Graduation Prep Guide – Finance Edition Pt 2
Hey all! Thanks for checking back in with us. If you haven’t already go ahead and check out part 1 of this series here. You may want to read through that through if you haven’t already as it’ll give you context around what we’re about to discuss next, which is interest rates and their impact on your repayment strategy.
When thinking of through your strategy, your interest rates should help guide you in terms of how aggressively you want to be paying off your various balances. If you happen to have loans that are in the range of 3-4% in interest it actually won’t help you tremendously to pay it off quickly. Reason being, at this low of an interest rate you are pretty much matching the cost of inflation. On the other hand, if you happen to have interest rates more in the range of 9-12% or possibly higher it’s definitely worth considering a plan that will aggressively lower your total balance.
Another thing to factor into your repayment plan is which type of repayment structure you’ll want to go with. You can choose among a standard, graduated, extended, income-based, pay as you earn, or income contingent repayment plan. With so many options to choose from we understand it might be a little daunting to start thinking this through, so in our effort to help we’ll touch on each of them briefly to get your better familiarized.
The standard repayment plan is the simplest and most straight forward of all the repayment options. This is likely what your lender will default to should you not make any adjustments to your terms. What this does is break down your balance into equal payments such that by the end of life of the loan your balance will be fully paid off along with the interest you owe.
The graduated repayment plan is one that starts out with lower monthly payments but increases every two years until the loan is repaid. This is probably the best option for those who come out of college with lower salaries but expect to make higher income down the line. One thing to note about this option though is that you will end up paying more in total interest compared to the standard repayment plan, so definitely something to think through and consider.
The extended repayment plan is interesting in that you still need to choose between the standard or graduated terms but the difference is that rather than paying the loan off in your typical 10 year time frame, you are extending it to 25 years. Hence the name. This plan is probably best suited for those whose loans are so burdensome they don’t foresee being able to pay off the entire balance in a matter of 10 years, but in order to qualify for this type of repayment plan your loans have to total more than $30,000.
Alright, you still with me? Good. So here’s where things get a little interesting. The next few repayment options that we’ll discuss can actually allow for loan forgiveness, crazy I know, but don’t get too excited just yet. In order to qualify for these loan forgiveness programs you must prove that you face financial hardships so strong that there simply won’t be any way for you to reasonably pay off your loans.
Let’s first touch on the income-based repayment plan. In this repayment plan borrowers are limited to monthly payments that equal 15% of their discretionary income. Discretionary income can be defined as the difference between their adjusted gross income and 150% of the poverty guideline for their particular family size and state of residence. Remember how we mentioned last time that where you live can have an impact on your well-being? Well even the government agrees but that’s beside the point. Getting back to topic, if the balance on the loan has not been paid off after 25 years it can be forgiven. The caveat is that someone under this plan is likely to pay more interest over the life of the loan. Even still, it can be a favorable plan for some if they are unable to make their monthly payments under any of the other repayment plans we’ve talked about up to this point.
Pay as you earn is actually very similar to the income-based repayment plan except that rather than being capped at 15%, monthly payments are now limited to just 10% of the individual’s discretionary income. Additionally, the time frame for loan forgiveness will also reduce from 25 to 20 years. All of this of course still hinges on the fact that the borrower is under intense financial hardship which they must be able to prove. Once again the individual is likely to pay more interest over the life of the loan than under the standard repayment plan but it’s definitely an option for those who simply cannot afford to pay back their loans otherwise.
Lastly, let’s touch on the income-contingent repayment plan. This particular repayment plan takes a lot of things into consideration when determining monthly payments such as the individual’s annual income, family size and total loan amount. Like the income-based repayment plan, if a balance still remains after 25 years it may be forgiven. However, unlike an income-based or pay as you earn repayment plan you don’t need to demonstrate financial hardship to qualify for this plan. The total interest payments will be more than they would be under the more traditional options but this is definitely worth considering for those who face external factors that make it difficult to meet their monthly payments such as needing to support a child.
It’s important to note that these repayment plans apply to federal loans only. If you want more detailed information on federal financial aid and repayment you can check out their website at StudentAid.gov. If you decided to take student loans from a private lender, they may offer similar types of repayment structures but it’s important to clarify with them directly either online or by phone.
I’d like to reiterate that when it comes to financial situations, there is almost never a one-size fits all solution. Therefore, I recommend you take our advice and that of others with a grain of salt since what worked for them may not be the best option for you. Listen and consider but always think through the repercussions of your decision and how that is likely going to affect your cash flow and credit over the long term.
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