To ask if you are paying off student loans the right way, may seem absurd. You receive your monthly balance, you pay it on-time, and all is good, right? Yes, but there may be some aspects of student loan repayment that you are unaware of. Whether you’re in the thick of student loan repayment, or approaching the end of your grace period and wondering how to tackle your loans, we have provided some strategies to pay off student loans in full.
Choose the Right Federal Student Loan Repayment Plan
For federal student loans, including Stafford, Perkins, PLUS, and Direct Consolidation, there are several repayment plans to choose from. The following are the most common:
Standard Repayment Plan
• the default plan unless you change to another repayment option
• will cost the least amount of money in interest payments
• fixed payment amount
• up to 10 year repayment time frame
• pay less over time than other repayment options
Graduated Repayment Plan
• low payments initially, then payments increase after about two years
• with this plan, you pay more over time than with the standard option
(ideal for those who are starting with a lower paying career, but expect income to steadily increase in the future)
Extended Payment Plan
• fixed or graduated payments
• up to 25 year repayment time frame
• with this plan, you pay more over time than with the standard option
(ideal for those who receive hourly wages and need the predictability of fixed monthly payments)
Revised Pay As You Earn Repayment Plan
• payment will be 10% of discretionary income
• payments will be recalculated each year based on income and family size
• married borrowers will have combined income considered
• after 20-25 years, if loan has not been repaid, the remaining balance will be forgiven
(ideal for those with a high debt-to-income ratio)
Income-Based Repayment Plan
• payment will be 10-15% of your discretionary income
• payments will be recalculated each year based on income and family size
• married borrowers will have combined income considered only if taxes are filed jointly
• to qualify for this plan, you must have a high debt relative to your income
(ideal for those with a high debt-to-income ratio)
Oftentimes, you will be assigned a repayment plan, but you have the freedom to change your repayment plan at any time with absolutely no cost associated. Consider each option and apply it to your personal situation. Just because a repayment plan has the lowest monthly payment, doesn’t necessarily mean it’s the best choice. This option might mean paying a significant amount of interest over the life of the loan.
Repaying Private Student Loans
Unlike federal student loans, private loans are not subsidized by the federal government. They are funded by credit unions, banks, or other lenders. The rates are set by the lender as well as the loan limits and terms.
The rates are generally higher than those offered through federal loans and the terms and limits are less flexible. If you happen to fall behind on your loan, private lenders generally don’t offer program resources to help you re-establish your footing.
Because of this, we recommend communicating with your lender in the event you are unable to meet your financial obligations. Be sure to review your private loan contracts carefully, making sure you are aware of what you are agreeing to and the rights you have.
Since private loans have higher interest rates and are less forgiving, the rule of thumb is to pay these off first.
Focus On High Interest and/or Variable Interest Loans First
Should you consider paying off some of your loans in advance? If so, start with loans with the highest rate. Keep in mind that unsubsidized loans will accrue interest throughout your repayment grace period. When your grace period ends, that accrued interest is added to your principal, increasing your debt. You don’t need to pay off that interest until your grace period ends, but it will be adding up and if you can afford to, why not focus on knocking out that interest?
Additionally, loans with a variable interest rate should be paid off as quickly as possible. Even if the interest rate is lower than your fixed rate loans, the rate could change in the blink of an eye. When the economy improves, interest rates go up, causing your monthly payments to increase with little forewarning.
Go Beyond the Bare Minimum
If your finances allow it, plan to pay more than the minimum balance on your student loans, or even two payments per month instead of one. This is one of the best strategies to pay your student loans in full sooner than originally anticipated. Online loan calculators allow you to test different payment scenarios to see what paying extra will do for you long-term.
Generally, your lender will apply the extra amount first to accrued interest that wasn’t covered by your monthly payment, then towards the principal balance. However, it is beneficial to have that amount go towards your principal balance. The more you put towards your principal balance, the less interest you will have to pay over time. It is best to contact your lender directly to let them know where you want the extra amount to go towards.
To Consolidate or Not to Consolidate
When consolidating, you are combining multiple loans into one so you can make a single monthly payment with one interest rate. This can be enticing since it makes repayment seamless with one bill to focus on instead of multiple bills.
Try to avoid consolidating federal loans into a private loan because you will lose your choice of repayment options and the benefits associated with federal loans (which are more flexible!).
Also keep in mind that consolidation limits the loan repayment strategies mentioned above like aggressively paying private loans initially or focusing on high-interest rate loans first. Once loans are consolidated, you can’t be as strategic as before.
