Are you one of the 43 million Americans working to repay student debt? Don’t worry, you're not alone.
In 2016, 7 out of 10 graduates left campus with an average of $28,400 in student loan debt. Today, student loan debt is the second largest type of consumer debt with $1.3 trillion outstanding.
If you are like most borrowers, you probably want to repay your debt as fast as possible. The key to paying off student debt is to plan for an efficient repayment. Repayment is a difficult subject with words like forbearance and programs named income-based repayment. In this article we are going to cut through the jargon and get you started down the right path. We will give you the facts you need to evaluate various options to make student loan repayment more efficient and affordable.
The Different Types of Student Debt
About 90% of student loan debt is owned by the federal government, the remainder is funded by private lenders. Before repayment begins, you should work to identify what type of student loan debt you have. Depending on the type of debt you have, your repayment options, strategies, and costs may be different.
All federal student loans have had fixed interest rates since 2006. The federal government provides the following student loan programs:
Direct Subsidized Loans and Direct Unsubsidized Loans (for undergraduates): For a subsidized loan, the government pays your interest until you graduate or otherwise no longer attend at least half-time. For an unsubsidized loan, the interest accrues throughout. The grace period on these loans is six months.
Direct Unsubsidized Loans (for graduates and professional-degree students): The grace period on these loans is six months.
Direct PLUS Loans (for parents, graduates and professional-degree students): These loans have no grace period.
Federal Perkins Loan (for undergraduate, graduates and professional-degree students): These loans are administered by the college you attend. The grace period is nine months.
Private student loans from banks and other sources are not guaranteed by the government, and are more expensive than federal loans. For various reasons, about 7 percent of education financing is lent by private companies, including Sallie Mae, Citizens Bank, Wells Fargo and many others. Naturally, the repayment terms vary from one lender to the next. Many private loans offer 6- to 12-month grace periods, a feature not available on Federal PLUS Loans.
Private student loans may feature fixed or variable rates, or a mixture of the two.
The two types of private student loans are:
Direct-to-consumer: The student interacts directly with the lender and must provide verification of enrollment. Proceeds are distributed to the borrower.
School channel: The school certifies the student’s enrollment and receives the proceeds from the lender. These loans are usually cheaper than direct-to-consumer loans, but take longer to arrange.
Grace Periods, Deferment, & Forbearance
Most federal and private student loans feature a grace period, which is a set period of time after graduating, leaving school, or dropping below half-time status before you must begin repayments. Unless the loan is subsidized, interest accrues on student debt as soon as it is incurred. Interest also accrues during the grace period. Both unsubsidized federal loans and private student loans will accrue interest during the grace period.
Federal student loans offer deferment and/or forbearance. Private student loans will in most cases only offer deferment.
A deferment is a temporary delay in the repayment of loan principal and interest, usually because of an inability to repay due to unemployment or other circumstances. During deferment, the government may pay the interest on direct subsidized loans and Perkins loans, but not on unsubsidized and PLUS loans, where the interest accrues. Accrued interest may be added to the principal amount of your loan once the deferment period ends.
Check the Federal Student Aid website for more information about qualifying for a deferment. Alternatively, you should contact your private student loan servicer for any specific questions.
Forbearance allows you to stop making payments or reduce your monthly payments for up to 12 months when you don’t qualify for a deferment. Interest accrues during periods of forbearance, although you can choose to make the interest payments during the period in order to avoid accrual.
There are two types of forbearance:
Discretionary: The decision to grant forbearance rests with your lender. It is usually requested because of financial hardship or illness.
Mandatory: You may qualify for forbearance if you meet any of the eligibility requirements listed on the Federal Student Aid website.
The federal government offers four income-based student loan repayment plans. Under these programs your income and family size are used to determine how much you shell out each month in student loan repayments. In short, these plans will limit your monthly payment to an affordable amount determined by your income. For example, under the income-based repayment plan your monthly payment will be capped to 10-15 percent of your discretionary income, but never more than the 10-year standard repayment plan amount. The four plans are:
Pay as You Earn Repayment Plan (PAYE Plan)
Revised Pay as You Earn Repayment Plan (REPAYE Plan)
Income-Based Repayment Plan (IBR Plan)
Income-Contingent Repayment Plan (ICR Plan)
See the Federal Student Aid website for all the details regarding income-based repayment programs. For reference, private student loans are no eligible for income-driven repayment plans.
Federal Consolidation vs. Private Refinancing
Federal Student Loan Consolidation
A Federal Direct Consolidation Loan lets you simplify your monthly payments, but at the risk of losing some benefits. These government-provided consolidation loans let you combine several federal education loans (but not private loans) into one, resulting in a single monthly payment instead of multiple ones. The new interest rate is the weighted average of the rates on the old loans.
You may, by virtue of consolidation, have access to alternative repayment plans that limit your monthly payments based on your income. These repayment plans include options to pay less now and more later, to base payments on earnings, or to cap payments as a percentage of discretionary income or annual income. The plans are:
- Pay as You Earn
- Revised Pay as You Earn
Recently, a number of companies have begun charging consumers for this service. You should not pay to file the forms needed for federal loan consolidation. You can file these forms for free.
You can pay off one or more old federal or private student loans by refinancing, receiving a new loan at a lower interest rate and use the proceeds to pay off the old loan(s). Refinancing reduces your monthly payments, and/or shortens the time needed to pay off the loan. When you refinance you can choose either a fixed or variable interest rate. In addition, you can choose a new term length from 5 to 20 years. You save on the total interest cost of the loan, even more so by taking a variable rate loan and repaying it on a short term length. Like consolidation, refinancing provides the convenience of one monthly payment.
Refinancing is not available from the federal government, only from private companies. However, private lenders can refinance federal and private loans, allowing consolidation of the two types. Parents can also refinance parent PLUS loans into the name of their child. While you can refinance a federal student loan, keep in mind that you might lose certain benefits, such as forgiveness for public service or income-based repayment plans. If you can do without the special benefits provided by federal student loans, you might be able to save money by taking out a low-interest private loan.
Avoid Student Loan Forgiveness Scams
The U.S. Department of Education offers relief that allow you to stop repaying your federal student loan(s). The relief is variously referred to as cancellation, forgiveness or discharge. There are several reasons why you can qualify for student loan forgiveness, and they are all laid out on the Federal Student Aid website. The important point is that you never have to pay a penny to receive counseling from the Education Department about loan forgiveness or to apply for a federal student loan discharge.
Unfortunately, there are many fraudulent businesses that advertise ways to receive “student loan forgiveness” or “student loan debt relief” and always for a fee (some as high as $1,500). Most often, these businesses simply file an application on your behalf for student loan consolidation (not forgiveness). Sometimes, they just steal your money and provide no service at all. They are all scams, and here are some ways to spot them:
Requests for payment: It’s a total red flag when the company asks for payment up front.
Official sounding names: Private companies might use words like “national” or “federal” in their names to trick you into thinking they are legitimate. Unless the website name ends in .gov, it’s not a government website.
Pie-in-the-sky promises: If they promise you outright forgiveness or immediate relief, run away. It takes time to consolidate or discharge student loans legally. Anyone who tells you otherwise is lying.
Phony advertising: Be skeptical if they advertise only on Facebook or via paid Google ads. Just ignore sites that don’t end in .gov and you’ll be much safer.
Dave Rathmanner leads consumer education at LendEDU, a friend of LendUp. Dave enjoys helping you optimize and learn about your personal finances. Dave has a dream that no student should pay more than required on their student loans.