Happy summer, Class of 2016! Now that you’re moving on to the post-college world, it’s time to start thinking about loan repayment. It’s great to enjoy your grace period while you can, but you’ll definitely want to start making plans for once loan repayment kicks in. I’m here to offer some information and tools to help you navigate that process. I’ll be focusing on federal loans, but there might still be some helpful resources for those of you who borrowed privately.
1. How loans work: The basics
Before we get into repaying your loans, let’s start with how interest-bearing loans operate. When you borrowed loans for your education, each one came with an interest rate attached to it. That rate is represented as a percentage, and used to determine how much money will be added to the amount you borrowed, and thus will have to repay.
This is known as “accruing,” as in your loan has been or will be accruing interest. As interest accrues on your loans each day, the accrual is added to the overall amount, which is again used to determine the next day’s accrual. Here’s a quick and easily calculation on how exactly these accruals are determined.
2. Federal repayment plans
The Department of Education offers several different plans that you can choose to enroll in, each with its benefits and costs in the short- and long-term.
The most commonly used are the Standard and Graduated plan, where you are assigned a minimum monthly payment based just on the total amount of loans you have outstanding, structured so that your loans are fully paid off in ten years. The Standard plan gives you the same monthly payment for all ten years, while the Graduated plan will start you at a lower monthly payment and increase that minimum payment every two years. The Standard plan is beneficial in that you’ll start paying off more sooner, meaning less interest accrues in the long run. At the same time, you’ll also know exactly what your payments will be and can plan and budget for them into the future. The Graduated plan has the perk of lower payments early on to allow you more time to get your feet on the ground, but also will have more interest accruals than the Standard plan.
The Income-Driven Plan is another option where your minimum monthly payment is a fixed percentage of your discretionary income. What is discretionary income? Essentially, your loan servicer will collect information on your income and the number of people you support besides yourself. Based on standard costs of living and estimates of normal tax payments, etc., your servicer will determine how much income you have that is not necessary for you to live on (necessities include paying rent and buying groceries). That discretionary income will be the baseline by which your monthly payment is determined.
Each year, the servicer will “recertify” the information and update your minimum payment accordingly. There are a few different options under the broader umbrella of the Income-Driven Plan, so you can decide which will work best for you. The biggest positive is that this plan will attempt to prevent any significant financial hardship if you are out of work or underemployed. However, since the payments might be very low, the amount of total interest you accrue will be very high. Your repayment period could end up being much longer and more costly in the long-term. Make sure you’re considering all of these factors carefully when picking a repayment plan!
To recap:
Standard Repayment Plan:
- Same monthly payment all ten years
- Fewer interest accruals
- Predictable payments (easy to budget)
Graduated Repayment Plan:
- Lower monthly payment to start; increases every two years
- More interest accruals
- Gives you more time to become financially stable
Income-Driven Plan:
- Payments a percentage of your discretionary income; adjusted every year
- High interest accruals
- Attempts to prevent any significant financial hardship
While these are the three primary plans, there are also a few other options, including an Extended Repayment Plan, which gives you up to 25 years to fully repay your plans. Here’s a list of repayment plans and the criteria and implications of each. And here’s a tool that allows you to “shop around” and get a preview of what your post-grad loan life will look like based on each plan.
3. Loan consolidation
Another option that you can look into is consolidation of your federal loans. What is consolidation? On the most basic level, it takes all the different loans you’ve taken out over the course of your studies and combines them into a single loan. The interest rate of each loan is pro-rated based on the relative size of that loan and then averaged out to assign a single interest rate to your new, consolidated loan. There are, of course, some pros and cons. On the positive end, consolidation will allow you to keep track of your loans a little easier, rather than paying back eight or ten total loans, you’ll have just one to worry about. Additionally, consolidation can sometimes make the overall amount you’re repaying go down. At the same time, though, consolidation can also end up making your overall repayment more costly in the long run.
Loan consolidation:
- Combines all loans into single loan
- Single interest rate an average of all loans
- Keep track of loans easier
- Could increase or decrease overall amount owed
So how can you tell if consolidation will be helpful or harmful in your situation? Calculate what consolidation would do for you, and use it in conjunction with the Repayment Estimator tool above.
Now that you know a little more about federal loan repayment, it’s time to start diving in. For those of you who graduated a few weeks ago, your repayment won’t start until November when your six-month grace period ends (unless you borrowed a Perkins Loan, which has a nine-month grace period). You have a couple months to start researching your options and figuring out what the best plan of action is. Don’t leave it ’til the last minute!
To get a head start, use the tools and calculators above to project about how much your monthly payment will be, and then start living like it. If your predicted payments are $150 a month, start diverting $150 of your normal spending money into your savings, or even start paying your loans back before your grace period ends. You’ll be that much more equipped to handle repayment when you officially enter it in November. While loan life isn’t the most fun, it doesn’t have to such a burden. With a little planning and research, you can equip yourself to have the most manageable repayment possible.