EDU Loan Support

Don't Stress Over Student Loans

The most straightforward repayment plan for federal loans is the standard ten-year plan. Under this arrangement, you pay the same amount each month until your loan is repaid. But that can be challenging for graduates with a lot of debt or a low-paying job. Borrowers who have $30,000 or more in loans can opt for the extended-repayment plan, which lowers the monthly bill by lengthening the re­payment period to as long as 25 years. The graduated repayment plan requires lower payments at first and then raises them, usually every two years, for up to ten years, presumably as your income increases. (With the extended and graduated plans, you’ll pay more interest than with the standard repayment plan.)

Or check out income-based repayment plans, such as Pay As You Earn, the newest of such options.

Income-based repayment is for borrowers with a lot of debt relative to income. You qualify if you have a “partial financial hardship”—that is, your monthly payments would be higher under the ten-year standard repayment plan than under the income-based plan.

With Pay As You Earn, you must also have taken your first loan on or after October 1, 2007, and received a disbursement of at least one loan on or after October 1, 2011. You put 10% of your “discretionary” income (the amount by which your income exceeds 150% of the poverty line) toward your loans over 20 years, after which any remaining amount is forgiven.

Borrowers in income-based repayment programs who work in public-service positions—for the federal government or a qualifying nonprofit, for example—also qualify for public-serv­ice loan forgiveness; federal loans are forgiven after ten years (or 120 on-time payments) instead of 20 years.

Consolidation lets you combine your federal loans under one interest rate and one bill (you can’t consolidate federal loans with private loans). The interest rate is based on the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth point. Consolidating still gives you access to the range of repayment plans.

No matter which repayment plan you choose, sign up for automatic debit. You’ll qualify for a 0.25-percentage-point reduction on your federal interest rate.

Among graduates of the class of 2012 who borrowed, the average debt is $29,400—not a crippling amount, but no easy lift, either. Many graduates have a mix of federal loans at a variety of interest rates (federal Direct Loans, the most widely available, carried a 3.86% rate for the 2013–14 school year), and some borrowers also have private loans with variable rates as high as 11%. You can pick a repayment plan that fits your finances; if your circumstances change, you can always change the plan. (See which best fits your budget with the Department of Education's Repayment Estimator.)

The most straightforward repayment plan for federal loans is the standard ten-year plan. Under this arrangement, you pay the same amount each month until your loan is repaid. But that can be challenging for graduates with a lot of debt or a low-paying job. Borrowers who have $30,000 or more in loans can opt for the extended-repayment plan, which lowers the monthly bill by lengthening the re­payment period to as long as 25 years. The graduated repayment plan requires lower payments at first and then raises them, usually every two years, for up to ten years, presumably as your income increases. (With the extended and graduated plans, you’ll pay more interest than with the standard repayment plan.)

Or check out income-based repayment plans, such as Pay As You Earn, the newest of such options. Income-based repayment is for borrowers with a lot of debt relative to income. You qualify if you have a “partial financial hardship”—that is, your monthly payments would be higher under the ten-year standard repayment plan than under the income-based plan.

With Pay As You Earn, you must also have taken your first loan on or after October 1, 2007, and received a disbursement of at least one loan on or after October 1, 2011. You put 10% of your “discretionary” income (the amount by which your income exceeds 150% of the poverty line) toward your loans over 20 years, after which any remaining amount is forgiven.

Borrowers in income-based repayment programs who work in public-service positions—for the federal government or a qualifying nonprofit, for example—also qualify for public-serv­ice loan forgiveness; federal loans are forgiven after ten years (or 120 on-time payments) instead of 20 years.

Consolidation lets you combine your federal loans under one interest rate and one bill (you can’t consolidate federal loans with private loans). The interest rate is based on the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth point. Consolidating still gives you access to the range of repayment plans.

No matter which repayment plan you choose, sign up for automatic debit. You’ll qualify for a 0.25-percentage-point reduction on your federal interest rate.

If you drop out of the program, you lose the benefit. Take the TEACH grant, which awards up to $4,000 annually to students who agree to work four years in high-need teaching positions, such as science and special education, in low-income areas. If you don’t complete your service, the grant converts to an unsubsidized Federal Direct Loan, or Stafford.

That means you will repay every dime of the grant at 6.8% interest starting from the day you received the award. And if you declined a subsidized Stafford loan—with a current rate of 3.4%—to accept a TEACH grant, you lose twice because the grant converts to the higher rate.

Some organizations, including AmeriCorps and Teach for America, offer grants after service is completed. Your federal loans go into forbearance during that time, meaning interest continues to add up. If you complete your service, the government will pay some or all of the interest, but you’ll pay it—on top of your loans—if you don’t.

The Peace Corps forgives 15% of Perkins loans for each of your first two years of serv­ice and 20% for each of the next two, capping the forgiven amount at 70% of your combined loans. That’s helpful, but only if you’re willing to commit to several years of hard work for minimal pay—and only if you have Perkins loans to begin with.

AmeriCorps and Teach for America offer more flexibility. Volunteers are eligible for the Segal AmeriCorps Education award, tied to the Pell amount ($5,550 in 2012). To receive the award, members must generally complete their term of service—for AmeriCorps, typically 1,700 hours; for Teach for America, about one year. Two terms of service earn you the maximum amount of $11,100 (in 2012). But bowing out early for eligible reasons, such as serious illness, may qualify you for a prorated payout.

The Public Service Loan Forgiveness program also rewards service. If you work in the public sector—say, in public health or at a public school—the PSLF program forgives the remainder of your student loans after 120 on-time payments while you’re employed in the public sector.

The catch? To benefit from the program, you must also qualify for an income-based repayment plan, which reduces your monthly bill below what it would be under a standard ten-year repayment plan. After ten years, the remaining amount is forgiven. But lower monthly bills mean the loan principal stays larger longer and accumulates more interest. If you drop out of the public sector before making 120 payments, you’ll end up losing the forgiveness and paying more than if you had paid over ten years.

Your program may not last. The dependence of volunteer programs on congressional funds means that you pin your chances of loan forgiveness on Washington politics. For instance, funding for AmeriCorps was briefly on the chopping block in 2011, during the debt-ceiling debate.

And at just five years old, the PSLF program hasn’t yet forgiven anyone’s federal student loans. The first beneficiaries will emerge in 2017, giving Congress plenty of time to impose new restrictions or even eliminate the program.

This article first appeared in Kiplinger's Personal Finance magazine. For more help with your personal finances and investments, please subscribe to the magazine. It might be the best investment you ever make.