Student loans tend to stick around years and even decades after graduation.
Continuing to make both student loan payments as well as fund your life goals − starting a family, saving for a down payment, starting a business − is easy when your income growth resembles the steep incline of Mt. Everest's North Face.
But how about sustaining that monthly payment plus fulfilling your life goals with an income progression that more closely resembles the shallow, up-and-down edges of a saw blade?
While making payments to my own student loans, I bobbed between a $40,000 salary to a post-layoff, $35,000 salary. After building back up to $43,000, I suffered another layoff and had to take a $36,000/year position I was darn lucky to snag from a 28-job application rally.
Yet my student loan bill remained the same.
Turns out that my 20-something self, you, and anyone else looking to tie their monthly payment amount with their uncertain and evolving life situation has another option.Student loans tend to stick around years and even decades after graduation Click To Tweet
What are Income-Driven Repayment Plans?
Upon graduation, your federal student loans are automatically placed in a 10-year standard repayment plan through your loan service provider. While this guarantees you'll pay your loans off in 10 years − with consistent payments − it also locks you into a bill amount without considering your income or cash flow needs.
Under one of the four types of income-driven repayment plans, your monthly payment is calculated based on your income, family size, and state of residence instead of on a 10-year timeframe.
But it gets even sweeter than just lowering your monthly payment.
A repayment plan tied to your financial capabilities has perks
While each of the four plans look different, they offer the following same perks:
- Will not ding your credit score: Paying a reduced monthly payment is no concern to the credit bureaus.
- You can get your payment changed in a pinch: You have to recertify annually for one of these programs. If you happen to suffer from a financial change, like losing your job, then you can submit an application for a payment recalculation early.
- Built-in student loan forgiveness: Each of the plans comes with a repayment period of between 20 or 25 years. After that? Your remaining balance is forgiven.
- Financial Hardship Deferment won't extend the repayment period: The months you're in an economic hardship deferment (should you need to be) generally count as qualifying months towards the 20-25 year repayment period on income-driven repayment plans.
Given all of these benefits, you'd think that signing up for one of these plans is the sure way to move forward.
Why wouldn't you sign up for an Income-Driven Repayment Plan?
There are potential financial consequences and other headaches with these programs. Consider that:
- Private student loans don't count: This is a federal student loan program only. Other loans that don't count? Federal loans in default, Parent PLUS loans, or privately consolidated federal loans.
- You'll likely pay lots of extra interest: Extending any type of loan to get a more manageable monthly payment means you're increasing the overall amount of interest.
- Your career field could make a difference: A big perk to these plans is getting the remaining chunk of student loans forgiven at the end of the repayment period. If you're on a career path that tends to offer that Mt. Everest-type income progression, then you could end up paying off your loans ahead of schedule due to increasing monthly payments over the years.
- Loan forgiveness could equal a large tax bill: Any loans forgiven in the end of the repayment period typically result in a tax bill because the IRS views forgiven debt as income.
- Your payment will change: You must recertify your repayment plan annually, which could change your monthly payment amount.
- Lots of different loan servicers equals lots of different applications: Do you have lots of loans you want on an income-driven repayment plan? Unfortunately, you'll be sending different applications to each loan service provider separately.
It's decision-making time
Let me take you plus your loans through this decision so that you can walk away knowing you've chosen the best option.
Step #1: See if you qualify
It's best to see all the options you have to consider. Plug your numbers into this repayment plan calculator (go ahead, I'll wait) to see if you qualify.
Write your new estimated monthly payment down, then move onto the next step.
Step #2: Consider your alternatives
Desperate to decrease your monthly student loan bill but wary of the terms above? You'll want to look into the following four alternatives:
- Student loan refinancing: Do you have private student loans or a mixture of private and federal loans? Refinancing them may be your best option. Research available interest rates to see how a refinance would impact your monthly payment. You'll need to consider what protections you'd give up by refinancing any federal loans into a private loan.
- Student loan consolidation: Consolidating your federal and/or private student loans may result in a lower monthly payment for you as well. However, that could be due to longer repayment terms, which generally leads to larger interest payments. Again, beware of losing any federal loan protections when consolidating federal loans with a private loan.
- Request a Deferment: Perhaps you're just in a short-term financial situation that should fix itself. Instead of signing up for an income-driven repayment plan, temporarily “pausing” your student loan bills might work for you. Make sure you understand whether or not your loans are subsidized or unsubsidized, and how this may result in a higher interest tab.
- Request a Forbearance: You'll be charged interest during forbearance whether your loans are subsidized or not (hint: paying that interest during the forbearance period will help lower your overall interest bill).
Step #3: Compare the numbers between options
You've read over each of your options plus the pros and cons they come with. Your final consideration should be the cold, hard numbers: which option will give you the lowest monthly payment?
Note: answer the following questions, with the help of these Student Loan Hero calculators.
Three questions to answer:
- Which option will save me the most money each month?
- What's the estimated extra interest I will pay over the life of the loan because of that option?
- Is that amount of monthly savings worth the extra interest I'll have to pay?
Step #4: Apply to the option you've chosen
Depending on which option you chose, here's how you can apply:
- Income-driven repayment plan
- Student loan refinancing
- Student loan consolidation
Income-driven repayment plans may or may not be for you today. So you'll want to bookmark this page under a “financial tools” favorites folder in case you need help opening up cash flow in the future. And if you don't qualify for a plan, keep in mind that you may as circumstances change. For example, in the span of a year when my income went from $40,000 down to $35,000 I didn't qualify in the beginning, but I did qualify by the time the New Year's ball dropped.