Taking out loans for an education can be a great investment in your future. That's sometimes hard to remember as you're paying off those loans. Luckily, you may be able to change your monthly payments and the length of the repayment period to fit your budget and your life. Federal student loans offer the most flexibility—but there may be options for private student loans as well.
For a refresher course on the types of student loans available, read Viewpoints on Fidelity.com: A guide for student loans.
Federal repayment plans
Unlike private loans from banks, student loans from the government, like a Direct Subsidized or Unsubsidized loan, offer some flexible repayment options including the ability to switch your repayment plan at almost any time. If you have a federal student loan and want to change your monthly payment—there's likely a program that will help fit your student debt payments into your budget.
Standard Plan: The base case
This is the default repayment plan for federal student loans. The monthly payment stays the same until the loan is paid off. The amount of the payment is based on the interest rate on your loan, the amount borrowed, and the length of time that payments will be made. The standard repayment period is 10 years. There's also an extended plan that lengthens the repayment period up to 25 years. In order to qualify for the extended plan, your loans must be above a certain threshold—$30,000 for Direct loans or Federal Family Education Loans (FFEL). You can switch to the extended plan at nearly anytime as long as you have $30,000 of debt outstanding at the time of application.
Graduated repayment plan
The graduated repayment plan starts out with very low monthly payments, just enough to cover the interest. The payment increases every 2 years by a set amount. You could expect your payment to increase by 25%–30% every 2 years—depending on the amount of debt you have.
Just like the base standard plan, the graduated plan also lasts for 10 years. There is an extended graduated option as well for borrowers with more than $30,000 in Direct or FFEL loans.
Payments increase every 2 years under the extended graduated repayment plan. With a 20-year loan term, the graduated payments could increase by just 10% every 2 years with a 20-year loan.
Under the graduated plan, your monthly payment during the final 2-year period cannot be more than 3 times the initial monthly payment. So the longer the repayment period, the more gradually the payments increase.
"The graduated repayment plan can be a good option if you need to lower your monthly payments in the short term and can budget for higher payments in the future. If you are in a profession where your income may increase drastically in the near future, a lawyer or doctor for example, the graduated plan could be a better option than the income-driven plans which could result in higher payments when your income increases," says Mike Rusinak, director in Fidelity's Financial Solutions research team.
Income-driven repayment plans
Monthly payments under income-driven repayment plans are based on a percentage of your discretionary income. In this case, discretionary income is measured relative to the federal poverty guidelines for your family size and state of residence.
"Income-driven plans are great options for any borrowers struggling to make their monthly payment. The payment can be lower than the interest that accrues monthly, even as low as $0 in some cases. And on some plans the government will pay any interest your monthly payment does not cover," Rusinak says.
There are 4 income-driven repayment plans currently available, and one for loans written under the FFEL program that are no longer available for new accounts.
Calculating monthly payments is much more involved under income-driven plans than it is under the standard plan. Factors that are considered include adjusted gross income (AGI), tax filing status, family size, and state of residence for the year in which you switch to the income-driven repayment plan. Each plan calculates your monthly payments a little differently but in general, payments range from 10% to 20% of discretionary income. Of the 4 main income-driven plans, 3 define discretionary income as the difference between AGI and 150% of poverty level for household size and state of residence. The fourth, the income-contingent repayment plan, defines discretionary income as the difference between AGI and 100% of poverty level for household size and state.
A general feature of income-driven plans is that if you have not paid off the loan balance in full after the specified repayment period (generally 20–25 years depending on plan type), any outstanding balance will be forgiven by the federal government. So, if after 20 years of repaying your loans on the REPAYE plan you still owe $10,000, the government will wipe out whatever balance is left and you will be student debt-free. The only catch: This forgiveness amount is treated as taxable income so you will have to pay federal income tax on the entire amount forgiven just as if it were normal salary or wages. There may be state income taxes due as well.
Consolidating federal student loans
If you have multiple federal student loans, combining them into one Federal Direct Consolidation Loan could help as you pay down the loan balances. While you won't get a lower interest rate, it can extend the repayment period, effectively lowering your monthly payment. The interest rate on the consolidated loan will be the weighted average interest rate of all the loans included in consolidation. With consolidation you can start a fresh new 10-year term (or longer, depending on your outstanding balance at the time of application) on your loans. If you’ve been making payments for a year or more, that can be like getting an extended loan term. Though the monthly payment may be lower, your total interest costs will be higher with the longer payback period.
More repayment options: Refinancing
Unlike the government, private lenders like banks don’t typically offer flexible loan repayment options. If you have a private student loan and want to change the terms of your loan, refinancing will likely be required. Refinancing means applying for a new loan.
One reason to refinance is to try to get a lower interest rate. The interest rate of your loans determines how much interest is applied on top of the amount you owe. Interest rates are almost always quoted as annual figures—for instance, 6%—but interest is usually applied on a daily or monthly basis. A $20,000 loan with a 6% annual percentage rate (APR) would amount to $100 of interest per month while a 5% APR would work out to about $83 per month in interest costs. Getting a lower interest rate is one way of potentially lowering your monthly payment. However, the lowest interest rates generally go to people with high credit scores.
But the interest rate isn't the only variable you may be able to change when refinancing your private loan—you may be able to lengthen your loan term in order to lower your monthly payment. The term can range from 5 to 20 or even 30 years. By extending the term of your loan you can lower the monthly payment on your debt. Doubling the term of your loan will cut your monthly payment almost in half. Lower payments could help with your daily or monthly budget but repaying for a longer period of time means that you will pay more in interest over the life of the loan.
Paying down a loan for a longer period of time isn't ideal. The cost of interest over an extended loan term can add thousands of dollars to your total debt repayment. But it may be an option if you find yourself struggling to make your monthly payments. The good news is that if your income rises thanks to your education, you can always make extra payments on the debt in the future.
Trying to figure out your student loan repayment options? The Fidelity Student Debt Tool lets you compare your existing student loans and repayment schedules with other repayment options. If you're interested in switching to an income-driven plan, you can model what your payments would look like under the revised pay as you earn (REPAYE) plan. If you’re already on one of the income-driven plans you can also model your current loan picture.
There's one final way to help pay down your student loans: with your employer's help. As student loan debt skyrockets and employers seek to attract and retain young workers, a new workplace perk has emerged: student loan assistance programs. Some employers, like Fidelity, offer a monthly payment to your student loan—generally up to a yearly maximum. The programs are not widely available yet—but they may be soon. Of young workers, 86% say they'd commit to their employer for 5 years if their employer helped pay off their student loans.
Next steps to consider
Pay bills and track spending while you manage investments.
See if there is a better way to pay off your student loans.
Paying off student loans faster could save you money.