There are a dizzying number of options to choose from when it comes to repaying your student loans. In an attempt to be more flexible and meet the needs of more struggling borrowers, the Department of Education seems to roll out repayment plan after repayment plan for federal student loans, each only a slight variation on the one that came before.
Despite having nearly more payment plans than any one person can reasonably be expected to understand, there are truly options to fit every situation, unlike those offered with more rigid private student loans. The key point in a repayment plan is to keep the loan in good standing despite fluctuating income and financial situations. Let’s look at each of the repayment plans to understand which is the best to choose and which gives the best chance for paying off debt.
The is the most basic plan available. The loan payments are calculated for up to 10 years and are fixed for the life of the repayment. This payment plan is the default payment plan. The biggest reason to choose the standard repayment is that the period of time it takes to pay back the loan is the shortest.
The is calculated for the same length of time as the standard repayment plan, over a course of 10 years. The difference is that payments on a graduated loan start smaller and grow with time. Borrowers may experience a hike in their payments about every two years. Although it is easier to make the smaller payments at the beginning of the loan, borrowers pay more in the long run with a graduated repayment plan. Paying less in the early stages of repayment means that the principal stays larger for longer, charging more and more interest.
If you owe more than $30,000, you may qualify for the . Instead of the usual 10 year repayment period, the extended plan calculates payments based on 25 years. Extended repayment lowers the amount that you have to pay every month, but borrowing the money over a longer period of time means paying a higher lifetime interest amount. This payment plan can be individualized by adding graduated payments if necessary.
The , or PAYE, caps payments at no more than 10 percent of your income after living expenses. By recalculating the payment every year, the theory behind this plan is that as you begin to earn more money you will be able to make bigger payments on your loan. The other benefit of a PAYE plan is that your student loan will be eligible for forgiveness after 20 years of steady payments. This plan is only available for borrowers who didn’t borrow any student loans before 2007 and received a disbursement of a direct loan after 2011. In order to qualify for this option, you’ll need to have a high ratio of debt to income.
The , or REPAYE, is another option that caps your payments at 10 percent of your discretionary income and allows for debt forgiveness after 20 or 25 years of payments. The difference between REPAYE and PAYE is who can qualify. The PAYE program is limited to newer borrowers, while REPAYE opens up options for those who have student loans older than 2011 or 2007.
An is similar to PAYE in that the payment amount is based on a portion of your discretionary income, 10 to 15 percent. The payments are recalculated each year so that as your income changes, your payment amount changes. With an income based-repayment plan, there are options for loan forgiveness after 20 to 25 years of solid payments. To qualify for an income based repayment plan, borrowers will need to have a high debt ratio because 10 to 15 percent of discretionary income cannot be larger than the standard repayment amount.
The Income Contingent Plan is also calculated using your income. However, under this plan your payment is the smaller amount between 20% of income after necessary expenses or the payment of a fixed 12-year loan. Unlike the income examples above, income contingent payment can be larger than the standard 10 year payment. There is a loan forgiveness component after 25 years.
Income Sensitive Repayment is more of a generic term where lenders can set up customized loan terms. Generally speaking, an income sensitive repayment plan is based on income and borrowers can take up to fifteen years to pay them back. Although the total repayment amount will definitely be larger than the standard repayment, the exact loan terms will vary.
It would be great if there was a perfect one-size-fits-all repayment plan that is the best for every situation. But that’s the whole point in having so many plans: to meet the needs of a greater range of borrowers.
That said, all plans are not created equally. The best option for lifetime wealth is the standard repayment. The reason behind this is that all other plans increase the length of time you are borrowing money, thereby increasing the amount of interest you will owe before the loan is paid. If you have a good income and credit score, you should definitely consider refinancing and consolidating your student loans to a lower interest rate.
The worst possible state for your student loans is default, and to be blunt, the best repayment plan is the one that allows you to avoid default. Lower monthly payments and longer repayment periods don’t help you pay off the loan any faster, they simply enable you to hold onto more money in the short term. If you cannot make the monthly payments of the standard plan, then the income based repayment plan is most likely going to be best for your situation.
For borrowers with very high debt to income levels, the best option might be the PAYE or REPAYE plans. If you expect to continue to be making payments well after 20 years, these plans give you a chance to face forgiveness after making diligent payments. If it weren’t for the forgiveness at the end of the rainbow, these options wouldn’t be financially smart, because over the course of the loan, the interest would be significantly larger than on the standard payment plan.