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Choosing a Student Loan Repayment Plan

19 August 2018 No Comment

Federal education loans offer four main repayment plans. The repayment options for a private loan are defined in the loan contract and vary from lender to lender. The type of payment plan that is best for you depends on your financial circumstances when you graduate and your plans for the future. You have the option of prepaying your federal student loans at any time without penalty if you suddenly come into a substantial amount of cash. Private lenders may impose a penalty for early repayment, depending on the loan contract.

You may switch from one plan to another by contacting your lender. According to Loan Advisor Top 10 FFEL lenders must allow you to switch at least once each year, but most will allow you to switch more often if your financial circumstances make it necessary. Borrowers with Direct Loans may change plans at any time by notifying the Department of Education. If you are repaying your Direct Loan through an income-contingent or income-based repayment plan, you cannot change plans until you have made payments in each of the previous three months before requesting the change. You cannot switch from an extended or graduated payment plan to an

income-contingent plan if the loan has been in repayment for more than 25 years.  Savvy Student Tip: Whenever possible, pay more than your scheduled monthly payment. Notify your loan processor that you want the excess payment applied to the principal of the loan, since reducing the principal will reduce the amount of interest you pay over the life of the loan. Lenders are allowed to credit any payment received first to accrued late charges or collection costs, then to any outstanding interest, and finally to outstanding principal. This is also true for schools collecting Perkins loans and for private loans. If you fail to notify the loan processor that an excess payment is to be applied to the loan principal, it will simply be applied toward your next monthly payment..

Standard Repayment Plan Under a standard repayment plan, you make a fixed monthly payment for a term of up to ten years. If your loan was not a large one, the term may be shorter, but most college graduates need at least ten years to pay off their loans. There is a $50 minimum monthly payment. For graduates who find a well-paid job soon after leaving college, this is the best option. Standard payment plans offer the best interest rate of all the repayment plans.

Extended Repayment Plan Under an extended repayment plan, fixed loan payments are stretched out over a longer term of 12 to 30 years, depending on the amount of the loan. The size of each payment is reduced, but the additional interest you will pay over the extended term will increase the total amount repaid over the lifetime of the loan. The smaller monthly payments are easier to manage when your income is low, you have many monthly bills and obligations, or you have had financial setbacks. The minimum monthly payment is $50.  Extended repayment is not available for FFEL loan balances disbursed before October 7, 1998, or for balances less than $30,000. If you choose this option, do not just set up automatic debit and forget about it. Make larger payments whenever you can afford to. If your financial circumstances improve dramatically, increase the amount you pay regularly every month as much as you can.

Graduated Repayment Plan A graduated repayment plan starts out with lower payments, which gradually increase every two years. The loan term is 12 to 30 years, depending on the total amount borrowed. The monthly payment must at least cover the interest that accrues, and must also be a minimum of $25. The monthly payment can be no less than 50 percent and no more than 150 percent of the monthly payment under the standard repayment plan. A graduated repayment plan is appropriate when you start your career with a modest income that you expect will rise steadily over time. It will pay off your loan faster than an extended repayment plan, but allow you some flexibility when you are starting your career.

Savvy Student Tip: The Income-Sensitive Repayment (ICR program) indirectly subsidizes the interest on a loan with an interest capitalization cap. When the monthly payments are not high enough to cover the interest on your loan, unpaid interest is capitalized (added to the principal) at the end of each year. This

capitalization is capped at 10 percent of the original loan amount; any additional unpaid interest continues to accumulate but is not added to the loan balance. As long as you remain in the ICR program, the unpaid interest that is capitalized will not exceed 10 percent of the loan balance and will not be compounded. If you switch to a different repayment plan, all of this accumulated unpaid interest will be added to the loan balance and will begin to be compounded.  The amount of debt discharged after 25 years is treated as taxable income under current law, so be prepared to pay extra taxes the year your loan is discharged. One flaw with the ICR formula for calculating the monthly payment is that it combines the income of married borrowers with that of their spouses, leading to a higher payment amount than the borrower would pay based on his or her own income. The qualifying documents require the spouse’s Social Security Number and may require the spouse’s signature, essentially making both spouses responsible for the loan. A federal student loan is discharged when the borrower dies, but if the loan is treated as a community property debt, the spouse might still be held responsible. Verify the terms of the loan agreement before signing.

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