Loan Repayment Schedules: Which One Is Best?
***This post assumes you won't be refinancing with a 3rd party and instead are paying back only government loans. We're also assuming you won't be eligible for public service loan forgiveness. For information on refinancing, check back next Wednesday!***
Ahhhh, repayment. This is about the time after grad school when most of us think "holy moses, my loans have grown HOW much?!" and start to wonder if that whole career move was even worth it. But I will say it's also the time when I thought "Okay, now that I have a paycheck, we can finally tackle this. And do it fast."
As with every step of the student debt process, it can be confusing. Why are there so many options? And which one is best for me, given my career trajectory and timeline?
First, let's take a look at all the choices. To put it simply, there are two families of repayment structures: fixed and variable [fixed meaning you will make the same payment every month until you're eventually all paid up, variable meaning your payments will fluctuate based on a number of different factors]. And to break it down a little further, variable payments may be income driven (i.e. the majority of them) or non-income driven (as in, you plan to make bigger payments towards the end of the loan, regardless of your income).
Here's little graphic to lay it all out:
For round numbers, let's assume again that you took out $120,000 in student loans and were super wise (and able) to pay off the interest along the way. So you're starting out with exactly $120,000 in Direct Unsubsidized federal loans with an interest rate, again, at 5.31%. [Though I have only a small sample size--i.e. my friends and colleagues-- to compare to, it seems this is the most common loan structure and a pretty accurate estimation of loans accrued.] Here are our options:
There are some basic takeaways you can gather from this shot:
- Standard payments are going to be high for the life of the loan. However, you become accustomed to paying this higher payment, so there's no shock factor each month (like there is if you choose a graduated plan, when payments increase later on).
- Extended plans last a long, long, long time. Paying for 25 years might sound appealing now, but I would strongly advise against that for anyone, in any situation. In 25 years, it's plausible you'll be planning seriously for retirement and still paying student loans. That is a devastating situation to be in.
- Income-Based, Income-Contingent, and Pay-As-You-Earn (but not Revised-Pay-As-You-Earn) require you to document some sort of financial hardship to qualify. What does this mean? Essentially, it means you have to show your loan burden or monthly loan payments are disproportionately high compared to what you'll be bringing home. To qualify for these, you have to fill out a separate application found here.
Some other nuances you need to know:
- The three "income-based" plans (income-based, income-contingent, pay-as-you-earn) require you to pay a percentage of your discretionary income each month, but you'll never pay more than the 10-year standard payment. As long as you're filing taxes separately from a spouse, their income won't be included in discretionary income.
- Revised-pay-as-you-earn is a new-ish plan that does include spousal salary, regardless of how you file. You also have payments equal to 10% of discretionary income, with no limits. It seems like no one would take this route, right? Well, it offers the benefit of "negative amortization", meaning if your payments don't even cover the interest on your loan, you'll only be responsible for 50% of the interest accrued. This plan is mostly good for those with really high debt, but also high income.
As always, this is a really personal decision that takes some serious discussion with your significant other or family. In our case, the graduated payments were never, ever an option. Why? Because your career trajectory, while somewhat predictable, is never guaranteed. Lawyers, for example, usually have a pretty upward, linear path (as in, they make less as the beginning of their career and much more once they've gained experience). But what do you do if you have a change of heart and want to work in the public sector, making way less money? What happens if, in 20 years, you're unable to work for one reason or another?
Feeling shackled to my job because of a loan payment will never be worth it. Nor will the fun things we get to do today, only to have to defer on in a few years because our payments have ballooned.
We decided early on that 10 years after we started paying, we wanted to be thinking about starting college funds for little ones, not how we couldn't afford to start a family because of loan payments.
Again, I know this is really personal and can get sort of scary, but I would urge anyone to consider paying more up-front. As I said, no career path is guaranteed, no growth in salary is a sure thing, and the quickest way to hate your job is to be a slave to it. The good news is there can be freedom from debt and the ability to switch jobs if you put in the work now! With the right mindset and a whole lot of discipline, it will happen. Truthfully, if you had told me 2 years ago that we would be debt-free by this point, I would have laughed and/or cried. But here we are, and I know that it's possible. :)
So we'll leave off today, but next time we're talking refinancing (my favorite- not kidding!). Until then!