It’s no secret that millions of college grads and dropouts have student loan debt.
As we pointed out in the first part of this series, student loan debt is second only to mortgages in the United States, with borrowers on the hook for about $1.3 trillion dollars. That’s a ton of money, and the way the student loan system is set up, nearly all of that money will have to be paid back.
The question is, how do students pay back their loans? Over the past 60 years, repayment options have grown and changed as the federal government has become more keen to the cries of students drowning in debt payments.
As it stands today, there are eight repayment plans for federal student loans:
- Pay-As-You-Earn (PAYE)
- Revised Pay-As-You-Earn (REPAYE)
- Income-Based (IBR)
- Income-Contingent (ICR)
- Income-Sensitive (ISR)
When you take a look at the history of repayment plans for federal loans, you’ll notice that those based on income are a pretty new development. Based on the experts we’ve talked to, those payment plans were created to help the swelling number of borrowers find manageable ways to pay off their loans.
At this point, we’re sure that you have questions about these student loan repayment plans. What are they? How are they different? Do they work for all loans?
It can be really hard to find one website or resource that explains everything you need to know, which is why we’re going to tackle all of it in the following sections.
We’ll also include a section on an increasingly important topic: Is college actually worth it?
1. The Standard Repayment Plan
Consider this repayment plan the simplest of them all. The Standard is a 10-year repayment plan in which monthly payments are calculated based on interest plus the amount borrowed. It does not take into account how much you earn like the income-based plans do, and monthly payments stay the same unlike the graduated repayment plan.
Think of it as a 10-year mortgage.
Mary Johnson, a financial literacy expert at BankMobile, said this plan is great … if you have the room in your budget for it.
“For those that can afford the payments, the standard repayment is probably the best option,” Mary said, “as the loan is paid off the fastest with the least amount of interest over time.”
Mary brings up a good point. While it might be tempting to go for a loan repayment program that extends your payments out to 30 years, you have to keep in mind that you’ll be paying a lot more interest.
Let’s say you’re the typical 2015 grad and you have around $30,000 in student loan debt. Over 10 years at 4 percent, you’ll pay $304 per month and $6,448 in interest over the life of the loan, which is about 21 percent more than the principal balance.
But let’s say the monthly payment is too high and you opt for an extended repayment of 30 years. That same $30,000 at 4 percent may mean your payments are only $143 a month, but, after three decades, you’ll have paid $21,561 in interest. That’s an insane 71% of your original balance of $30,000.
Because of this, we think the standard repayment plan is not only good for those who have enough income to afford their payments, but also for students with loans totaling less than $10,000.
Matthew Alden, a Cleveland-based bankruptcy attorney for Luftman, Heck & Associates, wraps up our thoughts about the standard plan pretty well:
“This type of plan can be a good repayment plan for borrowers who have a relatively small amount of educational debt or who have the means to pay their debt off as quickly as possible. The benefit of this plan is that you pay less in interest over time, but the challenge for some borrowers is that individual payments tend to be higher than other forms of repayment plans.”
2. The Graduated Repayment Plan
If the thought of paying about $350 per month in a standard repayment plan seems intimidating or impossible, but you still want to pay off your debt in 10 years, the graduated repayment plan is a great option.
This payment plan allows you to pay smaller payments at the beginning of the loan. As time goes on, the payment amounts increase. The idea with this option is that the low beginning payments allow you time to find a job, and as you build income, your payment amounts rise about every two years.
According to the U.S. Federal Student Aid Department, your payments will never be:
- Less than the interest you accrue each month, and,
- Three times the amount you’ve made on previous payments (this ensures your payments won’t get too high)
The graduated plan is paid off over 10 years, but in the case of FFEL (Federal Family Education) loans or Direct Consolidated Loans, they could be stretched out for up to 30 years, depending on how much you owe.
The key here is that you’ll be paying, at the very least, enough to cover the interest on your account. If you didn’t, your loans would actually grow while you were paying them back.
Jaycob Arbogast, a California-based financial planner and investment adviser, said the graduated plan is a great choice if you’re not making much money when you graduate. Unlike the IBR, where you could make $0 payments, you’ll always be covering interest in the graduated plan.
“You'll probably save more in interest in this plan compared to an income-based plan if you have a very low income, because you'll be making payments right from the start, whereas in an IBR plan, you might not make any payments in the beginning.”
3. The Extended Repayment Plan
While the first two repayment plans we’ve covered are available to all students, the extended repayment plan is reserved for borrowers who have more than $30,000 in student loan debt. If you fall in that category, your loan repayment period will be extended from the 10-year limit on standard loans to up to 25 years.
This is a pretty straightforward plan and very similar to the standard plan, mainly because your payments remain the same over time.
The Income-Driven Plans
The three plans we just mentioned have everything to do with time frames and set payment amounts. The only flexibility you have in terms of payment is the graduated plan, but that’s it. So, if you’re graduating with tens of thousands of dollars in debt like today’s students, you’re probably looking for an option that lowers your payments.
In 1998, lawmakers and financial aid experts recognized this, at least in part. That year, they created the income-contingent repayment plan – it still exists today and is one of five different options for repayment that is based on how much you’re earning.
Betsy Mayotte, the director of regulatory compliance at the non-profit American Student Association, was part of the team that helped create the Income-Based Repayment plan that you’ll read about in a few minutes.
The goal of creating new plans and tightening up or loosening regulations on student loans, she said, is to try and offer a solution for the most people possible.
“You can’t write regulations and statues to solve 100 percent of problems. That’s one of the hard things I’ve had to learn,” Betsy said. “You have to write regulations and statutes that work for the majority of the people and work with the outliers the best you can.”
And, for the most part, the introduction of these income-driven plans has covered most – but not all – borrowers.
However, the idea of creating a repayment plan based on how much money you make isn’t new and isn’t even American. Betsy says similar plans are already in use in the United Kingdom and Australia. In those countries, payments are taken directly from your paycheck. If you don’t make enough money to make payments, no payments are taken out.
Though the five income-driven repayment plans aren’t our idea, our government has made it clear that these plans were created for very specific reasons. First, Betsy says, students were coming out of college with so much debt they couldn’t corral it.
And second, she says, that debt was dictating the work they chose. So, graduates were making career choices not based on what they love doing, but on what could make them enough money to pay down their debt.
“If you look at some of the quotes from the Obama administration, they want to make sure people aren’t making their career choices based on the debt,” Betsy points out. “Because if someone came out with six figures in debt and they wanted to do social work, they couldn’t do it.”
4. Pay-As-You-Earn Repayment Plan
This is the first of two plans known as PAYE. This payment plan can be used on Direct Subsidized and Unsubsidized loans, PLUS loans made to students and Direct Consolidated Loans that don’t include PLUS/FFEL loans to parents.
As far as payments go, PAYE uses language you’ll see in the other four income-driven repayment plans:
- Max monthly payments will be limited to 10 percent of your discretionary income
- Payments are recalculated every year based on changes in income and family size
- For married borrowers, your spouse’s income and debt are used to calculate your repayments, but only if you file a join tax return
- At the end of 20 years, any debt that’s left will be forgiven.
One of the most confusing words in there is “discretionary income,” which is how much you earn per year minus 150 percent of the poverty guideline for your state. This number takes into account your family size, too. For example, in California, 150 percent of the poverty guideline for a family of three in 2015 was $1674.17 per month. If you’re making $2674.14 per month, your monthly payments will be, at the most, $100.00 per month (10 percent of $2674.14 - $1674.14).
Remember, though, that your payments are “up to” 10 percent of your discretionary income.
5. Revised Pay-As-You-Earn Repayment Plan
The REPAYE has many of the same features as PAYE, but with slight differences:
- You pay 10 percent of your discretionary income, not up to 10 percent.
- Your spouse’s income and student loan debt are factored into your payments, whether you filed separately or jointly.
- There are two repayment lengths instead of one: 20 and 25.
Another difference is eligibility: for PAYE repayments, only students who were new borrowers on or after Oct. 2007 and received a Direct Loan on or after Oct. 1, 2011. REPAYE is available to any student with a Direct Loan.
Both the PAYE programs offer loan forgiveness at the end of their repayment term. However, that forgiveness comes with a very important catch, says Mary Johnson.
“If any balance remains at the end of the repayment period, that amount is forgiven,” Mary said. “However, the borrower may have to pay taxes on the amount that is forgiven.”
What that means is the government counts any forgiven loan amount as income. So, if you get $30,000 forgiven in 2037, that $30,000 is counted as income when you file your taxes.
6. Income-Based Repayment Plan
The IBR is another option for students. It’s similar to the PAYE and REPAYE programs, but the biggest difference is this program accepts students with Stafford loans, which date back to before 2010.
The repayment terms are similar, but IBR has two payment amounts: 10 percent or 15 percent of your discretionary income. Jaycob Arbogast says this repayment plan is similar to the graduated plan in that it benefits students who may not make a lot of money to start out.
“For now, while you struggle with a low income, you could even have your minimum payments as low as $0 a month. I've seen quite a few people with very low—or even no—minimum payments when they aren't making very much money,” Jacob says. “I used this during my first year out of college while I was getting my business up and running.”
This loan also comes with a disclaimer – you might have to pay taxes on any amounts that are forgiven after your repayment term is up. As we pointed out earlier, if you get $30,000 forgiven, it counts as income in the year its forgiven.
“Most people don’t realize that the IRS counts a forgiven debt as income,” Jaycob told us. “The standard withholding isn’t going to cover that payment for you, so you’ll have to save up separately if you want to cover that tax bill.”
7. Income-Contingent Repayment Plan
The ICR puts its own unique twist on income-driven repayment plans. This program has a couple of quirks that really differentiate it from the PAYE, REPAYE and IBR:
- Your payments are either 20 percent of your discretionary income or the payment you’d make in for a 12-year, fixed-payment plan adjusted for income (whichever is less)
- Parents borrowers can use this if they consolidate their PLUS loan into a Direct Consolidation Loan
- Payments can be higher than what you’d pay in a Standard Repayment Plan
As you can see, the ICR puts you at risk of paying more than what you would in REPAYE, PAYE or IBR.
8. Income-Sensitive Repayment Plan
The final piece of this complex repayment puzzle is the ISR. Payments are calculated by your lender and can take place for up to 15 years. The main difference between this plan and the previous plans is that the ISR is the only plan that provides income-driven option for students who have FFEL PLUS loans (for graduate students).
General Loan Repayment Advice From the Experts
Understanding repayment plans is no easy thing, which is why we’ve tried to give you an overview of what each plan offers. The most important step you can take in all of this is to know exactly what kind of loans you have.
Once you know that, you can figure out which payment plans you’re eligible for and take it from there.
But actually choosing the right plan can be really difficult. The big monthly payments of the standard repayment can be intimidating, even though you’ll pay your loans off in just 10 years.
Income-driven plans are a savior for borrowers who are having a hard time finding work after graduation, but you’ll end up paying a lot more in interest over the life of the loan.
To help you decide which plan is best, we’ve collected some nuggets of wisdom from the experts:
Mary Johnson on the responsibility of the borrower:
“It is important for college students to take the time while they are still in school to understand how much they owe and what their repayment options are so that they are not caught off guard after they graduate or leave school. Student loans are a significant financial obligation that should be taken very seriously. Failing to make payments on time or defaulting on student loans can have dire consequences, such as severely damaging your credit or even having your wages garnished.”
Jaycob Arbogast on income-driven repayment plans:
“The overall thing to look at is whether you’ll be paying more interest over the life of the loan. While it seems nice to pay such a small amount each month, you’ll really be paying much more in interest over the course of the loan than you would if you paid more.”
Mark Kantrowitz, financial aid expert from Cappex.com:
“Students should choose the repayment plan with the highest monthly payment they can afford. This will usually be the Standard 10-Year Repayment Plan. It minimizes the total interest paid over the life of the loan.”
With All This Debt Floating Around, Is It Still Worth It To Go To College?
As we talked about in our previous article on the history of student loans, our country is fully aware of the student loan crisis. And that gets parents and high school students thinking, “Is it even worth it to go to college if I’m going to have to take on a bunch of loans to make it happen?”
Tony Aguilar, co-founder and CEO of Student Loan Genius, says, emphatically, “Yes.”
Aguilar graduated from college with $100,000 in student loan debt. The financial burden pushed him to come up with an innovative way help borrowers pay off their loans. Student Loan Genius does just that by setting up repayment plans in which employers match, up to a certain amount, the payments a borrower/employee makes on their student loans.
“Worth it? Absolutely. What makes America great is anyone can get an education,” he said. “Hands down, an education is the one determining factor that puts you on a level playing field with the people around you. It’s the great equalizer, right?”
He went on to say that that if college is a necessity for your career choice (sometimes it’s not), we need to shift the conversation away from finances and talk about the quality of life.
“The financial side of college is a huge component you need to consider, but there’s more to life than finances,” he said. “It’s about quality of life. Who do you get to meet while you’re in school? Professors. Mentors. Friends. You get the experience of working with some of the brightest people in the country.”
But the argument that college is still worth it goes beyond Tony’s well-versed wisdom.
In July 2016, the White House released a white paper titled, “Investing in Higher Education: Benefits, Challenges and the State of Student Debt.”
One of the more interesting parts of the paper is the section that tackles college as an investment:
“When prospective students decide whether to invest in college, economic theory suggests that they weigh the personal benefits they expect to realize against the costs they expect to incur. While some benefits like satisfaction from learning are realized immediately, a primary benefit that motivates most students is the expected gain in their future earnings.”
We tend to think the high sticker price of a college degree undercuts our ability to live a productive financial life, but the statistics may say otherwise.
The white paper goes on to point out the lifetime value of a degree. Here’s what they calculated, based on a full-time, full-year laborer who is older than 25:
- A graduate with a bachelor’s degree will earn nearly $1 million more than someone with a high-school diploma
- A graduate with an associate’s degree will earn about $360,000 more than someone with a high-school diploma
The study went on to say that “the additional lifetime earnings” from a degree “far exceeds the amount of debt borrowers typically accumulate upon graduation.”
“A graduate with a bachelor’s degree will earn $1 million more than someone with a high-school diploma.”
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Our conclusion? Though college seems like a pretty scary proposition in a financial sense, the statistics we’ve read through indicate your degree has a really good chance of paying off in the long run.
Another thing to remember is that having a college degree helps you keep your job during an economic downturn. According to a post-Great Recession study from Pew Research, workers with high school diplomas saw an 8 percent drop in employment after the Great Recession, as opposed to a 4 percent drop-off for college graduates. In other words, you’re twice as likely to keep your job during a recession as someone with a high school diploma.
Our Final Thoughts on Repayment Plans
Based on our investigation of the eight repayment plans and our interviews with experts, we think there are plenty of options for students to pay off their loans.
Now, when it comes to things like cars, our rule of thumb is always to get a shorter loan with a lower interest rate. While students don’t typically have control over the interest rates of their federal student loans, they do have the chance to choose the length of their loan.
We share Mark Kantrowitz’ opinion – the Standard Repayment Plan is the best option because it’s only 10 years long, which means you’ll pay a lot less interest than you would on a 20- or 25-year loan.
But, we know that sometimes the payments on a 10-year loan are pretty high. We think, however, that the payments are manageable if you’ve borrowed the average of about $30,000. That number might seem overwhelming, but think about it like this: the average price of a new car is about $33,000.
In reality, you’re paying $30K for an education that, on average, will make you nearly a $1 million dollars over your lifetime. A car, on the other hand, is going to lose you money as it ages.
We totally get that all the outcry about the student loan crisis. The number of borrowers has doubled over the past decade and tuition prices keep rising. However, remember that getting your degree has some really great benefits. You’ll earn more over your lifetime and you’ll be less likely to be laid off during a recession than someone who has a high school degree.
And having debt from college isn’t a completely evil thing, either. Managing that debt will teach you principles of budgeting, discipline, and foresight that will benefit other areas of your financial life. We’ve put together a series of articles about loans and finance that can be a great help to you once you graduate, and even before you take out your first student loan:
Budgeting – How you can use it to pay down debt and order your financial life.
How to Repay Student Loans Faster – Attitude and an understanding of repayment plans, loan forgiveness, and tax laws can help you get your balance down to zero.
Money Mistakes – The top seven, including taking advice from people who aren’t professionals and waiting too long to put money into a retirement account.
Should You Refinance Your Student Loan? – Startups and established companies are offering students a chance to refinance their loans much in the same way you’d get a refi on a home loan. We help you understand what the process is like.