A lot of people nowadays are carrying and working to pay off student loans. Here is the crazy thing, most people have paid and will continue to pay way more than need be because they haven’t read this article. You may know this already, or like most people, you may not.
Big concept: when you make a required loan payment, it is divided equally between all of your loans.
Now Lets Break This Down
I want to start with the different types of student loan pay-back structures. Here is the government website which explain in detail the plans: https://studentaid.ed.gov/sa/repay-loans/understand/plans
- First there is the standard plan which are fixed payments over ten years. This is the default plan.
- Next there is the graduated plan which payments start lower and increase over 10 years.
- Then there Is the extended graduated plan, which is the same thing but is paid over 25 years.
- Then there are the income based plans which is usually 10% of discretionary income will be paid over either 20 or 25 years, then any outstanding balance will be forgiven.
The Downsides To Income Driven Plans…Besides Paying Tons Of Interest
Income driven plans are better for when you know you will not have a large income, and yet you have a large debt, because this way you will pay less than your loan all together. There are two downsides to this:
1. Most likely you will have to pay 10% of your income for 20 years; and
2. If there is any left-over loan which is forgiven, you may have to pay income tax on it.
This means that the government treats the forgiveness like they gave the money to you. Depending on your tax bracket in 20 years and how much loan you have left, this could be a hefty tax bill.
For example: 20% tax bracket with 100,000 loan forgiveness could mean at least 20k in taxes that year with no income to show for it…time to start saving for that forgiveness.
Ok so maybe income driven plans are not for you. So, you pick the standard, the graduated or the extended graduated. I picked the extended graduated and here’s why.
Why You Should Pick The Extended Graduated Plan Every Time
Like most people, I have multiple loans because I attended multiple years and semesters of school. Each loan is at a different interest rate depending on what the federal interest rate was that year. For example:
Year 1 : I have used 10,000 at a 4% interest rate
Year 2 : I have used 10,000 at a 5.5% interest rate
Year 3 : I have used 10,000 at a 6.3% interest rate
Year 4 : I have used 10,000 at a 6% interest rate
Your Scheduled Payment Is Split Between Your Loans Based On Principle…Not Interest rates
When you pay the amount scheduled by your loan provider, they take that payment and spread it across all the loans. If you pay more than the minimum amount, then you can choose which loan the extra payment goes to.
Target Your Loans
You do not want your monthly payment going equally to your low interest rate and high interest rate loans equally, instead you want to tackle the higher rate loans first. I picked the extended graduated plan, because unlike the $800 a month standard plan, I am only required to pay $200 a month. This means that I can use the $600 I would have paid to tackle my high interest loan first. So basically, paying the standard amount to the extended graduated plan. This will allow me to pay my loan off in ten years, but with paying thousands less in interest.
Refinance Your Loans
Also, a final but very important point is refinancing student loans. If you have debt with a higher interest rate than your student loans, for example, credit card debt, it may be prudent to make small payments on you student loans and focus on the higher interest rate loans. If you have been paying down your principle on your student loans, you may be eligible to lower you monthly payment by refinancing your loans. Check with multiple loan providers to see what your options are.
In Conclusion
If you think you can take advantage of this like I did, contact your loan administrator to restructure your payment options. Or contact a refinancing company to lower your interest.
