Picking the Best Repayment Plan

Michael Lux Blog, Student Loans 0 Comments

Most student loans come with a number of repayment plan options.  Borrowers of Federal loans have many choices, including plans based upon monthly income, rather than amount of debt.  If you refinance your loans on the private market, lenders will give you a number of repayment plans and interest rate options.  Figuring out the best choice isn’t always an obvious.

Federal Loans

When Federal Student Loans go into repayment, the default plan is the 10-year repayment plan.  This is also the payment plan that results in the highest monthly payments.  Many borrowers quickly find themselves unable to keep up with these huge payments.  Fortunately, there are a number of options to pay back Federal Student Loans.

There are two important details that all borrowers should keep in mind when picking a repayment plan.  First, no matter what plan is chosen, the interest rates will be the same.  Second, there are no prepayment penalties.  Because these two factors exist, we suggest always picking the plan that results in the lowest minimum monthly payment.

By picking the lowest monthly payment, borrowers are able to concentrate their efforts paying back their highest interest student loan debt.  As an example, suppose a borrower has two federal loans, one at 4.5% and one at 7.9%.  By selecting plans with the lowest minimum payments, all of the extra cash available can be directed towards the highest interest loan first.  If the money were paid more evenly, the amount spent on interest over the life of the two loans would be higher.

In theory, a borrower could potentially pick a more aggressive repayment schedule for their highest interest loan, but we like the flexibility that comes with lower monthly minimums.  If unexpected costs throw your monthly budget into chaos, the lower payment could be a huge asset.

The final thing to keep in mind with federal loans is that there are also forgiveness programs in place, such as Public Service Student Loan Forgiveness.  If you are seeking forgiveness, it may make sense to just pay the minimum in order to maximize the amount forgiven.

Private Loans

When it comes to private loans, things get a little more tricky.  This is especially true if you are consolidating your student loans with a private consolidation lender.  During this process you will have a number of different repayment plans to choose from, and each one will have a slightly different interest rate.  The lower the interest rate, the less time you have to pay off the loan, and the higher the monthly payment.

In this case, it doesn’t make sense just to pick the lowest monthly payment.  Doing so could unnecessarily cost you extra money in interest over the long run.

To figure out the best plan, a good first step is to figure out exactly how much you can afford each month.  Because repayment can take a number of years, it is important to be conservative.  The goal is to find a number that you can comfortably pay each month, even when other bills might be higher than usual.

Once you have your comfort payment level, try to pick the plan that is closest to that number.  Picking a plan with even higher payments could result in a missed payment or late fees and picking a plan with a lower payment will result in an unnecessarily higher interest rate.

Ultimately, the best way to minimize spending on your student loan debt is to pay off the debt as quick as possible.  No matter what plan you select, it is important to pay off the loan as fast as possible.

Final Thought

Even though there are many payment plans and strategies that can be chosen, the important thing to remember is that each month you are paying interest to your lender.  The bigger your balance, the more interest you are paying.  The money applied to interest is how the lender profits.  The lower your balance, and the sooner you pay the loan off, the less that is spent on interest.