By Joel Chouinard, CFP®
October 10, 2023
Over the past few weeks, I’ve spent countless hours on the phone with the Federal Student Aid phone line and with various loan servicers trying to find the best student loan repayment strategy for my clients. Between the new changes that the Biden Administration announced in July 2023 and the end of the 3.5 year-long student loan repayment pause (with payments restarting this month), borrowers have found themselves with unanswered questions: What is the new SAVE repayment plan? When should I re-certify my income if I'm on an Income Driven Repayment Plan? Should I refinance my loans with a private lender? In my July 2023 blogpost*, I discussed ways to get your finances in order ahead of payments restarting, such as tracking down your loan information and dusting off your budget. This month, I’ll break down the different repayment strategies available.
Key Takeaways
- The repayment strategy you ultimately choose should be derived from doing a deep dive into your overall life goals.
- The Standard Repayment plan is a fixed, 10-year repayment plan and is based on your loan balance and your interest rate.
- Income-Driven Repayment plans are based on your discretionary income (not your loan balance and interest rate) and in some cases, can lead to loan forgiveness.
- Refinancing your student loans replaces your existing loan with a new loan. For borrowers, this often means taking your federal loans private.
Prioritizing your goals
Working with your end goal in mind should be standard practice in financial planning. A financial planner cannot build a retirement plan if they don’t know what you want to accomplish in retirement and when you actually want to retire. It should be the same for student loan planning. This is especially important because student loan repayment usually happens at a time in our lives when we have many other competing goals, such as buying a house (or upgrading to a bigger one), paying off credit card debt, saving for college, or making a career transition.
For example, if your number one goal is to buy a new house because your family is expanding, maybe you can put your student loan repayment plan on cruise control (i.e., switch to a plan with the lowest monthly payment) until you’ve closed on your new house. On the flip side, if you are planning a career transition soon and would like to have your loans paid off by the time you change jobs, then all your energy should be spent paying off those loans as fast as possible. Once you prioritize your goals, you can pick the most advantageous repayment strategy.
Choosing a Repayment plan
Standard Repayment plan
The Standard Repayment plan is the default repayment plan that you are put on after you graduate. It’s a fixed 10-year plan where your loan balance and interest rate dictate how much you will pay every month. Choosing this plan will likely result in the least amount of interest paid over time, as compared to the other federal repayment strategies discussed below. That said, if you have a large loan balance, the payments could be quite high and may not be affordable for everyone. The Standard Repayment plan is usually best for high-income earners who are looking to pay off their loans as quickly as possible.
Income Driven Repayment plans
If your goal is to eventually obtain loan forgiveness, or if you cannot afford the payments under any of the other plans, then you can turn to an Income Driven Repayment plan (IDR). As the name states, IDR plans are based on your income, not your loan balance or interest rate. The payment is calculated using a percentage of your discretionary income, usually 10-20%. Discretionary income is calculated as the amount of Adjusted Gross Income above the poverty guidelines for your state.
IDR plans can lower monthly payments significantly, especially for low-income families or borrowers with large loan balances. IDR plans are also used to obtain loan forgiveness through various federal programs, such as the Public Service Loan Forgiveness program (PSLF). Under the PSLF, borrowers who work for a public institution (government entity, non-profit, public hospital, etc.), can obtain complete loan forgiveness after making 120 monthly payments under any of the IDR plans. Borrowers who don’t work for public institutions can also obtain loan forgiveness after making IDR payments for 20-25 years. One important thing to note is that unless you are going for forgiveness under the PSLF, you will likely end up paying much more interest over the life of the loan under an IDR plan compared to the Standard Repayment plan.
For a full list of available IDR plans, click here**. You can also find out which IDR plan makes most sense for you by using this loan simulator from the Federal Student Aid website***.
Graduated and Extended Repayment plans
If you are not going for loan forgiveness, and the Standard Repayment plan payment is still too high for you, you could turn to a Graduated or Extended Repayment plan. The Graduated Repayment plan starts you off with a lower payment (about half of what it would be under the Standard Repayment plan), but it gradually increases over time and eventually surpasses the Standard Repayment plan. The Extended Repayment plan is simply a longer-term plan. Unlike the Standard 10-year plan, the Extended Repayment Plan can be extended up to 30 years. These plans are good alternatives for borrowers who make really good income, but are prioritizing other goals first and need to minimize their monthly payment.
Refinancing your loans
So far, we’ve discussed the repayment strategies available for federal student loans. But sometimes, it may make sense to refinance your loans through a private lender. Let’s discuss when that would be the case.
First, what is refinancing? In its most basic definition, refinancing simply means replacing your existing loans with a new loan, much like when you refinance the mortgage on a house. Most of the time, it involves replacing your federal student loans with a private loan, but it can also mean replacing an existing private loan for a new loan with better terms. When a borrower refinances, the interest rate on the new loan is based on current market rates, the term of the loan, as well as the borrower’s creditworthiness (credit score and debt-to-income ratio).
In most cases, refinancing is only beneficial when you can replace your current loans with a new loan with lower interest. Why would someone replace an existing loan with a new loan with a higher interest rate? Lowering your monthly payment or reducing the total interest paid on your loan should be the primary goals. But it’s important to note that refinancing comes with drawbacks, even if you’re able to get a lower rate. When you refinance your loans, you lose access to all of the benefits associated with federal loans, such as deferment, loan forgiveness, and income-driven repayment plans, hence the importance of weighing the pros and cons of every option.
Final note
The key to choosing the right student loan repayment strategy is that it must align with your overall life goals. Before you take on the task of researching all the different repayment strategies, make sure you make a list of what’s most important to you. This should guide you when deciding which strategy best fits your needs.
*https://www.sharpedgefinancialtx.com/.22.htm
** https://studentaid.gov/manage-loans/repayment/plans/income-driven
*** https://studentaid.gov/loan-simulator/
SharpEdge Financial LLC is a registered investment adviser registered with the State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments or types of investments are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment. The author of this publication may hold positions in investments or types of investments mentioned. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.
SharpEdge Financial LLC is a registered investment adviser registered with the State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments or types of investments are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment. The author of this publication may hold positions in investments or types of investments mentioned. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.