Did you just don your graduation cap and gown? Congrats! Now that you are ready to start your career, it’s time to think seriously about those pesky student loans that have been piling up. This is particularly true for those who are coming from a graduate school or a professional school where the rates (and the balances) are almost certainly higher!
Oftentimes, professional school graduates will be offered an opportunity to refinance their loans at a lower and more attractive rate than the one they have. The question is, should you pull the trigger and refinance your loans?
Here’s what you should know first: a debt load that rivals that of a mortgage requires a deeper analysis than simply a high rate versus a low rate. In fact, refinancing your federal student loans will result in losing the ability to choose your repayment plans. Before you jump the gun and refinance, make sure you understand how your monthly payment for the next decade or two will work with your overall financial picture.
The Main Repayment Plans
Your monthly repayment plans make a big difference in your overall financial health and your month-to-month budget. There are advantages and disadvantages to each strategy, so be sure to consider the bigger picture before deciding which one is right for you. Here are the main types of repayment plans that you can expect to encounter:
Standard Ten-Year Plan
Much like a mortgage, this type of repayment plan implies a loan that is amortized over a ten-year span. You will see a set payment that makes it easier for you to budget and plan for the cost of your student loan debt month after month. The monthly payments with this type of repayment plan will be slightly higher than many of the others, but it cuts down on the overall interest that you pay.
Standard Twenty-Five Year Plan
This offers the same amortized loan as the ten-year repayment plans, but your monthly amount due will be significantly less. Keep in mind that you are spreading out how much you owe over a much longer period which will increase the amount you pay in interest.
Revised Pay as You Earn (REPAYE)
This plan was first introduced a few years ago in December 2015 as the newest option for income-based payment plans. Monthly payments are set at ten percent of discretionary income. If you are married, your spouse’s income does still count even if you file your taxes separately. The balance is forgiven at the end of 25 years (or 20 years for undergraduate debt). This is great because you are making payments based on what you earn instead of the amount that you owe. It can make a huge difference if you are saddled with student loan debt that could rival your current mortgage.
One of the big benefits of this program is the interest subsidy of fifty percent of unpaid interest. This could be very helpful, particularly for people thinking about refinancing their loans later on down the road.
Income-Based Repayment Plan (IBR)
For loans taken before July 2014, this repayment plan asks you for fifteen percent of your adjusted gross income minus 150 percent of the federal poverty line. Newer borrowers after July 14 have it even better. They are required to pay 10 percent of discretionary income. Any balance left at the end of the twenty-year repayment period is forgiven.
Much like the REPAYE plan, many graduates like the IBR plan because it focuses on what you can afford to pay instead of what you owe. You can lower your monthly payments this way, particularly if you are not yet a high-income earner.
Pay as you Earn (PAYE)
The PAYE program is very similar to the REPAYE program with one small difference. Monthly payments are set at 10 percent of your discretionary income, but you must prove that you need assistance in repaying your student loans. You also must not have taken out any federal loans before October 2017. It is also important to note that spousal income could be excluded if your taxes are filed separately.
Beware the Tax Bomb
It might seem like the easiest way to get rid of your student loan debt is to run out the clock on your repayment plans to maximize student loan debt forgiveness. Unfortunately, many people are unprepared for the repercussions associated with this. In the year that it is given, all student loan debt forgiveness is taxed as income.
If you will be receiving assistance in paying off your loans this way, it is important to start a savings strategy now so that you will be prepared for what could be a massive tax hit ahead. Be sure to work with your financial advisor to create a plan for paying for your income taxes during this pivotal year.
Choosing Your Repayment Strategy Wisely
The simple truth is that there are pros and cons to each repayment strategy. Choosing a plan requires you to take a closer look at how it fits into your bigger-picture financial plan. You must consider more than just your interest rate. Think about your current income, your tax situation, your family, current cash flow, and so many other small things that make up your overall financial health. Before you decide to refinance your loans, make sure you talk with a financial planner about which repayment strategy suits you the best.