One of the great perks of federal student loans is the Income-Driven Repayment (IDR) plans. Borrowers struggling with student debt can qualify for monthly payments as low as $0 per month for an unlimited time period. Continued enrollment simply requires borrowers to certify their income, every year.
While owing zero dollars each month certainly has its advantages, there are some disadvantages that borrowers face. For starters, not having to make a payment doesn’t prevent the accumulation of interest on the loan. This means that borrowers may end up having to pay more over the life of their student loans. Secondly, a zero-dollar payment presents some challenges on credit applications, especially mortgages.
As a result of these disadvantages, many borrowers wonder if they can, and if they should, pay more than the $0 per month minimum payment on their federal loans.
Can I pay more than the minimum on a federal repayment plan?
The federal government charges no prepayment fees on student loans.
This means that borrowers can pay more than the minimum on their loans whenever they like.
Paying extra can be a smart strategy because it prevents the accumulation of interest on the loan. Borrowers worried about interest should also keep a close eye on events that trigger interest capitalization. Missing an income certification deadline for an Income-Driven Repayment plan can cause the interest to be capitalized and force borrowers to pay interest on a larger loan balance.
While paying extra certainly helps borrowers reduce the damage caused by interest, extra payments are not always the best strategy…
Should I pay more than the minimum on a $0 per month federal loan?
Even if borrowers can pay extra on their federal debt, it doesn’t mean they should.
A common mistake in student loan planning is just focusing on monthly payments. The goal, and primary focus, should be on debt elimination.
Many borrowers will conclude that they will have to pay their federal loans off in full. These borrowers should very seriously consider paying as much as possible to keep the balance low.
However, other borrowers may consider student loan forgiveness as their debt-elimination strategy. Public Service Loan Forgiveness is perhaps the best-known forgiveness program, but there are also forgiveness programs for all borrowers on Income-Driven Repayment plans. These plans include Income-Based Repayment (IBR), Pay As You Earn (PAYE), Saving on A Valuable Education (SAVE), and Income-Contingent Repayment (ICR). Student loan forgiveness takes 10 to 25 years on these plans.
In some cases, chasing after student loan forgiveness will end up costing more than just paying off the loan, so there is some math and planning that will have to take place.
The key is to evaluate whether or not forgiveness is a possibility. If forgiveness might be an option, it usually won’t make sense to pay extra on the loans.
Additionally, if you are on SAVE and qualify for the subsidy, in almost all cases the best strategy will be to make minimum payments.
Note on Taxes: Certain forms of forgiveness do come with taxes. Borrowers should plan for taxes on any student debt that might be forgiven.
Could paying extra help qualify for forgiveness?
Most borrowers going after Public Service Loan Forgiveness know that they are required to make 120 certified payments before their loans are forgiven.
Borrowers that qualify for $0 payments don’t actually have to make a payment, so they may fear that they could lose out on a year of public service work. Many propose making small monthly payments each month to have a record of payments to count towards 120.
The good news for PSLF people who have $0 monthly payments is that those $0 monthly payments will still count towards PSLF. They certainly have the right to pay $5 or $10 per month towards their loans, but it isn’t necessary. The important step that these borrowers should be taking is to submit an employer certification form (ECF) each year. Properly submitted ECF forms will give borrowers a tally the number of payments they have on record towards the required 120.
Will paying extra help qualify for a mortgage or car payment?
Mortgage applications can be complicated for borrowers on Income-Driven Repayment plans.
The good news is that the mortgage underwriting rules have improved considerably for student loan borrowers over the past few years. In the past, many monthly payments on IBR, PAYE, and SAVE were not eligible to be used in mortgage calculations. Instead, lenders used 1% of the student loan balance. For many borrowers, this wrecked their debt-to-income (DTI) ratio and sunk their chances of getting a mortgage.
Today, lenders are more willing to use actual payments on Income-Driven Repayment plans. The problem with a $0 payment is that it looks just like a deferment or a forbearance on a credit report. Lenders will not use a deferment or forbearance in payments when calculating DTI. They will want to know what the payments will be one repayment starts back up. They may also choose to use 1% of the loan value.
Some borrowers may be able to persuade a mortgage company that the $0 payment is an actual monthly payment so that it doesn’t hurt their mortgage application. Others may not be so lucky.
One thing that will not help is paying a bit extra each month.
Mortgage lenders look at credit reports when making credit decisions. They don’t care about prior payments. Borrowers with $0 per month payments can’t beat the system by paying $5 or $10 per month, because their credit report will still show a $0 per month minimum monthly payment.
When should I pay more than the $0 payment?
Borrowers who qualify for a $0 payment will benefit from paying extra because it will fight interest and prevents the balance of the loan from growing out of control.
Unfortunately, paying a little bit extra won’t help borrowers qualify for forgiveness or qualify for a mortgage.
Paying Extra for SAVE Subsidy Recipients
If you are on the SAVE plan an qualify for a subsidy, things get particularly interesting.
For those not familiar, the SAVE subsidy covers the excess interest that accures each month. This ensures that borrowers on the SAVE plan don’t see their balances spiral out of control. As long as you are on SAVE, your balance won’t increase.
What happens if you pay extra?
The good news for borrowers is that the extra payment will lower the principal balance. This means you can take advantage of the SAVE subsidy and reduce your debt burden.
However, making extra payments on SAVE isn’t always the best approach. I’d argue that most borrowers are better off making minimum payments on SAVE and finding a more effective use for the “extra” payments.
Ultimately, the SAVE subsidy gives borrowers a ton of flexibility. By understanding how it works, you can use it to the fullest advantage.
