A student living on campus at an in-state public 4-year institution can expect to pay a total of $108,584 to attend college[1]. Due to this high cost, student loans often become necessary for individuals seeking higher education. Currently, more than 43.2 million individuals have student loans[2], making this topic increasingly relevant. Some individuals may find themselves owing hundreds of thousands of dollars for student loans and therefore, pay thousands per year in interest alone. Understanding the basics of student loans and then sticking to a repayment plan can significantly impact financial well-being.
Debt Schedules
Before walking through student loan repayment options and the possibility of loan forgiveness, it is important to understand amortization. Simply speaking, amortization refers to the process of paying off debt over time. Each payment the borrower makes is made up of two components: interest and principal. Interest is the cost of borrowing money whereas principal is the amount that reduces how much is owed. In other words, each time a borrower makes a payment, only some of the payment goes towards reducing the amount that they owe. As time goes on, the payment may not change, but the amount of the payment that goes towards the principal often does.
To illustrate how this works, consider a student who recently graduated and has student loan debt of $37,088 (this is the average student loan debt balance)[3]. This student has selected to pay off this debt over 10 years, their interest rate is 6%, and they will be paying monthly.
Notice that the “Payment” of $411.75 never changes. Also, the “Loan Balance” decreases by the “Principal” component of the payment. Finally, the “Principal” component makes up a larger and larger share of the “Payment” until the “Loan Balance” reaches $0.
Repayment Plans
When it comes to repaying federal student loans, there are two types of repayment plans: Fixed Payment Repayment Plans and Income-Driven Repayment (IDR) Plans[4]. Let’s look at two of the most popular repayment plans for each.
- Fixed Payment Repayment Plans
- Standard: Payments are a fixed amount that ensure your loans are paid off within 10 years. This is the type of repayment plan that was illustrated in the amortization table above. This is also the default repayment option for individuals who do not select a plan.
- Graduated: Payments are low at first then increase over time (usually every two years). Like the Standard Repayment Plan, this ensures your loans are paid off in 10 years.
- Standard: Payments are a fixed amount that ensure your loans are paid off within 10 years. This is the type of repayment plan that was illustrated in the amortization table above. This is also the default repayment option for individuals who do not select a plan.
- Income-Driven Repayment (IDR) Plans
- SAVE (saving on a valuable education): Payment is 10% of your discretionary income. This is a monthly payment and the amount is adjusted yearly. Discretionary income for SAVE is the difference between annual income and 225% of the poverty guideline depending on family size[5].
- PAYE (pay as you earn): Payment is 10% of your discretionary income but never more than what you would pay under the Standard Repayment Plan. Note that discretionary income for PAYE is the difference between annual income and 150% of the poverty guideline depending on family size[6].
- SAVE (saving on a valuable education): Payment is 10% of your discretionary income. This is a monthly payment and the amount is adjusted yearly. Discretionary income for SAVE is the difference between annual income and 225% of the poverty guideline depending on family size[5].
Forgiveness
Student loan forgiveness is a topic of considerable interest and speculation, especially given the significant burden of student loan debt on millions of borrowers. Currently, there are a few notable forgiveness programs for federal student loans.
- Public Service Loan Forgiveness (PSLF): Current employees of the government or qualifying not-for-profit organizations can apply for loan forgiveness after they have made 120 payments under an accepted repayment plan. Qualifying for PSLF isn’t about the job you perform, it’s about who you work for. On studentaid.gov there is an employer search tool to see if your employer qualifies for this type of forgiveness[7].
- Teacher Loan Forgiveness (TLF): Individuals who teach full-time for five complete and consecutive academic years in a low-income school or education service agency may be eligible for up to $17,500 of loan forgiveness[8].
- Income-Driven Repayment (IDR) Plan Forgiveness: Under all IDR plans, any remaining loan balance is forgiven if your federal student loans aren’t fully repaid at the end of the repayment period (either 20 or 25 years). Note the length of your repayment period depends on the plan in which you are enrolled.[9].
While several forgiveness programs exist for federal student loans under specific conditions, broader initiatives such as total federal student debt cancellation remain a subject of ongoing debate and speculation. Borrowers should monitor developments and assess their eligibility for existing forgiveness programs based on their circumstances.
Which Repayment Plan Makes Sense for You?
Choosing the right repayment plan depends on individual circumstances, but several considerations can guide your decision. A Fixed Payment Repayment Plan may be suitable for those with higher incomes and fewer financial commitments. Since the Standard and Graduated Plans aim for full repayment in 10 years, they generally involve higher monthly payments. This means the loan is paid off quickly and less total interest is paid compared to long-term debt. Individuals with high capacities to save and/or pay down debt after graduating should consider Fixed Payment Repayment Plans.
Conversely, some individuals may find that an Income-Driven Repayment (IDR) Plan is more suitable for them. Since the payments are a percentage of discretionary income, the dollar amount of the payment may change over time, but the percentage of income this accounts for won’t. An individual with other financial commitments (mortgage, car loan, other debt, etc.) may opt for this plan so they can be certain student loan payments don’t account for a large portion of their earnings. Further, those anticipating eligibility for Public Service Loan Forgiveness (PSLF) or expecting a remaining balance after 20 or 25 years of payments under an IDR Plan may opt for an IDR Plan to maximize potential forgiveness opportunities.
Ultimately, navigating student loan debt requires careful consideration. Different payment plans can result in drastically different monthly obligations. Understanding and then paying down debt is one of the crucial first steps in accumulating wealth. If you have any questions about which type of repayment plan might be right for you or your loved ones, please contact us.
[1] https://educationdata.org/average-cost-of-college#:~:text=The%20average%20cost%20of%20attendance,or%20%24234%2C512%20over%204%20years.
[2] https://educationdata.org/student-loan-debt-statistics
[3] https://educationdata.org/average-student-loan-payment
[4] https://studentaid.gov/manage-loans/repayment/plans
[5] https://studentaid.gov/help-center/answers/article/discretionary-income
[6] https://studentaid.gov/help-center/answers/article/discretionary-income
[7] https://studentaid.gov/manage-loans/forgiveness-cancellation/public-service
[8] https://studentaid.gov/manage-loans/forgiveness-cancellation/teacher
[9] https://studentaid.gov/manage-loans/repayment/plans/income-driven