In case you haven’t heard, student loan debt is now the second largest consumer debt behind only mortgages. Luckily, the government has been more active in addressing this issue recently with the introduction of revised-pay-as-you-earn (REPAYE). In addition, there are a variety of private lenders who are more than willing to refinance your student debt. Let’s talk about how to navigate between these options.
There are currently 6 repayment plans if you stay within the FedLoan system:
Standard repayment – payment is a fix amount each month, paying off all loan principal and interest in 10 years.
Graduated repayment – payments start lower than the standard repayment plan, but gradually increase every two years, also paying off all loan principal and interest in 10 years.
Income-driven repayment (IDR) – these plans determine your payment amount based of your income and other criteria.
Income contingent repayment (ICR) – payments vary based on income, family size, loan balance, and interest rate. More details below.
Income-based repayment (IBR) – payment based strictly on your income and family size. Your payment is limited to 10-15% of your discretionary income. More details below.
Pay-as-you-earn (PAYE) – payment is also based on your income but uses 10% of your discretionary income instead of the 15% used in IBR. More details below.
Revised-pay-as-you-earn (REPAYE) – opens up PAYE to more borrowers but with a few twists. More details below.
We won’t address the standard or the graduated repayment plans since you end up paying all your loan principal and interest with both of those at a relatively high interest rate of 6.8%. But the IDR plans have seen increased popularity since payment is limited to a percentage of the borrower’s discretionary income, allowing you to pay off your student loans and still have a life.
Forgiveness without PSLF
Forgiveness with PSLF
10% of discretionary income 20 years if only undergraduate loans
25 years if any graduate loans
If your monthly payment doesn’t cover the full amount of interest that accrues, the government pays
The full amount of the difference on your subsidized loans for the first three years, and half of the difference after the first three years, and
Half of the difference on your unsubsidized loans during all periods
After 20 or 25 years if you have graduate loans. Forgiven amount is considered taxable income. After 120 qualifying payments, Forgiven amount is not taxable.
PAYE 10% of discretionary income, but never more than the 10-year Standard Repayment Plan amount 20 years
If your monthly payment doesn’t cover the full amount of interest that accrues on your subsidized loans, the government pays the difference for the first three years After 20 years. Forgiven amount is considered taxable income. After 120 qualifying payments, forgiven amount is not taxable.
IBR 10% of your discretionary income* if you’re a new borrower on or after July 1, 2014
15% of your discretionary income* if you’re not a new borrower on or after July 1, 2014
*Never more than the 10-year Standard Repayment Plan amount.
20 years if new borrower on or after July 1, 2014
25 years if borrower before July 1, 2014
If your monthly payment doesn’t cover the full amount of interest that accrues on your subsidized loans, the government pays the difference for the first three years
After 20 or 25 years. Forgiven amount is considered taxable income. After 120 qualifying payments, Forgiven amount is not taxable.
ICR The lesser of either:
20% of your discretionary income or
What you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income.
25 years No interest benefit
After 25 years. Forgiven amount is considered taxable income.
After 120 qualifying payments, Forgiven amount is not taxable.
A brief look above would show you that PAYE, REPAYE or IBR for new borrowers after 2014 would offer the best terms – allowing you to have a low monthly payment and possibly even the benefit of partial loan forgiveness.
Essentially, when you refinance your student loans through a private lender, you are applying for a new loan with new terms to pay off your student loans. Kind of like doing a balance transfer between credit cards.
There are plenty of pros to refinancing your student loans:
- 1 monthly payment – this is probably the biggest benefit of refinancing your loans. Instead of making multiple monthly payments to multiple lenders, you get 1 bill and 1 payment.
- You may qualify for a lower interest rate – the standard interest rate for federal student loans are fixed at 6.8%. If you have good credit and income, it’s likely you will qualify for a lower interest rate. I say “may” because your mileage will vary depending on your situation.
- You can lower your monthly payment – this can result from you getting a lower interest rate on the new loan, by extending your repayment term, or a combination of both.
- Choice of variable vs. fixed interest rates – variable rate usually start with a low “teaser" rate and then fluctuate depending on the market conditions. Choosing a variable interest rate will benefit those who are planning to pay off their student loans rapidly.
However, there is no free dinner. Refinance comes with its own cons:
- Refinancing your loans with a private lender will make you ineligible for federal loan forgiveness programs such as Public Service Loan Forgiveness (PSLF), and other benefits such deferments and forbearance.
- Your interest rate may go up if you choose a variable interest rate plan. Most variable interest rate loans have a cap as to how high the interest rate can reach, but it’s usually more than the standard 6.8% fixed you would get through the government.
- It’s a permanent decision – if you ever leave the federal system, there is no recourse if you decide later that you’ve made a mistake.
- Fees – this is a minor consideration for those with a large loan balance, but there may be fees associated with a private loan refinancing application.
I hope this helps you get an idea of the pros and cons of income driven repayment options vs. student loan refinancing through a private lender. As usual, a decision about large sums of money should not be quick and easy. Make sure you do your homework and make an informed decision.
Colin is the Founder & CEO of LeverageRx, a personal finance company exclusively for doctors. Colin has over a decade of experience in financial services and is a licensed life and health insurance agent.