When it comes to federal student loan repayment plans, there isn’t a plan that is clearly the best. Some plans work great in certain circumstances, while others excel under different conditions.
Today we will take a deep dive into the federal student loan repayment plans and various options avaialble. For each repayment plan we will cover the payment schedule, rules and regulations, and explain who could benefit from that particular payment plan.
Before getting started, it is important to cover a couple of definitions and tips regarding repayment of federal student loans:
Federal Student Loan Servicers – The company paid by the government to collect your federal loans is your student loan servicer. While the servicer is arguably required to help borrowers find the best repayment plan, servicers often fall short of this standard. Working with a loan servicer is essential, and they can be a valuable source of information. However, it can be a big mistake to rely entirely upon federal student loan servicers.
If you are unsure of the lender charged with servicing your federal student loans, the federal student loan database will have up to date records on the servicer(s) you should be working with.
Repayment is the Goal – Much of this article will cover the minimum payment requirements on various plans. Selecting the repayment plan with the lowest minimum monthly payment can have significant advantages, but it is important to remember that the vast majority of borrowers will have to pay back their loans in full with interest. Simply making the smallest payment can result in maximum interest spending. For this reason it is important for borrowers to not just seek out the “best” federal repayment plan, but to come up with a strategy for debt elimination. The goal should be to eliminate student loans while spending as little as possible. Merely delaying payments will only serve to increase the cost of the debt.
The Student Loan Repayment Estimator – One of the most useful resources for federal borrowers is the Federal Student Loan Repayment Estimator. This tool allows borrowers to use their actual loan information to see how much they would be expected to pay on various repayment plans. It isn’t a perfect resource, but it does a nice job helping people see how the various repayment plans would work in their individual circumstances.
Federal Student Loan Consolidation – Federal student loan consolidation is the process by which the federal government combines all of a borrowers existing federal loans into one or two individual loans. Borrowers normally go through this process to convert an old loan that may not be eligible for a desired repayment plan or program into a new loan that is eligible for the preferred program. Deciding whether or not to consolidate can be a tricky question, but is essential, especially for borrowers considering pursuing Public Service Loan Forgiveness.
Finding the Best Federal Repayment Plan
If there isn’t a single definitive repayment option that stands out as the best, how is a borrower to pick the right plan?
The best way to view the federal repayment plans is to consider them tools in a toolbox. As an example, a borrower might opt for a plan with a very low minimum payment so that they can focus their efforts on paying down high-interest credit card debt. Once the high-interest debt is paid off, it is time to switch tools, and our borrower might switch plans to a more aggressive repayment strategy.
The key is to understand how these tools can be used. Once you have an understanding of the various options, you can pick the right tool for the job.
The Standard Repayment Plan
The first student loan bill can have a very intimidating minimum monthly payment. By changing repayment plans, borrowers can find a more affordable alternative.The Standard Repayment Plan is often called the 10-year repayment plan. This is the default plan for most student loan borrowers. That means that the first student loan bill that shows up in your mailbox or inbox is likely to be based on this plan. It is also the repayment plan that usually has the highest minimum payment.
The math on the standard repayment plan is simple. Payments are calculated so that the loan is paid off in full after 10 years, or 120 payments. The monthly payments stay level for the duration of the loan. (Note: for borrowers who consolidate their loans, the standard repayment plan can actually have a repayment length of 10 to 30 years.)
The Graduated Repayment Plan
The Graduated Repayment Plan was set up to help borrowers ease into their student loan repayment.
Borrowers enrolled in the graduated repayment plan will see their monthly payments increase every two years. The repayment length on the graduated repayment plan is 10 years, unless the borrower has previously consolidated their federal student loans, in which case repayment can last for 10 to 30 years.
While starting with smaller payments and gradually increasing payments may sound appealing, this repayment plan is normally not the best choice for most borrowers. One of the major flaws with the graduated repayment plan is that it doesn’t qualify for some of the best federal student loan forgiveness programs. Borrowers looking for lower payments are typically better off opting for an income-driven repayment plan due to their increased flexibility.
The Extended Repayment Plan
The Extended Repayment Plan gives borrowers 25 years to repay their student loans.
The Extended Plan comes in two varieties. Option one is to have fixed payments for the entire 25 years while. Option two is to have graduated payments, sometimes called the extended graduated repayment plan. Borrowers who opt for lower payments now and higher payments in the future will end up spending more on interest.
Like the Graduated Repayment Plan, the Extended Repayment Plan isn’t ideal for most borrowers because it does not qualify for student loan forgiveness under Public Service Loan Forgiveness or Income-Driven Loan Forgiveness. Even for borrowers who do not expect to pursue loan forgiveness, opting for an income-driven plan is often preferable because it keeps that possibility open in the future.
If the Extended and Graduated Repayment Plans seem like lousy options, part of the reason is that these plans were created long before the newer, more borrower friendly plans were created. In some ways, these plans are useless relics. That being said it is certainly conceivable that circumstances might exist such that a borrower chooses one of these plans.
Public Service Loan Forgiveness NoteWhile the Graduated and Extended Repayment plans are not eligible for PSLF, borrowers who are otherwise eligible may have a limited opportunity for forgiveness.
Income-Driven Repayment Plans
The remaining federal repayment plans fall into the category of Income-Driven Repayment plans or IDR plans.
What makes these plans special is that monthly payments are based upon how much a borrower makes rather than what they owe. In theory this means that all federal borrowers should be able to afford their monthly payments.
Under all of the IDR plans, borrowers must first submit income verification. For employed borrowers, this usually means their most recent tax return or latest paystubs. From this information, the loan servicer will calculate a borrower’s discretionary income. We have previously looked at discretionary income calculations in more detail, but the short version is that once a borrower earns enough to be above 150% of the federal poverty level, they must pay a portion of the remaining income towards their student loans. The percent of discretionary income required depends upon the specific income driven repayment plan selected.
The other big perk is that all borrowers who enroll in an income-driven repayment plan are eligible for student loan forgiveness after 20 to 25 years, depending on the plan. For borrowers with no hope of ever repaying their federal loans, this route to forgiveness offers a light at the end of the tunnel. The bad news is that the IRS considers forgiven debt to be income for tax purposes, and unlike PSLF, there is no special exception for this type of student loan forgiveness. As a result, borrowers planning on forgiveness after 20 to 25 years need to also plan for a giant tax bill in that year. If you have $50,000 in student loans forgiven, you will be taxed as though you made an extra $50,000 that year.
The table below shows the basics of each Income Driven Repayment Plan:
|Plan||Discretionary Income Required||Years Until Forgiveness|
|ICR - Income-Contingent Repayment||20%||25|
|IBR - Income-Based Repayment||15%||25|
|PAYE - Pay As You Earn||10%||20|
|IBR for New Borrowers*||10%||20|
|REPAYE - Revised Pay As You Earn||10%||20 or 25**|
** Borrowers with graduate school debt will take 25 years while those with undergrad only can qualify after 20 years.
While our handy table does cover the basics of the various IDR plans, there is fine print associated with each program that borrowers should understand. It some cases this fine print prevents certain borrowers from applying to their desired repayment plan. In other cases, some repayment plans have unique perks that make them an ideal option.
Does My Spouse’s Income Count in Repayment Plan Calculations?
Being married can make federal student loan repayment a bit more complicated.
As a general rule, the Department of Education looks at a couple’s ability to pay the debt and calculates discretionary income for the couple rather than the individual. For married couples who both have federal student loans, this means that the math will get a little more tricky, but household spending on federal student loans will remain constant. When calculating payments, the Department of Education determines the exact number that a couple will be expected to pay each month. The monthly payment is then based upon relative loan size.
For couples who both have federal student loans, the math might look like this:
Mr. and Mrs. Example both sign up for IBR. Based upon their latest tax return, the Department of Education determines that 15% of their combined income results in a $300 per month IBR payment. Mr. Example owes $40,000 on his student loans while Mrs. Example owes $20,000. Because Mr. Example’s debt is double his wife’s, he will owe double the payment. This means Mr. Example will be charged $200 per month while Mrs. Example gets charged $100 per month. If Mr. and Mrs. Example had equal debt, they would each be expected to pay $150 per month. Filing separately wouldn’t save the couple any money, it just means the individual payments may be slightly different depending upon loan balances.
For couples with one spouse who has federal loans and one who does not, things get more tricky. This because most IDR plans will calculate payments based upon their combine income, rather than just the student loan borrower. The good news is that on certain repayment plans, the couple can file their taxes separately in order to secure a lower payment. The bad news is that by filing separately, the tax bill in April can be more expensive. For some couples it makes more sense to file jointly and live with the higher monthly payment because the debt will have to be paid anyway. For others, filing separately to get lower payments might make sense if the student loan borrower is chasing after student loan forgiveness.
Unfortunately, not all repayment plans allow for filing separately to get lower payments. Specifically, the Revised Pay As You Earn Plan (REPAYE), does not allow couples to use this tax move to get lower payments. The other IDR plans will allow for separate filing in order to secure lower monthly payments.
Pay As You Earn (PAYE)
The Pay As You Earn Plan (PAYE) is one of the most popular federal student loan repayment plans. Borrowers are only expected to pay 10% of their discretionary income and forgiveness comes after 20 years. The 10% and 20 year numbers are both the lowest available of all the IDR plans. The PAYE plan is also an eligible repayment plan for Public Service Loan Forgiveness.
The downside to PAYE is that it is only available to borrowers who are new borrowers as of Oct. 1, 2007, who received a disbursement of a Direct Loan on or after Oct. 1, 2011.
With the many advantages to PAYE, those that are eligible are likely to find PAYE to be the best income-driven repayment plan.
The one notable exception would be borrowers who have large balances and small incomes…
Revised Pay As You Earn (REPAYE)
The Revised Pay As You Earn Plan (REPAYE) was initially created to help borrowers who were too old to qualify for PAYE. Like PAYE, REPAYE requires only 10% of a borrowers discretionary income, and like PAYE borrowers with only undergraduate debt can have their balances forgiven after 20 years. Unlike PAYE, borrowers with graduate debt cannot qualify for forgiveness until they have made 25 years worth of payments.
REPAYE is also an eligible repayment option for borrowers hoping to qualify for Public Service Loan Forgiveness (PSLF).
When the final rules were drafted there was some unique fine print on REPAYE that makes it a better option for some borrowers and a worse option for others.
REPAYE is unique in the way it treats excess interest. Excess interest is best described as the interest your loan generates each month that your payment doesn’t cover. For example, if your loan generates $200 per month in interest each month but your minimum monthly payment is only $100, your balance is actually growing by $100 per month. REPAYE helps borrowers in this situation because half the excess interest goes uncharged. In our example, the loan balance would only grow by $50 per month rather than $100 per month.
When loan balances grow with each passing month the loan is said to be negatively amortized. REPAYE is the only repayment option with a favorable perk for borrowers with negatively amortized loans.
Important Note for Borrowers with Negatively Amortized LoansIf your interest is growing faster than your payments pay down your loan, your balance is going up each month. However, this extra interest isn’t immediately added into your principal balance. Instead, it waits for an event to trigger interest capitalization. When the interest is capitalized, it means you start paying interest on the extra interest, which can cause a balance to grow really fast. Borrowers in this situation need to understand the events that can trigger income capitalization and avoid them when possible.
The downside to REPAYE is that it will include spousal income regardless of whether or not the couple files separately.
Due to the way REPAYE handles excess interest, it should be the preferred option for most borrowers who have massive debts but low monthly payments. REPAYE is also a good option for borrowers with loans too old to qualify for PAYE or IBR for new borrowers.
Income-Based Repayment Plan (IBR)
The Income Based Repayment Plan or IBR is one of the most popular repayment plans. For a long period of time the IBR plan was by far the best option for a large number of borrowers. As time has passed, new programs such as PAYE and REPAYE were created. While IBR might still be the preferred choice for some, it is no longer the slam dunk it used to be.
Before we get into the IBR specifics, it is important to note that their are actually two forms of IBR, IBR for New Borrowers and standard IBR. These two repayment plans work in the same manner, but there are three key differences:
- IBR for new borrowers only charges 10% of discretionary income (standard IBR is 15%),
- IBR for new borrowers offers forgiveness after 20 years (standard IBR is 25), and
- IBR for new borrowers is only available to borrowers who started borrowing after July 1, 2014.
The IBR for new borrowers plan is an excellent option, but few borrowers are currently eligible for this repayment plan.
IBR used to be the best option for borrowers who were not eligible for PAYE because it is only open to new borrowers as of Oct. 1, 2007, who received a disbursement of a Direct Loan on or after Oct. 1, 2011. However, the creation of REPAYE has largely fixed that issue because it does not have a “new borrower” limitation.
Today the old borrowers that might still opt for IBR would be those who desperately want to file their taxes separately so that spousal income in not included in their monthly payment. These borrowers are willing to pay 15% of their discretionary income and pay a higher tax bill.
Income-Contingent Repayment Plan (ICR)
The Income-Contingent Repayment Plan (ICR) is much less desirable than the newer income-driven repayment plans. This is because ICR charges 20% of discretionary income and requires a full 25 year before standard student loan forgiveness is an option. ICR is an eligible repayment plan for Public Service Loan Forgiveness purposes.
However, ICR is still a good option for some borrowers, because it is the only option for some borrowers. The most common example would be parents who borrowed PLUS loans to pay for their kids college. If these parents consolidate their PLUS loans into a federal direct consolidation loan, they can become eligible for ICR and Public Service Loan Forgiveness. For many Parent PLUS loan borrowers, this is the best option.
FFEL Loans, PLUS Loans and Perkins Loans
The Federal Family Education Loan (FFEL) program and the Perkins loan program were two very popular forms of student loans for a number of years. In 2010 the FFEL program was terminated and in 2017 Congress chose not to renew the Perkins Loan program. These two programs were unique in their funding structure and as a result the government treats repayment of these loans somewhat differently than the standard federal direct loans.
The PLUS loan program continues to this day, but also receives specialized treatment in repayment.
Borrowers with FFEL Loans, PLUS Loans and Perkins Loans should know that these loans may not be eligible for all repayment plans. They should also know that federal direct consolidation can often serve as a backdoor to make the debt eligible for the desired repayment plan. However, some of these loans can also be toxic and destroy program eligibility. For example, consolidating a PLUS loan made to a graduate student into a federal direct consolidation can make that loan eligible for repayment plans such as REPAYE and get the debt eligible for Public Service Loan Forgiveness. However, including a PLUS loan made to a parent in a federal direct consolidation loan means the entire consolidated loan isn’t eligible for REPAYE.
We won’t be getting into the specific eligibility issue for these loan types, but borrowers with these loans should be aware of the potential issues. Handling these loans will require a bit more research and extra conversation with your student loan servicer.
How do I change Repayment Plans?
Enrolling in your desired plan can be as easy a phone call to your student loan servicer, though enrollment in an income-driven repayment plan will require a little more work.
The key to a successful enrollment is constant contact with your loan servicer to make sure that things are being done per your instructions.
Signing up for an Income-Driven Repayment plan will require completing an Income-Driven Plan Request with the Department of Education. The form takes just a few minutes to fill out and most borrowers are able to have the IRS send their most recent tax return information directly to the Department of Education, making the process fast and simple. Other borrowers may have to manually submit recent paystubs if they are not using a tax return.
IDR requests can take well over a month to be processed, so borrowers should not expect instant results on their request.
Is Deferment or a Forbearance on Option?
Borrowers who are struggling to repay their federal loans can opt to sign up for a deferment or a forbearance, but generally speaking a deferment or a forbearance is a bad strategy.
When a borrower isn’t making payments towards their loans, the balance grows and a difficult situation becomes even harder to manage. Opting for an income-driven repayment plan can mean $0 per month payments, but it starts the borrower on a path to forgiveness and debt freedom.
In short, a forbearance or a deferment is a short-term solution to a long-term problem. They may be helpful in some limited circumstances, but most borrowers would be better served by putting a plan in place to eliminate their debt rather than just delaying payments.
Refinancing with a Private Lender
Another option for federal student loan repayment is to refinance with a private lender.
This option carries major risks because the refinance process pays off old federal loans in full and creates new private loans. These new private loans don’t have the same great forgiveness programs or the flexibility afforded by income-driven repayment plans. Making things even riskier is the fact that there is no way to “undo” a student loan refinance. One the federal loan is paid off, it can never come back.
The benefit is that borrowers can get dramatically reduced interest rates. There are approximately 20 nationwide lenders offering refinancing services, and they get aggressive going after borrowers with good jobs and a strong credit rating.
Weighing the risk vs. the reward on the refinancing decision can be tricky. We normally suggest borrowers hold off on refinancing until they are confident that they will be paying back their federal loans in full. At that point, it is time to check the current refinance rates to see if there is any potential savings available.
Which Federal Repayment Plan is the Best Option?
There are a variety of federal repayment plans and there are specific circumstances where each repayment plan excels.
Many borrowers may find that one plan is best initially, but change plans as their repayment situation evolves.
The most important thing for borrowers is to understand the options available so that they don’t miss out on any savings opportunities.