Student loans are the largest type of debt incurred by U.S. consumers, other than mortgages. Americans now owe more than $1.48 trillion in student loan debt, according to the latest data.
Although student loans are certainly a major debt burden in the U.S., federal student loans are one of the most flexible types of debt. Specifically, there are several different repayment options you can choose from in order to keep your payments affordable and take advantage of loan forgiveness programs. If you're a student loan borrower, here's a rundown of the options that may be available to you, and what you need to know about each one.
When do you need to start repaying your federal student loans?
It depends. The short answer is that you have to start repaying your loans after you leave school or drop below half-time enrollment, plus a grace period if your loans have one.
The length of your grace period depends on the type of loans you have. Federal direct loans and Stafford loans, subsidized and unsubsidized, have a six-month grace period after you leave school before your first payment will be due. If you have Federal Perkins Loans, your grace period may vary -- check with the school where you received the loan.
If you have PLUS loans, which are made to parents and graduate students, there is no grace period or automatic in-school deferment. They enter their repayment period once the loan has been fully disbursed.
Standard student loan repayment
The "standard" repayment plan consists of 10 years of equal monthly payments. All federal student loans are eligible, and your loans will be completely paid off after the 10-year period.
The downside to the standard repayment plan is that your monthly payment will generally be higher than it would be under other repayment plans, at least at first. However, you'll also end up paying less interest over time than you could by stretching out repayment over a longer period of time.
To be perfectly clear, this is the default option your loans will be initially placed in when your in-school deferment runs out. If you want to use any other repayment option, including income-based repayment (more on that in a bit), you'll need to make the switch yourself. The standard repayment plan is not a good option if you're planning to apply for Public Service Loan Forgiveness, and it's rarely a good option in any situation, so it's important to know that you'll need to make the effort to get into the best repayment plan for you.
The graduated repayment plan is also a 10-year repayment plan, but it can be longer if you have a consolidation loan, which I'll discuss later on.
The basic idea of the graduated repayment plan is that your payments will start out low but will increase every two years. This can be an especially good choice for people in careers where the initial salary is low, but where there is an expectation of significant increases over time.
All federal student loan borrowers are eligible for the graduated repayment plan, but it's important to point out that it's not a qualifying plan for Public Service Loan Forgiveness -- after all, the PSLF program forgives a remaining balance after 10 years, but the graduated repayment plan will result in complete repayment in that time.
To qualify for extended repayment, you must have more than $30,000 in direct or FFEL program loans (Federal Family Education Loan).
The extended repayment plan amortizes your loans over a period of up to 25 years instead of 10. This is essentially the same idea as obtaining a 30-year mortgage versus a 15-year mortgage when buying a home -- the main point is to reduce the amount of your monthly payment, although you'll end up paying more in interest over time.
It's also important to point out that your payments under the extended repayment plan can be either fixed (the same throughout the loan) or graduated (increasing every two years). And the graduated plan is not a qualifying repayment plan if you plan on participating in Public Service Loan Forgiveness.
Income-driven repayment is the best option for most people
Now for the good part. For the vast majority of student loan borrowers, an income-sensitive repayment plan is the best option. If you qualify for income-driven repayment, the following benefits apply.
- Your payment is capped at a certain percentage of your discretionary income, which is defined as your annual income minus 150% of the poverty level for your family size.
- Your payment will never be greater than it would be under the standard repayment plan, no matter how much you earn.
- Income-driven repayment plans qualify for Public Service Loan Forgiveness.
- Any remaining balance is forgiven after a certain amount of time, even if you don't pursue PSLF.
There are several varieties of income-driven repayment plans, so here's a rundown of each one.
- Pay As You Earn (PAYE) -- This is only available to individuals who were new borrowers after October 1, 2007 and who have received a direct loan disbursement on or after October 1, 2011. Under the PAYE plan, your monthly payments are capped at 10% of discretionary income, and any outstanding balance after 20 years of on-time payments will be forgiven if your loan isn't fully repaid by then.
- Revised Pay As You Earn (REPAYE) -- This is the newest repayment option and was intended to extend the benefits of the PAYE plan to borrowers who didn't meet the time criteria of that plan. Like the PAYE plan, the REPAYE plan also limits payments to 10% of discretionary income. One key difference is that the loan forgiveness time is increased by five years to 25 if any of the loans were taken out for graduate or professional study.
- Income-Based Repayment Plan (IBR) -- The IBR plan limits monthly payments to 10% or 15% of discretionary income, depending on when the first loan was taken out. And any outstanding balance will be forgiven after 20 or 25 years, depending on the first loan date.
- Income-Contingent Repayment Plan (ICR) -- The ICR plan gives you a monthly payment of 20% of your discretionary income or the amount you would pay under a 12-year fixed repayment period, whichever is less, and any outstanding balance after 25 years will be forgiven. For most student borrowers, one of the other options is generally better, but unlike the previous three, the ICR plan can be used by Parent PLUS Loan borrowers if they consolidate the loans into a direct consolidation loan.
A few things to note: First, you'll need to update your income and family size each year, even if nothing has changed, and your payment will be recalculated annually. If you are married, your spouse's income and student loan debt can be considered for income-driven repayment if you file a joint tax return. And finally, it's important to mention that if you end up having any amount of your student loans forgiven, it can be considered taxable income.
Is consolidation a smart option?
If you have several federal student loans, you may be able to consolidate them into a Direct Consolidation Loan. There are obvious advantages to doing this, such as combining all of your payments into one. Consolidating can also allow you to extend repayment for up to 30 years, and you can switch any loans with variable interest rates to fixed interest rates.
However, there are some big disadvantages. Most importantly, if you consolidate loans that you're currently paying under income-driven repayment, you lose any progress you've made to loan forgiveness, including the Public Service Loan Forgiveness program.
In short, if you don't think you'll end up qualifying for any type of loan forgiveness, a consolidation loan can be an option worth considering. On the other hand, if you do plan to pursue loan forgiveness, a Direct Consolidation Loan is probably not a great option for you.
Here are the key points to remember. First, there are several factors you should consider when selecting a repayment plan in addition to the actual dollar amount of your monthly payment. Second, if you want any repayment plan besides the standard 10-year plan, you need to request it. And finally, income-based repayment is the best option for most student loan borrowers, so it's certainly worth exploring.