Choosing the right repayment plan for you involves careful consideration of all of your options and an honest assessment of your finances. For most Federal Loan borrowers the Income Based Repayment and Pay As You Earn plans will result in the lowest monthly payment and the most favorable terms. Due to the volume of private lenders and the fact that each lender has its own unique repayment plans, we will focus on the Federal Repayment Plans. It is worth noting at this point that the Federal Repayment terms are almost always superior to those offered by private lenders (A more detailed comparison of Federal Student Loans vs Private Student Loans can be found here). If you are stuck with private loans, there are ways to get your payments lowered.
Here are the basic Federal Government repayment plan options:
Standard Repayment. This is the default repayment plan if you take no action. The minimum payment under this plan is $50 per month and the maximum repayment term is 10 years. This repayment plan will be the highest monthly bill.
-> Sherpa Tip: Paying your loan off under the standard repayment plan does not get you a lower interest rate. Because there are no prepayment penalties with Federal Government loans, signing up for one of the alternative repayment plans described below allows you to make lower payments on months where the budget is tight, and pay more than required when you have the money. If you plan smart you can still pay your loan off in ten years, but you have flexibility when you are short on cash.
Extended Repayment. This plan is very similar to the Standard Repayment plan. The key difference is that the loan term will be at least 12 years and can be extended up to 30 years.
-> Sherpa Tip: If you are on a 30 year repayment plan, you should definitely consider one of the income based repayment plans. The way the repayment plans are set up now, everyone should be able to have their loans paid off or forgiven after 25 years.
Graduated Repayment. The graduate repayment plan has a loan term similar to that of the extended repayment plan (12 to 30 years). Every two years the required monthly payment gradually increases. This plan is ideal for people who expect their income to steadily increase over the years.
-> Sherpa Tip: While this plan is a very easy way to get your monthly student loan payment down, if the graduated repayment plan is a necessity for you to afford your payments you will almost certainly qualify for Income Based Repayment as described below. The Graduated Repayment Plan is an older plan with terms that are not nearly as beneficial as the Income Based Repayment and Pay As You Earn plans.
Income-Contingent Repayment (ICR) and Income Sensitive Repayment (ISR). ICR plans are available only for Direct Loans and ISR plans are available only for FFELP loans (such as Graduate Plus Loans). The great part about these repayment plans is that if you make all of your payments for 25 years, the remainder of your Direct Loan and/or FFELP loan debt is forgiven (Note: There are tax consequences). Your monthly payment is based upon your income and it is calculated so that you pay 20% of your income above the poverty level. The downside of the lower payments is that the interest will really add up over time.
-> Sherpa Tip: While this plan offers good terms, the IBR and PAYE plans offer superior terms (Instead of paying 20% of your income over the poverty level IBR and PAYE only require 15% and 10% respectively).
Income-Based Repayment (IBR). This plan was created as part of the College Cost Reduction and Access Act of 2007. Under this plan borrowers are expected to pay 15% of their discretionary income towards their federal student loans (Discretionary income is defined as that which is in excess of 150% of the poverty level). If borrowers make their monthly payments for 25 years the remaining debt is forgiven (Note: there are tax consequences). This plan is also eligible for the 10-Year Public Service Student Loan Forgiveness Program. Under the IBR, there is no monthly minimum payment which means, depending on your income, your monthly bill could be $0.
-> Sherpa Tip: Signing up for this plan can be somewhat tedious. Borrowers must either submit their previous years tax return or two recent pay stubs for determination of income. If you have multiple federal loan servicers, though it isn’t necessary, consolidation helps streamline your monthly payment determination.
-> Sherpa Tip: If you are wondering whether or not you qualify for IBR a calculator can be found here.
Pay As You Earn (PAYE). This plan is brand new and was announced on December 21, 2012. It is very similar to IBR, but offers slightly better terms. The loans are forgiven after 20 years instead of 25 and instead of paying 15%, borrowers are expected to pay 10% of their discretionary income. The downside of this plan is that not everyone will qualify. While the details are still being ironed out, at this point in time, it appears as though borrowers who had an existing loan balance prior to the Fall of 2007 will not be eligible. The federal government has released the specifics of PAYE here.
-> Sherpa Tip: Check back here for updates and further information as it becomes available.