With November quickly approaching, many student loan borrowers are suddenly realizing that their grace periods are about to end. Soon, they’ll have to start making payments on the student loans that they took out over the last few years.
What exactly is a grace period and why does it have to come to an end?
A student loan grace period is the 6-month breather provided by the federal government and many private lenders before borrowers are required to start making payments on their student loans.
The clock starts when students graduate, drop below full-time status, or leave school. This article provides insights on how borrowers can take control of their student loans before payments even come due.
Federal Student Loan Income-Based Repayment Options
About 90 percent of student loans are made by the federal government, which provides qualified borrowers with a litany of repayment options:
- Income-Based Repayment (IBR): Students who had outstanding loan balances before July 1, 2014, are eligible for a program that lets them make monthly payments equal to 15 percent of their discretionary income for as long as 25 years. For “new borrowers” taking on student loan debt after July 1, 2014, payments equal to 10 percent of discretionary income can be stretched out over 20 years.
- Pay As You Earn: A 20-year repayment plan with monthly payments equal to 10 percent of a borrower’s discretionary income. Only Direct Loans are eligible under the Pay As You Earn plan. You can consolidate a Federal Family Education Loan (FFEL) or a Federal Perkins Loan into a Direct Consolidation Loan, which may be eligible for Pay As You Earn.
- ICR (Income-Contingent Repayment): A 25-year repayment plan that requires the lesser of either what a borrower would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to a borrower’s income or 20 percent of discretionary income. Like Pay As You Earn, only Direct Loans are eligible for ICR plans, although other loans can be consolidated into a Direct Consolidation Loan that may qualify for an ICR plan.
Pros of Federal Student Loan Repayment Options
- Lower Monthly Payments: By definition, monthly payments under the Income-Based Repayment and Pay As You Earn plans must be lower than they would be under the 10-year Standard Repayment Plan. This should make payments more manageable and free up money for other expenses.
- Loan Forgiveness: If borrowers have a remaining loan balance after the 20- or 25-year maximum term, the balance will be forgiven. This applies to all three of the Income-Driven Repayment Plans.
- Public Service Forgiveness Program: By repaying loans through one of the Income-Driven Repayment Plans, borrowers may be eligible for their loan balance to be forgiven after 10 years of timely payments through the Public Service Loan Forgiveness Program. This program only applies to certain career fields. But as an added bonus, the forgiven balance isn’t taxed as income.
- Payments Change With Income: With all three Income-Driven Repayment Plans, borrowers are not locked into fixed, monthly rates. Borrowers’ payments will change as income changes, ensuring that monthly payments are always affordable. Even if a borrower’s income drops to zero, the payment will be adjusted to zero and still count as a timely payment towards the loan.
Cons of Federal Student Loan Repayment Options
- Increase in
Total Interest: By making smaller payments over a longer period of time, the total amount of interest borrowers will pay over the lifetime of the loan will be higher compared to the 10-year Standard Repayment Plan. Though no one wants to pay more than they have too, it may be worth the tradeoff of having affordable monthly payments. - Longer Loan Term: All three of the Income-Driven Repayment Plans extend the term of the loan to 20 or 25 years, twice as long as the 10-year Standard Repayment Plan.
- Taxes on Forgiven Debt: Though these repayment plans may allow any remaining loan balance to be forgiven after the set 20- or 25-year term, the forgiven balance may be taxable as income. Debt forgiven through the Public Service Loan Forgiveness Program is tax-free, though.
- Required to Provide Income Information: Borrowers are required to provide updated income and family size information to their loan servicer annually in order to continue to qualify for these repayment plans. This may not be a major con for everyone, but it can add to the headache of loan repayment. If borrowers forget to provide this information, they will be dropped from their current plan and put on the 10-year Standard Repayment Plan.
- Not All Loans Qualify: These Income-Driven Repayment Plans are only available for federal student loans, and not all federal student loans qualify.
Other Student Loan Repayment Options:
If borrowers don’t qualify for income-based, federal student loan repayment options or are not interested, there is also consolidation and refinancing that can enable borrowers to combine their loans into one single payment, lower their interest rates, lower their monthly repayment and/or change other terms of their loans.
Federal Student Loan Consolidation
Interest rates on student loans consolidated through the federal government are calculated by taking the weighted average of the interest rates of all the separate loans being packaged together. The repayment term and the lender can be changed during the consolidation process.
Can Private Student Loans Be Consolidated?
Most federal student loans are eligible for government-backed consolidation, but private education loans are not. Borrowers can still consolidate private student loans, but not through a government program.
What Is Student Loan Refinancing
Similar to consolidation, student loan refinancing is taking out a new loan to pay off the existing loans. Unlike consolidation, though, student loan refinancing allows the borrower to seek better interest rates and repayment terms, potentially reducing both monthly payments and the total repayment amount of student debt. A borrower can refinance both federal and private loans.
When Refinancing Makes Sense
Even though many people don’t think twice about refinancing their mortgage or auto loan, student loan holders often don’t look into refinancing solutions. Yet those who end up refinancing their student loans can save thousands of dollars over the life of their loan. Also, student loan debt can be refinanced more than once, so it pays to explore options periodically. Student loan refinancing makes the most sense when a borrower has a steady income and a solid credit score.
So What Should A Borrower Whose Grace Period Is Ending Do?
Prudent borrowers should research, compare their options, and consult a financial adviser. As student loan debt has grown, many borrowers have found themselves behind on their payments or even in default by not taking these simple steps.
Starting off on the right student loan repayment path is crucial for borrowers’ financial futures. More information on student loan repayment options can be found on Federal Student Aid.
