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Student loan repayment plans: What students need to know when they sign on the dotted line


College is an exciting time. It’s a time for new friends and new experiences, for expanding one’s horizons and preparing for career and life to come. It’s worthwhile financially, too: As reports continue to suggest, earning a college degree is one of the surest investments out there. (For a striking illustration of this, check out this chart from TG’s Adventures In Education website.)

As with all investments, however, college requires an up-front financial commitment in order to reap the benefits down the road. For most students these days, that commitment comes in the form of student loans, and while it’s easy to take advantage now of money you may not have to repay for years, eventually those bills start rolling in. Often, students take out loans without a clear understanding of how their repayment obligation may affect them once they graduate. This post will focus on what students need to know in order to mange loan repayment in the way that works best for them.

First, borrowers should know that for most federal student loans, a “grace period” of six months begins once they leave school. This provides a welcome payment-free window in which to look for a job, move to a new permanent residence, and get organized in the working world. Borrowers should take note of when their grace period ends, however — it can be easy to lose track of when their student loan bills are coming due at the end of it!

Borrowers should be aware that during their grace period they can choose which plan they want to enter into for repaying their student loans. If they make no selection, they will automatically be entered into the standard repayment plan — which may or may not be the best choice for them.

So what options do borrowers have for repaying their federal student loans? Let’s take a look at the six repayment plans federal student loan borrowers can choose from.

Standard Repayment Plan
Under this plan, borrowers repay their loans in fixed monthly amounts over a ten-year repayment term. The minimum monthly payment is $50 or the monthly interest accrued on the loan, whichever is greater. This plan generates the lowest total interest costs over the total repayment period. As mentioned above, this is the plan borrowers will automatically enter if they don’t select a different plan.

Of course, for borrowers with substantial student loan debt, the monthly repayment amount under the standard plan may be difficult or impossible to manage on their current income. If this is the case, they may be able to choose other repayment options. These are described below.

Extended Repayment Plan
Borrowers with at least $30,000 in student loan debt can qualify for this plan, which lengthens the payment term from 10 years to at least 12 and no more than 25 years. Like the standard plan, under this option borrowers pay a fixed amount each month. Extended repayment lessens the burden of each monthly payment, but of course increases the interest amount paid over the total repayment period.

Graduated Repayment Plan
This plan provides for smaller monthly payments at the beginning of the loan term, then gradually increases the payment amount every two or three years. The repayment period is 10 years unless the borrower qualifies for extended repayment. Choosing this plan requires optimism on the part of the borrower that his or her income will increase significantly and regularly over the repayment period.

Income-Based Repayment
Income-Based Repayment (IBR) is the newest plan available for borrowers with high debt; it was introduced by the College Cost Reduction Act of 2007 and became available in 2009. Under IBR, monthly payments are based on a borrower’s income, family size, and student loan debt. Borrowers can choose IBR if they qualify as having a partial financial hardship, which is determined by comparing the borrower’s income to the poverty guideline for the borrower’s family size.

Borrowers have to reapply for IBR every year, and so their payment amount may change every year. But the IBR plan can greatly reduce monthly payment amounts, and any outstanding principal and interest still owed after 25 years of qualifying payments will be forgiven. Borrowers can access an IBR calculator at www.AIE.org/ibr to estimate their monthly payment amount if they qualify for this plan.

Income-Contingent Repayment
As with IBR, under the income-contingent repayment (ICR) plan, the borrower’s monthly payments are recalculated each year on the basis of the borrower’s income, family size, and student loan indebtedness. Unlike IBR, if the payment doesn’t cover the accumulated interest, the unpaid interest will be capitalized once a year, up to 10 percent of the original amount owed. If the borrower hasn't fully repaid his or her loans after 25 years, the remainder will be forgiven, but the borrower may have to pay taxes on the amount that is discharged.

ICR is only available on loans issued under the Federal Direct Loan Program (FDLP), in which the U.S. Department of Education acts as the lender. Beginning July 1, 2010, all federal student loans are originated under this program.

Income-Sensitive Repayment
Income-sensitive repayment is available on loans issued under the Federal Family Education Loan Program (FFELP), in which private lenders issued federal student loans. Beginning July 1, 2010, all loan originations ceased under this program, but many of today’s student borrowers have FFELP loans. As with IBR and ICR, this plan adjusts monthly payments annually based on the borrower’s income, family size, and student loan debt. Unlike IBR and ICR, the maximum repayment period under this plan is 10 years.

Learn more
For more information on each of these plans, as well as calculators to determine what monthly payments might be under each of them, visit the Department of Education’s Repayments and Calculators page. For side-by-side charts displaying monthly payment amounts and repayment periods for each plan with various loan balances, visit TG’s Comparison of Repayment Plans page.