As students get ready to embark on their college careers, most probably don’t give much thought to how they’ll pay back their student loans after they graduate.
These four years go quickly, however, so it’s good to have an idea of how repayment works. The good news is that you have a few options. The bad news is that these choices may prove both overwhelming and confusing (income-driven plans, in particular, have very similar names).
Before we get to those, though, there are a couple of things worth mentioning. First, remember that the goal of any interest-accruing debt is to pay it off as quickly as possible. Earlier payoff means you’ll pay less over the life of the loan (it probably goes without saying, but this is due to the additional costs incurred through interest). Second, you can switch to a different repayment plan at any time to suit your needs, goals, and situation as long as your account is in good standing.
That being said, below is an overview of the different student loan repayment programs. For a more extensive breakdown, complete with all the fine print, you should consult StudentAid.gov. But for now, consider this your student loan cheat sheet.
The General Plans
There are three basic repayment schemes available to loan recipients: standard, graduated, and extended. These do not take an individual’s income into account, and terms range from 10 to 25 years.
Standard Repayment Plan
This is the default program that you’ll be placed into when you complete your studies. It’s designed so that your loans will be paid off in 10 years, and payments are set at a fixed amount of at least $50 per month. This is the best strategy if you can swing it — you’ll end up paying relatively little in interest compared to other plans — but due to its high monthly installments, not everyone can. And if you can tack on extra to your minimum payment every month, you can shorten the life of the loan even more substantially.
Graduated Repayment Plan
This option starts out with payments that are low, but which then gradually increase every two years. The idea is that as your earnings increase over time, so too will your payments. It is also a 10-year plan, but because of its low cost up front, you’ll pay more in interest than with the standard plan. This is because larger repayment amounts, and the interest they accrue, are held for later. It’s good for students who need to establish some financial footing but don’t necessarily want to extend the life of their loans.
Extended Repayment Plan
For those who are really strapped for cash, this program gives you a much longer time frame in which to pay off your loans — up to 25 years. As a result, it also requires a lower monthly payment. Over time, you’ll be paying a lot more for your loans because of the accumulating interest, but the minimum payment will be more manageable on a month-to-month basis.
The Income-Dependent Plans
The next options are all income-driven repayment plans. They are designed to reduce your student loan payments at times when you have a lower income. What’s different, however, is that some of these plans include an eligibility requirement (in other words, you’ll have to complete paperwork and are subject to an approval process). These plans may also have different rules (regarding both time and amount) depending upon when your loan originated.
A general rule of thumb is that if your federal student loan debt is higher than your annual discretionary income — your income after subtracting taxes and the cost of personal necessities like food, clothing, and rent — or represents a significant portion of your annual income, you should qualify. Here’s a quick overview of these options:
Income-Based Repayment Plan
Choosing this plan means your maximum monthly payments will be set at 15 percent of discretionary income (which is the difference between your adjusted gross income and 150 percent of the poverty guideline for your family size and state of residence). I know that sounds complicated, but there’s a formula that will calculate this figure for you on FinAid.
In simpler terms, your payment amount will change as your income changes. You have up to 25 years to pay off your loans under this program. If you have not repaid them in that time, however, any outstanding balance on your loan will be forgiven (assuming you kept your payments in good standing).
Pay-as-You-Earn Repayment Plan
This is very similar to the income-based plan, except that your maximum monthly payments will be set at 10 percent of your discretionary income (instead of 15 percent), and you’ll have up to 20 years to pay off the loans.
Income-Contingent Repayment Plan
Under this plan, payments are adjusted each year based on your adjusted gross income, the size of your family, and the total amount of your direct loans (loans from the government, as opposed to from a school).
An additional attribute that sets this option apart from others is that it does not have an initial income eligibility requirement. This makes it well-suited for individuals pursuing work in relatively low-earning fields, such as social work or nonprofit careers. There is a 25-year term on this option.
Income-Sensitive Repayment Plan
While your monthly payment will fluctuate based on your annual income for this plan, you will have up to 10 years to pay it off. However, the formula for determining your monthly payment will vary depending on the lender.
If you think moving into any of these programs will help you successfully pay off your student loans, don’t just pick one at random. Start by using the Federal Student Aid repayment estimator to do some number-crunching. Then, get in touch with your loan servicer to discuss your options and asks lots of questions so that you can choose the payoff plan best suited to your needs.