As of March 2021, there were $1.736 trillion of student loans outstanding. If you are like me, that number is too large to comprehend. Student loans are an important issue for many students going into college, current college students, and graduates.
Unfortunately, student loans can be confusing. There are many rules, forms, and repayment options. If not planned for properly, it can cost tens of thousands of dollars or more.
Let’s take a look at how you can handle student loan debt and the proactive steps you can take to put yourself in a better financial position. We’ll explore the benefits of income-driven repayment plans, how monthly payments are calculated, and when refinancing might make sense, as well as a word of caution if trying to do the planning by yourself.
As with all posts, you should consult an expert about your personal financial situation. I am not a student loan expert and this is only for educational purposes.
Step 1: Understand your Loans
The first step in determining how to handle your student loan debt is to understand your student loans. If you have separate lenders, I recommend making a Google Sheet to visually see everything. You could set it up with the following information:
- Loan Servicer
- Loan Type
- Total Loan Amount
- Current Balance
- Loan Length
- Interest Rate
- Estimated Payment
If you have federal loans with different interest rates, it’s important to note that information in your spreadsheet. This way when you make a plan, you can target the highest interest rate debt first if you are not consolidating your loans.
Once you have your loans organized, you can start to analyze what options are available.
Step 2: Decide if You Want to Consolidate or Refinance Your Loans
For federal loans, you can consolidate your loans into one to reduce the number of bills you receive. When you consolidate multiple federal loans into one, your separate loans become one loan with an average interest rate of all your outstanding federal loans. For example, if you had a $25,000 loan with a 3% interest rate and $35,000 loan with a 6% interest rate, your consolidated loan would be $60,000 with a 4.75% interest rate.
Another benefit is being able to switch variable-rate loans to a fixed interest rate.
Consolidating loans is helpful for repayment plans and Public Student Loan Forgiveness, but is not a good option if you plan on paying extra towards your loans and want to target your loan with the highest interest rate first.
There are also other disadvantages, such as any outstanding interest becoming part of the original principal balance, which means more interest may accrue on a higher principal balance. Another disadvantage is that the interest rate may be a little higher than your individual interest rates because when you consolidate, the combined interest rate is rounded up to the nearest eighth of a percentage (0.125%). Also, if you are paying under an income-driven repayment plan or have made qualifying payments under PSLF, you would lose credit for payments towards the repayment plan and PSLF if you consolidated.
This is why it is usually best to consolidate your loans immediately after graduation if you plan on working towards PSLF.
If you have private loans already, you may want to refinance your loans to one lender to decrease the number of separate bills you are paying. It may be possible to obtain a lower interest rate, which could decrease the amount you pay for the loan over time. For example, if you have a loan balance of $10,000 with a 7% interest rate, another with $5,000 at a 6% interest rate, and you could refinance into a $15,000 loan at 4%, you’ll not only reduce the headache of having to pay two different lenders, you will lower your monthly payment and the total amount you pay.
There are certain scenarios where it makes sense to refinance federal loans into private loans, but exercise caution if you decide that may be right for you. Once you refinance, you lose the benefits federal loans provide, such as Public Student Loan Forgiveness, repayment plans, and loan payment relief during a financial hardship. People typically only refinance federal loans into private loans if they feel comfortable in their career, obtain a low interest rate, and have a clear plan to pay off the loans without any of the federal benefits.
Consolidating or refinancing your loans can help simplify how you repay your loans to become debt free, but you need to thoroughly investigate what that would mean in your individual circumstance before doing anything.
Step 3: Select a Repayment Plan
Each repayment plan for federal loans has specific rules about whether you can qualify. For example, to qualify for Pay As You Earn (PAYE), you must have received a federal loan on or after October 1, 2007 and had no outstanding federal loans then, received a Direct Loan or Direct Consolidation Loan after October 1, 2011, and demonstrate partial financial hardship.
The standard repayment plan for federal student loans is a 10-year timeline. You can select an income-driven repayment plan, which can extend your payments to 20 or 25 years. We’ll cover in which situations that might make sense.
The main repayment plans are:
- Revised Pay As You Earn (REPAYE)
- Pay As You Earn (PAYE)
There are others, such as the income-based repayment plan (IBR), income-contingent (ICR), income-sensitive repayment plan (ISR), extended repayment plan, and others, but these rarely make the most sense for people. Most people are going to be on the standard, REPAYE, or PAYE repayment plans.
The standard repayment plan is a 10-year repayment plan. If you are looking to pay off your loans quickly and pay less over time, it can be a good plan. The problem for many people is they may be unable to afford the monthly payment.
For example, if you had $50,000 in student loans with an average interest rate of 5%, your monthly payment would be $530. Over the 10 year period, you would pay $63,639 total. Some people may be able to afford that, but if not, a repayment plan may be a better option.
The REPAYE plan is available for direct loans and calculated as 10% of your discretionary income. The monthly payment is recalculated annually based on your income and family size. If you have an outstanding balance after 20 years, the loan balance is forgiven and you may pay income tax on the forgiven amount.
The PAYE plan is available for direct loans and calculated as 10% of your discretionary income, but will never be higher than the payment under the 10-year Standard Repayment Plan. Like REPAYE, payments are recalculated annually based on your income and family size. If you have an outstanding balance after 20 years, the loan balance is forgiven and you may pay income tax on the forgiven amount.
There are three main differences between REPAYE and PAYE.
- PAYE caps your monthly payment. REPAYE does not.
- REPAYE counts your spouse’s income when calculating the monthly payment even if you file taxes separately. PAYE does not count your spouse’s income if you file taxes separately.
- REPAYE offers an interest subsidy
Using the $50,000 in student loans from above, if your discretionary income was $150,000 and you were on PAYE, your monthly payment would still be $530, but if you were on REPAYE, your monthly payment would be $1,511. You can see how REPAYE not having a cap can be detrimental for individuals who are earning a higher income or plan to in the future.
If you were married and your spouse had income, their income could also potentially increase your monthly payment if you were on REPAYE, even if you filed your taxes separately. With PAYE, you can file separately, and your spouse’s income won’t affect your payment.
REPAYE also offers an interest subsidy where the government pays 50% of your interest after the first three years, whereas PAYE does not. This is why it is important to not follow general advice about which plan is best. Rather, you should investigate your own situation and/or consult with an expert.
If you are seeking Public Service Loan Forgiveness (PSLF), you’ll want to get on an income-driven repayment plan because having direct loans under an income-driven repayment plan is a requirement.
PSLF is generally a great option for those who plan to be employed full-time by a U.S. federal state, local, or tribal government or non-profit organization for ten years and have debt that is more than 1.5 times their annual income. After ten years of qualifying payments, your remaining student loan balance is forgiven.
For example, if you borrowed $300,000, paid back $181,000, and had $266,000 left in student loans at the end of ten years, the full $266,000 would be forgiven. You’ll want to use the Employment Certification for Public Service Loan Forgiveness form each year to track your employment and qualifying loan payments. It makes it easier to apply for forgiveness at the end of 10 years. If you are interested in learning more about if PSLF might be right for you, try the PSLF Help Tool.
Lastly, Student Loan Planner has online calculators, but I really appreciate the Excel calculator they give people for free if they sign up for their newsletter. You can input your loan balance, average interest rate, future income, family size, and other assumptions to determine which repayment plan may be best, the total cost of it, the amount forgiven, when it will be repaid, and your first monthly payment.
Step 4: Consult Experts
Although I believe in educating oneself about finances, I also believe in bringing in experts when you don’t have the time, energy, or knowledge to make an informed decision. Even if you have all those things, sometimes it can still be helpful to hire someone to give you peace of mind that you are making the right choice.
When deciding whether to hire someone, I like to ask these questions:
- Do I want to spend the time learning how to do it?
- If I am wrong, what could possibly go wrong?
- Given the dollars involved, would I hire someone in another area of life?
These questions help me see when it is time to bring in an expert. I recently hired a student loan expert to help with student loans. I made that decision based on the following:
- I wanted to spend the time learning how to do it, and I did spend the time, but I was still not confident. I don’t deal with student loans every day.
- If I made the wrong decision, the consequences could be a mistake in the tens of thousands of dollars.
- The student loans were over $150,000. I thought about how if I was buying a $150,000 house, I’d hire a real estate agent. If I wanted to spend $150,000 remodeling, I would hire contractors. Yes, I would hire someone if $150,000 was at stake in another area of life.
The cost was $395 to develop a custom student loan plan. It was well worth the cost given a mistake could cost tens of thousands of dollars.
I know it can seem strange to spend money when you are already tens or hundreds of thousands of dollars in debt, but it can provide peace of mind and ensure you are not costing yourself more money.
Summary – Final Thoughts
Student loans are complicated. There are countless rules and general advice about what is best.
The truth is, each person’s situation is unique and one small detail can drastically change the recommended advice. I recently discovered this as I went through a student loan consultation and learned about the fact that you can split the income in a community property state by filing taxes separately and using Form 8958 for a potentially lower income-driven repayment.
Federal loans offer many benefits. Although you may see advertisements to refinance your loans into private loans, be wary. As soon as you refinance, you lose the benefits of federal loans, such as PSLF.
Before choosing a repayment plan, thoroughly research which plans apply in your situation, and consider consulting with an expert to help you determine what will be best for you. The wrong decision could cost you tens of thousands of dollars or more. Keep in mind if you have substantial debt, consulting an expert is an investment in your future – much like school.
I wish you the best in handling your student loan debt!