COLLECTION: STUDENT DEBT

Lower student loan payments - yes or no?

What student loan repayment strategy should you follow? Get the details on what your monthly payment should be according to your needs.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print

If you're one of the millions of Americans with federal student-loan debt, your monthly payment can be an unwelcome burden, and the low-payment options on offer may seem tempting. However, there's one good reason you should choose the most expensive monthly payment option you can afford: the interest you'll end up paying.

Student-loan repayment options

When you repay your federal student loans, you have several choices of repayment plans, which you can change periodically. The most commonly used options are:

  • Standard: Spreads your student loans over 10 years of equal payments. Unless you apply for one of the other payment options, your loans will automatically be placed in this plan after you finish school.
  • Graduated: Also spreads your loans over 10 years, but your payment starts out small and gradually gets larger. Intended for people who are expecting their salaries to increase significantly in the early part of their careers.
  • Extended: Spreads your student-loan balances and interest over a 25-year time period of equal payments. To qualify for an extended repayment plan, you must have more than $30,000 in federal student loans.
  • Extended graduated: A 25-year payment plan whose payments start small and increase over time.
  • Income-based repayment: Known as IBR, this plan limits your monthly payment to 25% of your discretionary income, which is defined as the difference between your income and 150% of the poverty guideline where you live. After 25 years of on-time payments, any remaining loan balance is forgiven, and your payment will never be more than the standard 10-year payment amount.
  • Pay as you earn: The newest repayment plan is available only to borrowers who took out their first loan after Oct. 1, 2007, and received at least one loan disbursement after Oct. 1, 2011. This plan is similar to IBR but limits your payment to just 10% of your discretionary income and forgives any remaining balance after 20 years.

Consider the total cost

Let's look at an example of a recent graduate with $35,000 in student-loan debt, and what this would translate to with each of the repayment options. For the income-dependent payment plans, we'll assume that the borrower earns a starting salary of $40,000 per year and receives 5% annual pay increases for the duration of the loan (yes, this is optimistic, but it's the assumption the Department of Education uses).

Repayment Plan Initial Payment Final Payment Total of Payments Interest Paid
Standard $389 $389 $46,629 $11,629
Graduated $222 $667 $49,742 $14,742
Extended $226 $226 $67,652 $32,652
Extended graduated $175 $339 $73,601 $38,601
Income-based (IBR) $217 $389 $53,773 $18,773
Pay as you earn $145 $389 $66,293 $31,293

Note: Assumes average student-loan interest rate of 6%.

Even though you can probably qualify for a lower monthly payment than the standard amount, the most expensive option will cost three times the interest of the standard repayment plan. Of course, this is a simplified example, and the difference between repayment options for you will vary depending on your loan balance and income level, but the same principle applies. To compare the repayment options for your loans, the Department of Education provides a payment estimator here.

Which repayment option is best for you?

Bear in mind that many people do have good, legitimate reasons for choosing one of the lower payment options. For example, if you work in public service and will be eligible for forgiveness after 10 years of payments, it makes sense to pay as little as possible through either the IBR or pay-as-you-earn plan. And if you have reason to believe that your salary will increase dramatically throughout your career (many medical professionals fall into this category, for example), a graduated repayment option may be the most practical choice for you.

The point is that if you can afford it and you have no reason not to, it could greatly benefit your long-term financial health to choose the most ambitious repayment plan that you can reasonably fir into your budget. You may feel a bit of a squeeze at first, but you could save yourself thousands in interest over the years.

Topics:
  • College Planning
  • Loans and Debt Management
  • Student Loans
  • College Planning
  • Loans and Debt Management
  • Student Loans
  • College Planning
  • Loans and Debt Management
  • Student Loans
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print
This article was written by Matthew Frankel from The Motley Fool and was licensed as an article reprint. Article copyright 5/1/2015 by The Motley Fool.
The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
This reprint is supplied by Fidelity Brokerage Services LLC, Member NYSE, SIPC.
The third party provider of the reprint permission and Fidelity Investments are independent entities and not legally affiliated. Photo source: Flickr user KitAy
The images, graphs, tools, and videos are for illustrative purposes only.
Fidelity Brokerage Services Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
728030.2.0
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.

Also in this collection

What you need to know about managing your student loans

Whether you're trying to reduce your monthly payments or pay off your loans faster, there are programs that might help.

Get motivated to pay off your student loans with these tips

With some planning, persistence, and the right motivation, you can eliminate your student loan debt and move on with your life. Learn how.

Ditch debt and start saving

Getting yourself out of debt requires a solid plan. Get pointers on how you can reduce your credit card or student loan debt and start saving.

Split Decisions: Student debt or retirement

When you only have so much money to go around, do you use it to pay down your student loan debt or add to your retirement fund? Money guru Jean Chatzky has your answer. See her advice. (2:28)

Get your student loans squared away for the New Year

Student loan debt is the number one concern of millennials, and a new year is another chance to get your finances squared away.

Lower student loan payments - yes or no?

What student loan repayment strategy should you follow? Get the details on what your monthly payment should be according to your needs.

Student loan forgiveness programs

Student loan forgiveness programs seem too good to be true. How do you qualify? Get the details.

Are your student loan payments too high?

Do you need a way to reduce your monthly student loan payments? Your options each have their pros and cons.

2% cash back on everyday purchases1

Deposit your cash rewards into an eligible Fidelity account. No annual fees.