Which Federal Repayment Plan is right for me?
If you are like many young Americans, then most likely you have federal student loan debt. You probably didn’t think much about it when you took the loans out. Because payments are not required while you're enrolled in school, you may not have thought about them for four, six or even 10 years.
The problem is that the interest on some of those loans is accumulating and has been since day one.
In 2016, the average student graduating from a Massachusetts public or not-for-profit school carried $31,563 in total student loan debt, according to a recent report.
Let’s first take a look at the two main types of federal loans: Direct Subsidized Loans and Direct Unsubsidized Loans.
Direct Subsidized Loans vs. Direct Unsubsidized Loans
Subsidized loans are the better of the two. The difference between subsidized and unsubsidized is how the interest accrues during loan deferment when you're not required to make payments.
Subsidized loans do not accrue interest during school or deferment. The federal government pays for the interest during that period, hence the term “subsidized”.
Deferment is when you are not required to make monthly payments on the student loans under certain conditions. The most common reason is the borrower is attending school at least half time. Other possibilities include active duty military and economic hardship lasting up to three years. Just be sure to continue payments until deferment is approved by the loan servicer.
Unsubsidized loans, which are the less attractive than subsidized, begin accruing interest the day the loan is dispersed. This makes a huge difference as the interest may be accruing for eight years or more with no payments being made. Some of the worst student loan debt cases we have seen have stemmed from significant amounts of interest accruing during extended deferments.
So what can you do about it? Pay the interest!
You are not required to make a payment during deferment but if you simply pay the accruing interest on the loan then it will prevent it from growing into a paralyzing total. If you are really ambitious, pay a little extra and watch the principal go down as well. But maybe it is too late for that, now you’re out of school and have already accrued the interest, let’s explore your options.
Federal Student Loan Repayment Options
Standard Plans: This is a common repayment method where the borrower can afford to make monthly minimum payments. There are two types: level and graduated. On the level plan, the borrower pays the same minimum monthly payment over a 10-year span. The monthly payment is determined by the loan balances and interest rates.
Generally, you will pay the least amount of interest with the level plan. The graduated plan spans 10 years as well but rather than making the same payment over that time, it will start with a lower minimum monthly payment and increase usually every two years. You will pay more interest over time with this plan, but it can be helpful for borrowers who have a low starting salary but expect it to increase in the future.
Extended Plans: If you have greater than $30,000 in Direct Federal Loans or from the Federal Family Education Loan (FFEL) Program (but not a combination of the two), then you may be eligible for a plan to pay the loans off over 25 years rather than 10. You have a level and graduated plan just like the standard plan. However, the monthly payments are lower. Most likely payments in the early years will go towards interest only, and will not decrease the principal amount. This option will take longer to pay off, and you will pay a significantly greater amount of interest on the loans.
But what if you can’t afford to make a monthly minimum payment? Then there are four Income Driven repayment plans available which offer forgiveness options. We would highly recommend consulting with your financial planner or a student loan expert before choosing one of these repayment plans as picking the wrong plan could cost you tens, or hundreds, of thousands of dollars.
For more information on student loan repayment options check out these resources: