The Different Payment Plans

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In my last post, I covered strategies for a person who has entered repayment on their student loans. There are actually several different payment plans for federal student loans, which I want to discuss today. Remember, these payment plans are available only for federal loans, not private loans. This is just another reason why federal loans are much better than private loans.

Let’s look at the first 3 repayment plans:

Standard Repayment. As mentioned in earlier posts, the standard repayment plan for federal loans is a 10 year repayment plan, with fixed equal monthly payments of at least $50. The monthly amounts are calculated so that after making 10 years of payments, your loan will be paid off entirely.

Graduated Repayment. Graduated repayment is also for 10 years, however, relative to standard repayment, your monthly payments start out lower and slowly increase (usually every two years). So, while your monthly payments will be less than those for standard repayment at first, towards the end of the loan your payments will be much higher than under standard repayment.

Extended Repayment. You can extend the repayment of your loans beyond 10 years under an extended repayment plan. Repayment can be extended up to 25 years, and can include either standard (fixed) payments or graduated (increasing) payments. In order to start an extended repayment plan, you must have an outstanding direct loan balance of at least $30,000. Extending the repayment of your loans will decrease your monthly payment amount, if you make only the minimum payment each month you will pay more over the course of the loan in interest than if you had used a standard 10 year repayment.

The Department of Education also offers repayment plans that tie your monthly payment amount to your income. These plans can be helpful as they help borrowers who are struggling to make their payments with their current income. Each year, the borrower has to re-certify with their current income, which will determine their monthly payments for the coming year. Thus, if income rises, the payments on the student loans will rise accordingly. However, the monthly payment for an income-based plan will never be greater than the monthly payment under a standard repayment plan.

Most of these income-based repayment plans also have a provision where if you make your monthly payments for a certain amount of time (usually 20 or 25 years) and still have an outstanding balance on your student loans, that balance will be forgiven. A caveat to this is that the forgiven amount of loans is taxable as income.

So which of these many payment options is the best? Well… it doesn’t matter. Looking at these different payment options, we can see that their purpose is to decrease the amount of your payments. However, as I discussed in the last post, your goal with paying back your loans should be to pay as much as possible each month so that you can pay off your loans faster and pay less in interest over time.

These alternative methods of payment do two things: decrease your monthly payments and increase the term of your loan. While you have the benefit of paying less per month, this gives more time for interest to accrue on the principal of your loans. So you’ll end up being in debt longer and paying more on that debt!

Romans 13:8 says “Owe nothing to anyone except to love one another…” That sounds like good advice to me! There are so many advantages to being debt-free, or at least removing the burden of student loans off your shoulders. For more discussion of this, I would refer you to my first post in this series. If you asked someone if they would rather be debt-free in 10 years or 20 years, I’m sure that they would say 10 years! And if you asked them that same question but with 5 years or 10 years, I bet that they would again pick the lower number.

That’s why I say the repayment plan doesn’t matter… paying off your student loans as quickly as possible is much more important and more beneficial than trying to pay the smallest amount per month.

Now, that’s not to say these repayment plans are useless. In fact, I think an income-based repayment plan can be extremely helpful in certain situations. Things happen in life, and say that you lose your job. The very next day you could file for income-based repayment. Think about it – the income that your payments is being calculated on is $0! So your monthly payments for the next year will be $0 (remember, you only have to re-certify once per year, not whenever your income changes).

Of course, while your monthly payments are $0, interest will continue to accrue on your loan. However, such a strategy can help to give you some breathing room in a time of financial crisis. The nice thing about income-based repayment is that you can still pay extra on your monthly payments. So, in a time of need you can file for income-based repayment, and when things are back in order you can ramp up the payments on your loans to get them paid off as quickly as possible. In this scenario, income-based repayment acts as the “ace up your sleeve”

When looking at student loan repayments, there are generally two schools of thought. There are those who try to make their student loan payments as small as possible, and those who try to pay off their loans as quickly as possible. As I have already stated, I am firmly in the camp of those who try to pay off their loans as quickly as possible. While these different types of repayment can offer relief in a time of financial crisis, I think by and large they can be ignored in favor of this repayment plan: Pay as much as you can as soon as you can so that you can be debt-free as quickly as possible!

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