College graduation is an exciting time. Moving on to the next chapter means new possibilities as well as new responsibilities, including repaying student loans - a process that can be confusing.
To make student loan repayment more manageable, it's important to understand your options. Here are things you should consider before choosing a repayment plan:
- Whether or not you have federal or private student loans
- How much you can afford to pay each month
- What your interest payments will be
- What your longer-term financial goals include
- The pros and cons of each repayment plan you consider
Do You Have Federal or Private Student Loans?
Student loan repayment can vary depending on the type of student loans you have. To understand what repayment plans are available, you'll need to know whether you have federal student loans, private student loans or both.
If you have federal student loans, you can choose from several repayment plans. If you don't pick a repayment plan, your loan servicer will enroll you in the Standard Repayment Plan, which allows borrowers up to 10 years to pay back their student loans. You can also switch your repayment plan at any time during the course of your repayment.
If you have private student loans, your repayment options will depend on your lender, which may have several plans for you to consider. Typically, you can't change your repayment options with private student loans unless you are opting for assistance like deferment or forbearance.
How Much Can You Afford Each Month?
Before choosing a repayment plan, find out how much you can reasonably afford. To start, look at how much your base expenses are for food, rent, gas and other necessities. That's your required spending each month. Next, calculate how much income you earn every month after taxes (hint: you can do this by looking at your paystub).
Depending on your financial situation, you could put more toward your student loans each month, or you may want to pursue a plan that can lower your monthly payments.
If you are unable to make your monthly payments, it's important to contact your loan servicer or lender. If you have federal student loans, you could apply for an income-driven plan that limits your monthly payments to a percentage of your monthly income, typically 10 to 20 percent. If you have private student loans, you may want to contact your lender about what options they have available. For both federal and private student loans, you can consider deferment or forbearance, which temporarily postpones your payments. While that can be helpful when it comes to managing your student loan payments, be aware that any time you postpone payment or extend your repayment term, the cost of your loan will increase due to the additional interest that has accrued.
How Much Will You Pay in Interest?
All student loans have interest rates, but those will vary depending on the type of loan.
Federal student loans have fixed interest rates, whereas private student loans may have fixed or variable interest rates. Fixed rates stay the same throughout the life of the loan. Variable rates, however, may change during the life of the loan, which can affect the amount of your payment and how much interest you pay. Before choosing a repayment plan, it's crucial to know your interest rate, which can help you assess what repayment plan is right for you.
Ultimately, you want to know how much interest you will pay over time because, depending on the rate, it can add to the total cost of the loan, effectively increasing how much you will pay back. For example, if you have federal student loans and end up choosing a longer repayment term, you will pay more in interest. Conversely if you have a shorter repayment term, you will pay less cumulative interest even though your monthly payments will be higher.
What Are Your Financial Goals?
It's important to choose a repayment plan that aligns with your financial goals. If you want to get out of debt quickly, choose a repayment plan with a shorter repayment period. If you are having trouble making payments or have other financial priorities, such as saving for future goals like buying a home or retirement, consider a plan that lowers your monthly payment. However, keep in mind that this will increase the overall cost of your loan.
What Are the Pros and Cons of Each Plan?
Not all repayment plans are created equally, and all have pros and cons. For federal student loans, a shorter repayment term - like the Standard Repayment Plan, which is 10 years - can mean paying less in interest, but it comes with higher monthly payments. If you opt for an income-driven plan, you may have lower payments but more interest.
Additionally, income-driven plans for federal student loans are eligible for student loan forgiveness after 20 to 25 years. While that sounds great, any loans that are forgiven are considered taxable income. In other words, you will be taxed on the amount of your forgiven balance the year your student loans are forgiven. So if you have $40,000 forgiven, you might have a high tax bill that year.
When considering federal and private student loan repayment options, weigh the interest rate, repayment term, monthly payment amount and eligibility requirements to decide what is right for you. Everyone has different priorities and different financial situations, so you want to consider how each repayment option will affect you and your life.