Whether you are about to graduate, just graduated, or have been making student loan payments for a while now, it’s important to be aware of the many options you have to streamline the way you make your monthly payments. These days there are so many options other than the standard ten-year repayment plan.
More people than ever are refinancing or consolidating their loans to both simplify their payments and save money. And the increased availability of income-based repayment plan options means that nearly everyone with student loans can adjust their monthly payment amounts to correlate with their income and make their payments more affordable.
In this article, I’ll quickly cover the basics of refinancing, consolidating, and income-based repayment plans.
When I speak of refinancing student loans, I am talking about refinancing existing debt, whether federal loans or private loans, with a new private lender. In the next section I’ll cover consolidation, which is sometimes confused with refinancing, but which has important differences.
Refinancing is generally done to get a better interest rate and save money. In addition to a better interest rate, refinancing can also change other loan terms, such as the length of the loan.
For examples, if you took out a private student loan while in school and agreed to repay it at 9% interest over a ten-year term, then you might be looking at refinancing to get a lower rate.
Or, you might find that your monthly payments on a ten-year plan are too large for your budget, so you want to refinance to a fifteen- or twenty-year plan, either with or without a better interest rate.
There are many options for refinancing, and many lenders. Banks and credit unions traditionally offer refinancing for student loans. These days, online banks and non-traditional online lenders also offer refinancing.
When borrowers refinance federal loans with a private lender, the advantage is saving money with the better rate. But it’s important to weigh that savings against the potential disadvantages of privatizing your debt.
Most private lenders don’t offer the same range of hardship programs that the federal government does, such as hardship deferral if you lose your job or get seriously ill, income-based repayment if your income drops, and even deferral if you go back to school for another degree.
And once you privatize your loans, you cannot transfer them back to the government later, so those options are gone forever.
The best strategy is to weigh the pros and cons carefully. Consider factors such as how long you plan to take to pay off the debt, whether you have savings or an emergency fund with which to make payments if you experience illness or other hardship, and whether you plan to go back to school again.
Many people such as millennials do not take advantage of refinancing because they do not think these steps through. It is important to know that if you can save a lot on your monthly payment by refinancing and aren’t likely to need to take advantage of the federal hardship options, then refinancing could be a good option for you.
Consolidating your loans is another option to streamline how you make your payments. When I talk about consolidation, I’m talking about a Direct Loan consolidation with the federal government, as opposed to consolidating your loans privately, which would fall under the topic of refinancing.
Some of the past benefits to federal consolidation were to lock in a low interest rate and to consolidate servicers so that borrowers did not have to make multiple payments.
These days, federal consolidation loans use a weighted average of the underlying interest rates, and even prior to consolidation most borrowers will have only one servicer for all of their federal loans. So these are no longer compelling or relevant reasons to consolidate.
However, while those particular benefits no longer apply, there are still situations where it makes good sense for a borrower to get a federal consolidation loan, and I’m going to tell you about them.
The first reason to consolidate is if some of your loans were taken out by your parents as Parent PLUS loans. Normally, Parent PLUS loans are not eligible for income-based repayment.
However, by consolidating them with your other loans they are rolled into the consolidation loan and those amounts become eligible.
And as I’ll explain in the third section below, income-based repayment programs offer a lot of flexibility to borrowers.
The second reason is to lower your monthly payment, even if you don’t intend to get on income-based repayment. A consolidation loan can extend the length of time you repay your federal loans, and that means the payments are lowered.
The disadvantage is that doing so will cost you more money over the life of your loan, because you’ll be paying interest for a longer period of time and repaying the debt more slowly.
For some borrowers who cannot make their original monthly payments, this option makes sense. But those who can avoid extending the loan term will save money if they stick to their original term.
Get on Income-Based Repayment
Income-based repayment is often simply shortened to IBR. If your monthly payments are high compared to the income you’re currently making, you may be eligible for IBR.
These programs are only available for federal loans, since IBR is actually a series of related programs that correlate your monthly loan payment with your income.
Depending upon the program, your monthly payment amount could be capped at 15% or even 10% of your monthly disposable income.
Each year when you file your tax return you’ll have to re-qualify for IBR, and your monthly payment will be set for the year based upon what you made the year before.
As in consolidation, the disadvantage to IBR programs is that less debt is paid off each month, resulting in more interest accumulating on the unpaid principal balance of the loan.
The best way to determine which of the several IBR programs would work best for you – including which ones you qualify for – is to talk directly to your student loan servicer.
To apply for any of the programs, you’ll need to submit an application with them. Often, a qualified borrower can be put onto an IBR program within a month or two of applying.