If you have Federal student loans, it's completely understandable to be confused by some of the student loan repayment options available to you. While the standard 10-year and extended repayment plans are fairly straightforward, some of the others can be very confusing.
Specifically, the income-based repayment (IBR), income-contingent repayment (ICR) and pay-as-you-earn plans can be tricky to follow. Who is eligible for which plan and how will you save the most money on your loans? Here is an overview of some of the student loan repayment options to get you started.
The standard plan: best for high-income individuals
If you are making a high salary right out of college, or if you don't have a high student loan balance, you may be better off going with the standard repayment plan.
Basically, the standard plan consists of 10 years of equal monthly payments. While you'll have the highest monthly payment obligation of all the plans, you'll get your loan repaid fast and end up paying less interest over the life of the loan.
If you earn a lot of money or have a relatively low loan balance, you're not likely to save any significant amount of money by going with the other repayment options.
Extended or graduated repayment is rarely the best option
Both of these options will provide you with a lower initial monthly payment, but almost all borrowers would be better off with another repayment plan.
The extended option stretches out your repayment term to up to 25 years. Sure, your payment will be much lower than the standard plan, but you'll pay a lot more in interest, and will not be eligible for any of the major loan forgiveness options, which I'll get to later.
And the graduated plan is similar to the standard plan in that the repayment length is 10 years, but your payments will start out lower and gradually get higher over the course of the loan. Before choosing this option, realize that you're committing to substantially higher monthly payments a few years down the road. You may be making a lot more money by that point, but you could also be earning a similar salary and have some additional financial responsibilities then (mortgage, kids, etc.).
IBR and ICR
Until recently, Income-Based Repayment (IBR) and Income-Contingent Repayment (ICR) were the only two income-sensitive repayment plans offered.
Under both plans, the amount you pay is dependent on your income, and both plans forgive any remaining balance after 25 years of on-time monthly payments. So, while you'll pay more interest under these plans than the standard arrangement, lower-income borrowers could get a substantial amount of loans forgiven, making income-sensitive plans a much better choice than the extended repayment plan.
And, the difference between the two plans is how your monthly payment amount is calculated. Under IBR, your monthly payment is capped at 15% of your discretionary income, which is defined as the difference between your income and 150% of the poverty guideline for your state and family size.
For ICR, your payment is the lower of 20% of your discretionary income, as defined above, or what you would pay on a fixed 12-year repayment plan. Usually IBR produces the more favorable monthly payments.
Pay-as-you-earn is the best bet for most borrowers, if you qualify
The pay-as-you-earn repayment plan was created just a few years ago in order to help make student loans more affordable as debt levels continue to hit record highs.
This plan reduces the payment required by IBR by a third, capping the monthly payment amount at just 10% of discretionary income, while also reducing the forgiveness time to 20 years.
However, the only borrowers currently eligible for this plan are those who took out their first student loan after October 1, 2007, who also received a new loan after October 1, 2011. In other words, only recent students have been eligible.
A recently announced change to the law will open up this program by removing these restrictions, but this won't take effect until December 2015. So, older borrowers will have to tough it out with one of the other repayment plans for a little while longer.
Things to consider
When figuring out the best plan for you, of course you should take into account your current income and which repayment plan will produce the lowest payment. However, that doesn't tell the whole story.
If you plan on qualifying for one of the quicker forgiveness programs, such as public service loan forgiveness, which takes 10 years, or teacher loan forgiveness, which takes five years, it may be in your best interest to arrange for the lowest qualifying payment possible. These programs have their own rules, so make sure to do your homework if you plan to apply for one of them.
Your credit is another consideration, and if you can afford to pay more than the bare minimum you qualify for, it could definitely help your credit score as your balances go down.
In short, you need to pick the best repayment plan for your overall circumstances, not just the lowest payment you can get away with.
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