The end of the payment pause also means the return of interest charges to federal student loans.
The good news for borrowers is that there are options to minimize the damage caused by the return of interest charges.
Many borrowers can avoid interest charges altogether, thanks to a new repayment option and generous subsidy.
SAVE Could Mean Zero Interest Charges
The newly created SAVE (Saving on A Valuable Education) plan will charge the lowest monthly payment out of all federal Income-Driven Repayment plans.
One of the highlights of SAVE is that it offers a subsidy that covers 100% of the unpaid interest that accrues each month.
Suppose your monthly bill is $150 on save, but your loan generates $300 per month in interest charges. The SAVE subsidy will cover that extra $150 that accrues each month. This means that balances won’t go up for borrowers on SAVE. In our example, the borrower’s interest rate is effectively cut in half.
Because SAVE sets discretionary income at 225% of the federal poverty level, many more borrowers will qualify for $0 per month payments. These borrowers won’t have to make payments, and they won’t have to pay any interest.
Strategy for Attacking Debt
Many federal borrowers stopped making payments during the pause and elected to set that money aside in a high-yield savings account. The idea was to earn money on interest while student loan interest was 0% and then make a large payment once the government starts charging interest again.
These borrowers may choose to pay off their loans as quickly as possible to minimize interest spending.
If you fall into this category, the strategy is typically to pay off the loan with the highest interest rate first.
What About Student Loan Forgiveness? The new SAVE plan might change the forgiveness analysis for some borrowers.
If pursuing IDR forgiveness or PSLF might be an option for you, making extra payments may not be the best choice.
Tread Carefully on Refinancing
Historically, the borrowers who opted to pay off their federal loans as quickly as possible often used a private refinance to accelerate the process.
The idea was that with a lower interest rate, the debt could get paid off faster.
Two things have changed that make refinancing less appealing. First, the SAVE plan means IDR forgiveness might work for more borrowers. Second, the interest rates on refinance loans are much higher than they were back in 2020.
Refinancing only makes sense if you can get a lower interest rate. Otherwise, giving up the federal perks and protections is a mistake.
As of October 2023, the lowest interest rates on 5-year fixed-rate loans are:
|Rank||Lender||Lowest Rate||Sherpa Review|
|T-1||4.96%*||Splash Financial Review|
Knocking Out Private Debt Still the Priority for Most
Many federal loan borrowers used the payment and interest freeze to focus on their private student loans. This was a really clever strategy.
Now that the payment freeze is over, making extra payments on private loans may be a bit harder. However, most borrowers will still want to focus on eliminating private loans while making minimum payments on their federal loans.
The analysis is simple. Federal loans have great perks that protect borrowers who are unemployed or in difficult financial circumstances. Private loans are less forgiving. This is why refinancing federal loans into private loans can be risky.
The one time a borrower might elect to focus on their federal loans before their private loans is if they have extremely low interest private loans. If your private loan charges 3% interest and your federal loan charges 7%, attacking the federal debt first could make sense.
Even then, it isn’t a certainty. Paying off private loans before federal loans only makes sense if you are reasonably confident that you will eventually pay off all of the debt. At that point, it is just a question of reducing interest spending.
If you have sufficient job security, it could make sense to pay off higher-interest federal loans first.
Revisit Your Debt Elimination Strategy and Financial Goals
It’s also important to remember that student loan repayment doesn’t happen in a vacuum. We all have financial goals, concerns, and challenges outside of student debt.
Aggressively paying off your federal loans to save money on interest doesn’t make sense if you also have high-interest credit card debt.
Similarly, paying extra on a mortgage charging 4.5% doesn’t make sense if you have student loans at 6.5%.
Your student loan interest rate has gone up. How you adjust to this change will depend considerably on your other financial goals and hardships. Student loans are just one piece of a much bigger puzzle.