Graduating from college takes determination, hard work, and fortitude — but so does paying for your education. Picking the right student loan repayment option is so hard because you often enter into the process before you have a real idea of what your future will hold. And while you can change the terms of your loan down the road, you can’t change the amount you borrowed.
“Many students just borrow loans without thinking about what the payments will look like, what their job prospects will be, and how they will handle their finances in the future,” said Betsy Mayotte, director of consumer outreach at American Student Assistance, a Boston-based nonprofit. In other words, if you’re drawn to a career that typically pays $35,000 a year, it may be unwise to take on $200,000 of debt to pay for a private school education.
And when it comes to private loans, tread lightly! It’s important to remember that unless you have a well-established credit history, you’re going to need a cosigner to take out a non-federal student loan — private lenders won’t take on the risk. And private loans don’t come with the protections and flexible repayment options of federal student loans: Once you have a private loan, your only real option for changing the terms of it is through refinancing.
Federal Student Loan Repayment Options
Don’t panic, though: When it comes to your federal student loans, you have options. The Department of Education’s (DOE) website lists a number of federal loan repayment options meant to cater to borrowers’ needs. There’s also the Federal Student Aid Repayment Estimator, a great tool for estimating repayment for all of the federal plan options available, including how much you’d pay per month, overall, and if there is any forgiveness available.
But while you’re here, let’s take a look at the two primary types of federal loan repayment plans: Basic and Income-Driven Plans (IDP), and what they encompass.
Basic Repayment Plans
Basic loans are not driven by your post-graduation income. There are three types of Basic plans: Standard, Graduated, and Extended.
- Definition: This is where you start, a 10-year plan at a fixed amount. If you’re consolidating with other loans, be sure to review this repayment schedule, as your term may be longer.
- Who should consider: Those who are confident that a lucrative post-college career will allow them to pay down their loans without trouble.
- Definition: Same style as the Standard plan, except your payments start small and grow every two years.
- Who should consider: People entering into careers with regular promotions that lead to increasingly larger paychecks.
- Definition: Similar to Standard, with lower monthly payments spread out over a longer period of time. The borrower must have $30,000 in outstanding direct-loan debt, and no outstanding debt from previous loans; check here to see if you qualify.
- Who should consider: People who need longer periods to repay their debt, but don’t necessarily want their repayments to be calculated based on their income.
Income-Driven Plans (IDP)
Most of us fall into the income-driven spectrum. There are a few different flavors of Income-Driven Plans, but they all share many of the same traits:
- Repayment is based on a percentage of your discretionary income—usually 10% to 20%. Discretionary income, according to Mayotte, is “your adjusted gross income minus 150% of the poverty line for your family size.”
- The loan periods are longer than basic plans — 20 or 25 years.
- More money is paid in the form of interest over the life of the loan.
- With Income-Based and Pay-As-You-Earn plans, it’s your discretionary income at the beginning of the payment schedule that counts. These loans will never become more expensive per month than the Standard Plan. With Revised-Pay-As-Your-Earn and Income-Contingent Repayment plans, your monthly repayment schedule changes based on your income. These loans could get more expensive per month than the Standard Plan. More information is available on the DOE website.
- IDPs feature loan forgiveness at the end of their terms — however the forgiven balance is treated as taxable income. That means if you have $50,000 in student loans after 25 years for an Income-Based Repayment loan, that balance will be forgiven — but will be considered taxable income.
Speaking of forgiveness, check to see if you’re eligible for Public Service Loan Forgiveness (PSLF), which wipes out your balance after 10 years of governmental or accredited non-profit employment. PSLF is not taxable.
Income-Based Repayment Plan (IBR)
- Definition: Your monthly payment is limited to 15% of your discretionary income (10% if you have no outstanding Direct or FFEL loan balances). There are income level and family size requisites, so check to see if you qualify. Outstanding balances are forgiven after 20 years.
- Who should consider: People not earning enough based on their debt to pay off a loan under the Standard plan. With this plan, married borrowers should file their taxes separately.
Pay As You Earn Plan (PAYE)
- Definition: Repayment is capped at 10% of your discretionary income. There are income level and family size requisites — check here to see if you qualify. Outstanding balances forgiven after 20 years. The main difference between IBR and PAYE is that with IBR, you pay 15% of your income if you aren’t considered a new borrower.
- Who should consider: People with high debt-to-income ratios. As with the IBR plan, married borrowers should file their taxes separately.
Revised Pay As You Earn Plan (REPAYE)
- Definition: Like PAYE, payment is capped at 10% of your discretionary income. Outstanding balances are forgiven after 20 years (undergrad loans) or 25 years (grad school loans).
- Who should consider: Pretty much everyone qualifies for this plan. People interested in but not eligible for the PAYE plan usually consider REPAYE.
Income-Contingent Repayment Plan
- Definition: Monthly payments will be either 20% of your discretionary income or the amount you would pay based on a 12-year fixed payment plan, whichever is less. Outstanding balances forgiven after 25 years.
- Who should consider: Any borrower with an eligible loan can access this plan, including parents.
When it comes to student loans, remember to consider the “long game,” as Mayotte says. “It’s not about paying the least amount per month–it’s about paying the least over time,” she says. If you take a close look at the DOE’s website, talk with your loan servicer, and consider your future career, you’ll make the right loan choice for you.