 years.

   Recommendation

   If you are steadily employed, but lack the disposable income to pay off your loans in ten years, this may be a good option to explore.

3. Graduated Repayment Plan

   The graduated repayment option provides a more realistic payment plan than both the standard and extended repayment options.

   Defined

   Under a graduated repayment plan, monthly payments start lower than the other options (as low as $25), and rise every two years, presumably as your employment becomes more stable and you begin to see salary increases.

   Notes

   Loan terms vary from 12 to 30 years, depending on the amount borrowed.
   
   While there is a $25 minimum monthly loan payment, the actual payment can never be less than 50%, or more than 150%, of what it would have been under the standard repayment option.

   Recommendation

   As mentioned earlier, this plan makes the most economic sense, and is sensitive to the fact that jobs right out of college usually do not pay as well as jobs you will have as you progress your career.

   However, as with the extended payment option, overall interest expenses will be higher due to the extended loan term.

4. Income Based Repayment Plan

   Income-based repayment plans are the most flexible, and offer the potential for the lowest monthly payment.

   Defined

   Income based repayment plans limit your monthly payment to a percentage of your income. This percentage varies depending upon your income level and the size of your family.

   Notes

   These loans are set at an initial term of 25 years, although you have the option of paying off the loan sooner if you wish or are able to.

   If there is still a loan balance at the end of 25 years, the remaining balance is forgiven, and is added to your annual income for that year.

   For careers in qualified public services positions, your loan will be forgiven after only 10 years of work.

   If your monthly payment is not high enough to cover the interest on the loan, the interest will be added to the principal balance of the loan (unless you have a subsidized Stafford loan, for which the government will waive the unpaid interest for the first three years of the loan). Note that up to a 10% limit, you will be charged interest ON the interest that is added to your loan balance.

   Additionally, you need to submit tax returns each year so that your minimum payment can be determine.

   If you get married and file joint tax returns, the income of your spouse will be included when determining your minimum monthly payment. If this will make a significant different in your payment, it may be better to file separate tax returns.

   Recommendation

   This option is best for individuals with very high debt levels and/or low incomes, as it provides the greatest ability to lower your monthly payments. You also should not expect significant increases in income going forward. If you do, have a plan for re-applying under another option going forward.

   However, you need to be cognizant of two things.

   One, if you expect to generate higher income in the future, you could see a significant increase in your required monthly payment under this option. To avoid this, you would need to reapply for another loan repayment method, which is time-consuming and may lead to a higher interest rate on your loan.

   Two, this option leaves the door open to paying the largest amount of interest. While your immediate payments may be significantly lower, you are simply deferring payments to some point in the future. Assuming you see salary increases in the future, you will be required to pay all of the accrued interest that you are not paying today.

5. Loan Consolidation

   In addition to considering the different loan repayment options discussed above, you should also consider loan consolidation.

   By consolidating your student loans into a single payment, you may be able to lower your interest rate while also increasing your loan term, significantly lowering your monthly payment.

   However, you can only consolidate your student loan balances once, so be sure to do your homework before making this decision.

I want to make mention of two variations of the income-based repayment option. The income-contingent and income-sensitive repayment options are similar to the income-based repayment options. They differ in two ways.

The income-contingent repayment option defines income in a slightly different way than the income-based approach does, and the income-sensitive option requires a minimum payment of 4% of gross monthly income, and requires the payment to cover any accrued interest.

Additionally, the income-sensitive approach has a repayment term of 10 years, and requires re-applying for this option each year.

As such, it is widely accepted that the income-based repayment method is the best option for most borrowers.