How To Pick A Student Loan Repayment Plan

I have never had a federal student loan. What I have done is sit at a kitchen table with somebody who did, her servicer's website open on a laptop, four plan names on the screen, and no honest way to tell them apart.

We spent an hour reading the descriptions and got nowhere, because they are written in the language of the programme rather than the language of a person deciding something. Then we stopped reading names and wrote down two numbers instead.

Four minutes.

The two numbers

Every repayment plan, whatever it happens to be called the year you read this, resolves into two figures. What you pay each month, and what you pay in total by the time the loan is gone.

They move in opposite directions. There is no plan that improves both, and any plan that appears to is moving the end date instead.

That is the decision. Everything else is detail about how a particular programme arrives at those two numbers, and details change.

Almost nobody picks a plan, which is the other thing worth saying out loud. A federal loan starts on a standard schedule unless you go and do something about it, so the most common way to end up on a repayment plan is to not open the letter. That is a perfectly fine outcome for some people and an expensive one for others, and it is worth at least being the person who chose.

What a longer term actually does

Take a $40,000 balance at a 6 per cent fixed rate, roughly the shape a four year degree leaves behind, and pay it off on a straight schedule over different lengths.

Going from ten years to twenty-five cuts the payment from $444.08 to $257.72, which is $186.36 of breathing room every month. It also moves the total from $53,290 to $77,316.

Twenty-four thousand dollars.

I want to be careful with that number, because it gets used to shame people. If $444 a month is the difference between making rent and not making rent, then $257 is the correct answer and $24,026 is what it costs. That is a real trade made by an adult, not a mistake.

The abstraction does have a scene attached and it is not a dramatic one. It is a Tuesday in your thirties, the payment leaves the account, and it is still leaving the account during the conversation about a deposit on a house.

Twenty-five years is not a number. It is your forties.

Where income-driven plans work differently

Fixed schedules are the simple case. The plans that generate most of the confusion run on a different principle: rather than dividing your balance across a number of months, they take a percentage of your income above a protected amount, and recalculate it each year when you recertify.

The protected floor is the part worth understanding. These plans do not take a share of your income, they take a share of what is left after an amount tied to the federal poverty guideline for your household size. Two things move your payment that have nothing to do with your loan: a raise, and a child.

Two consequences follow from all this, and both surprise people.

Your payment is not tied to what you owe. Somebody with $25,000 of debt and somebody with $180,000 can carry the identical monthly payment on the same income, because the balance is not an input to the calculation.

And your payment can be smaller than the interest accruing, in which case the balance grows while you pay every month on time. Some programmes subsidise part of that gap and some do not, which is one of the most important questions to ask about any plan and one of the least advertised.

The forgiveness question, and the tax question under it

Most income-driven designs end in forgiveness: pay for a set number of years and whatever remains is cancelled. There is also a separate route for people working in qualifying public service jobs, Public Service Loan Forgiveness, which cancels the remaining balance after a defined count of qualifying payments made while employed full time by a qualifying employer.

Forgiveness changes the arithmetic completely. If a balance is going to be cancelled, minimising the monthly payment is often the right move, and total repaid stops being the thing you are optimising, because you are no longer repaying the whole thing.

Which makes the next question the one I would ask first. Is the forgiven amount taxable, under the rules that apply to that programme, in the year the forgiveness actually lands?

The answer has differed by programme and has been changed by act of Congress more than once. A forgiven balance treated as ordinary income can produce a tax bill in a single year on an amount larger than anything you have ever earned.

A forgiven balance that is excluded produces nothing at all. Same forgiveness, opposite outcomes, and the difference is a line in the tax code rather than anything about your loan.

Do not accept a general answer on this one. Ask about your specific programme, for the year you expect to reach the end of it, and get it from the Department of Education rather than from a forum.

The one door that only opens one way

Refinancing federal loans with a private lender is the only decision here you cannot reverse.

A private refinance can lower your rate, sometimes by a lot, and that saving is real money. What you hand over in exchange is the federal side of the loan: income-driven payment options, the forbearance and deferment rules, any forgiveness you might have qualified for, and the discharge provisions that apply in specific circumstances.

None of it comes back. There is no route from a private loan to a federal one.

If your income is high and stable, your balance is modest against it, and you have no plausible path to forgiveness, that trade can be a good one. If any of those three is uncertain, the rate saving is being bought with optionality you may turn out to need.

What the monthly number has to survive

When people say pick a payment you can afford, they mean an average month, and an average month is not the constraint. Nobody defaults in an average month.

Use this instead. Take your worst month in the last two years, the one with the car repair and the dental bill and the flight you had to take at three days' notice.

Write down what was left after everything. That is the number the payment has to fit inside.

How to actually pick

Open the Loan Simulator at studentaid.gov, which is the Department of Education's own tool, and put your real balance, your real rate and your real income into it. It shows you the plans you currently qualify for with your numbers already inside them, which is a different exercise from reading four descriptions.

Write down three things for every option it returns: the monthly payment, the total repaid, and the end date. Three columns, one row per plan, on paper.

Then apply the test in this order. Cross off anything whose payment does not fit inside your worst month, because a plan you fall off is worse than a plan you never chose.

Of what survives, if forgiveness is genuinely in play for you, take the lowest payment. If it is not, take the lowest total repaid you can hold.

Four things worth doing regardless

• Recertify your income on time every year if you are on an income-driven plan, because missing the deadline can push your payment back to a standard amount and, on some plans, capitalise unpaid interest onto your balance.
• Learn what capitalisation is before it happens to you. Unpaid interest added to principal means you start paying interest on interest, and it is usually triggered by an event such as leaving a plan or ending a deferment rather than by time passing.
• Know who services your loan and keep your own copy of your payment history, because servicing contracts change hands and payment counts have been reconstructed badly before.
• Pay something toward interest during any period when the loan is not asking you to, if you possibly can, because that is the cheapest dollar you will ever put into this.

The plan names on that screen will be different in three years. The two numbers will not. Write them down and the decision gets small enough to make in an afternoon.