Repayment Options for Federal Student Loans by Monica Steinisch

Repayment Options for Federal Student Loans by Monica Steinisch

Courtesy: Consumer Action News-January, 2018.

If you’re one of the 44 million Americans with outstanding federal student loans, repayment is probably never far from mind. Fortunately, federal student loan borrowers have multiple repayment options, for now.

Recent or near graduates

The government gives borrowers a six-month grace period after they graduate or leave school to start repaying their debt. This is intended to allow recent students time to find a job and get their finances in order before having to juggle monthly bills, but interest will still accrue on most loans. Your first payment due date will be 30 to 45 days after your grace period ends.

The amount of your monthly payment will depend on the type of loans you have, the amount borrowed, your interest rate and the repayment plan you choose.

You can select a repayment plan during your grace period, or you’ll be assigned one when your loan payments begin. But regardless of the plan you start out with, you can change repayment plans at any time, for free.

Visit the Federal Student Aid (FSA) website for an overview of all plans.

In repayment

The Standard Repayment Plan, which calls for fixed monthly payments for up to 10 years (up to 30 years for Direct Consolidation Loans), is what borrowers start out with unless they select a different plan upfront. On this plan, your monthly payments may be higher than under other plans, but you’ll pay less interest over the life of the loan.

The Graduated Repayment Plan will cost you a bit more over the life of the loan, but it still gets you out of debt in 10 years (up to 30 years for Consolidation loans). This plan starts out with lower payments, which automatically increase every two years. The Graduated plan assumes that over time you will earn more money, making higher loan payments more affordable.

For at least the first two years, you’ll be making interest-only or slightly greater payments. Your payments will increase rather significantly every two years in order to pay the balance off in the remaining repayment period. This plan may be more manageable for some, but it relies on continued salary increases, which is not always the reality. Before choosing a Graduated plan, ask the loan servicer for a repayment schedule and use a repayment calculator to study your payment increases over time.

The Extended Repayment Plan could cost significantly more over the life of the loan because payments, which can be fixed or graduated, can continue for up to 25 years. This option is designed for borrowers with higher ($30,000+) loan balances.

Note: There are no fees charged to take advantage of any federal student loan repayment plan. So do it yourself—for free!

For borrowers who are struggling to pay their bills, there are four income-driven repayment (IDR) plans.

While the prospect of payments based on income sounds ideal, an IDR plan is not always the best choice for every borrower, and not every loan type or borrower qualifies for every plan. If you opt for an income-driven plan, it will most likely cost you more in interest over the life of the loan, but it can make monthly payments manageable.

Use the Department of Education’s (ED) online Repayment Estimator to compare your estimated monthly payments and see how much interest you’d pay with each income-driven plan.

Income-based plan

Under an Income-Based Repayment (IBR) Plan, your payment is capped at 10 percent of your discretionary income if you took your first loan out in July 2014 or later, or at 15 percent if you first borrowed before July 2014. (Discretionary income is the difference between your adjusted gross income and 150 percent of the annual poverty line for your family size in your state.) Based on the formula, some borrowers end up with a $0 payment. However, the Republican-controlled U.S. House of Representatives has proposed a sweeping higher education bill that aims to change IBR terms, including elimination of the $0 payment tier, and many federal loan repayment relief options and borrower protections.

If you have a subsidized loan and your income-based monthly payment is not enough to cover the interest that accrues, the government will pay the difference for the first three years, and your overall balance won’t increase.

Any remaining loan balance is forgiven after 20 years of payments for students who first borrowed in or after July 2014, or 25 years for those who borrowed before July 2014.

To qualify for an IBR plan, you have to prove financial hardship, which essentially means the amount owed on your loans each year under the Standard Repayment Plan is more than 15 percent of your annual discretionary income.

Note: The IRS considers any forgiven loan balance taxable, which means you could end up paying income tax on the amount of debt that is forgiven.

PAYE Plan

Pay As You Earn (PAYE) caps monthly payments at 10 percent of your discretionary income and forgives any remaining balance after 20 years. PAYE also offers the same three-year government-subsidized interest benefit as IBR. To qualify for PAYE, you have to have been a new borrower as of October 2007 and received a Direct Loan disbursement on or after Oct. 1, 2011.

Like IBR, the PAYE Plan requires financial hardship, but in this case the annual amount due on your loans under the Standard Repayment Plan would have to exceed 10 (rather than 15) percent of your discretionary income.

REPAYE Plan

The newest plan, REPAYE, also sets payments at no more than 10 percent of income. You can qualify even if you can’t prove financial hardship. Loan forgiveness happens at 20 years for undergraduate study, or 25 years for graduate study.

Unlike PAYE and IBR, REPAYE is available regardless of when eligible loans were taken out. It also offers an added benefit: In addition to covering all accrued interest that exceeds the monthly payment for the first three years, the government will continue to pay half of the excess interest on subsidized loans after the three years, and will pay half of the excess interest on unsubsidized loans over the entire loan period.

Income-contingent plan

Under an Income-Contingent Repayment (ICR) Plan, qualifying borrowers pay the lesser of 20 percent of discretionary income or what they would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to income. There’s no payment cap, no financial hardship requirement, and no interest benefit—if your monthly payment doesn’t cover what accrues, it’s added to your loan balance (capitalized) annually until the balance is 10 percent greater than it was when the loan entered repayment. Any outstanding balance is forgiven after 25 years of qualifying repayment. This is the one IDR plan that accepts consolidated parent PLUS loans.

To apply, recertify or switch to a different income-driven repayment plan, visit the ED’s Income-Driven Repayment (IDR) Plan Request page.

If you work full-time for a qualifying government or non-profit employer, you might qualify for loan forgiveness in 10 years—instead of 20 or 25—through the Public Service Loan Forgiveness Program.

Annual renewal

In order to retain your income-driven repayment plan, you must “recertify” your income and family size with your servicer every year. If there are changes to your situation, your monthly payment can increase or decrease. You have to recertify even if you don’t have changes to report. You’re not required to report changes (such as increased income) before your annual certification date, but if your situation changes for the worse, you can reapply at any time, asking the servicer to recalculate your payment immediately.

Recertification requires proof of income—typically a tax return, which the IRS may be able to “push” electronically to your loan servicer. You should get a recertification reminder from your servicer. But, given the consequences for missing the deadline—increased payments, etc.—you should set up a foolproof reminder.

Deferment & forbearance

Deferment and forbearance allow you to stop or reduce your federal student loan payments temporarily. These payment pauses are granted for many reasons, ranging from serving in the military or enrolling in a training program to being unemployed or having overwhelming medical expenses.

Borrowers in deferment may not need to pay interest during the deferment period, depending on the type of federal loan. Find out more in the Deferment and Forbearance section of the Federal Student Aid website. Borrowers who have been granted forbearance still must pay interest regardless of loan type. Loan interest can be paid as it accrues, or it can be capitalized.

If you want a deferment or forbearance, you’ll need to apply through your loan servicer. Suspending or reducing payments can help you avoid default.

Borrowers in default

The consequences of defaulting on your student loans are serious and include losing access to all flexible income-driven repayment plans and most forms of credit.

The two main ways to get out of default are loan consolidation and loan rehabilitation. A Direct Consolidation Loan allows you to combine multiple federal loans into one loan and pay it off over 30 years. This could simplify, and even lower, your monthly payments. You may also resume eligibility for an income-driven repayment plan.

But there are drawbacks too. You will pay more in interest over the extended life of the loan. You might lose rebates and interest rate discounts, and you may also lose credit for any previous payments made that counted toward loan forgiveness.

Unless you make three consecutive monthly payments on your defaulted loan(s) before consolidating, you will limit your repayment plan choices. You can apply for a Direct Consolidation Loan through StudentLoans.gov, or get answers to your questions at 800-557-7392.

Loan rehabilitation is a longer process but offers some benefits over consolidation. Loan rehabilitation removes the default from your credit history and stops wage garnishment. You’ll also regain eligibility for loan deferment, forgiveness, forbearance, federal student aid and a choice of repayment plans.

To rehabilitate your loans, you have to contact your servicer and agree in writing to make nine “reasonable and affordable” monthly payments for nine consecutive months. A “reasonable” payment equals 15 percent of your annual discretionary income divided by 12. You can request a lower payment by documenting your income and expenses. Once you have made the nine payments, your loans will no longer be in default. (Requirements for some loan types might be different.)

Find a rundown of consolidation and rehabilitation requirements in the Getting Out of Default section of the Federal Student Aid website.

As you wend your way through the many options for managing your federal student loans, consider yourself fortunate: Borrowers of private student loans don’t have nearly as much flexibility or assistance (see Private student loans).

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