June 16, 2017

How to Lower Student Loan Payments

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After college, you get a six-month grace period on your student loans. That's not a long time. Suddenly your loan payments become due. How will you pay them back?

Before you panic, know you have choices to lower your payments. They each involve talking to your loan servicer. They are not automatic. Waiting to see what happens can cause you to default on your loans.

Many options are available. We discuss them here to help you make sense of your student loan payments.

Understand What Happens If You Do Nothing

If you do nothing, your federal student loans go on the Standard Repayment Plan. This includes principal and interest payments for the next 10 years. The good news is your loan is paid in full in 10 years. This assumes you make your payments on time. You also pay the least amount of interest with this plan.

The bad news is your payments can be higher than they need to be. Here's an example:

Let's say you borrowed $30,000 at 5%. Your standard payment equals $318.20. In 10 years, this loan is paid off.

If you can't afford a payment that high, consider the following steps.

Step 1: Look at Income-Driven Repayment Plans

Income-based repayment plans offer lower payments and longer terms. The U.S. Department of Education (DOE) bases your payment on your discretionary income. Depending on the plan, you could pay between 10% and 20% of this number. You may also pay the loan back over a term of up to 25 years. You may even be eligible for loan forgiveness after 20 to 25 years.

Tip: If you opt for any of the income-driven repayment plans, you must recertify annually. If you don't, your payments revert back to the standard payment plan. You also lose any qualifying payments you made towards loan forgiveness.

There are four plans to consider:

  • Income-based repayment: If your loan originated after July 1, 2014, you pay 10% of your discretionary income for 20 years. Any loan left after that time is forgiven. Graduates with loans originated before July 1, 2014 pay 15% of their income for 25 years before loan forgiveness occurs. The payment must be lower than your standard payment to qualify.

  • Pay as you earn: Your loan must have originated after October 1, 2007 and you must have had a loan disbursement after October 1, 2011 to qualify for this plan. If you qualify, you pay 10% of your discretionary income for 20 years. The payment must be lower than the standard repayment plan payment to qualify.

  • Revised pay as you earn: There are no date restrictions for this plan. There also aren't any caps on payments. You pay 10% of your discretionary income for 20 years. After 20 years, the remaining balance is forgiven. If your income increases a lot, your payments go up accordingly.

  • Income contingent repayment: There aren't any income restrictions on this plan. You pay the lower of 20% of your discretionary income or a 12-year fixed payment plan. The term is 25 years. After that time, your loan balance is forgiven.

Discretionary income is income that exceeds 150% of the national poverty level. If you are single, any money you make over $18,090 counts.

Who Should Consider Income-Driven Repayment?
Income-driven repayment plans offer lower payments. That's a good thing. But they cost more in the long run. You pay more interest because you stretch your payments out over a longer term. If you can't afford the standard payment, though, it's an option.

Borrowers who shouldn't pass up an income-driven repayment plan are those eligible for loan forgiveness sooner than in 25 years. Graduates working in public service roles, for example, may qualify for the Public Service Loan Forgiveness (PSLF) program. If so, a repayment plan works best. You lower your payments, which means more money forgiven at the end of 10 years. If you stay on the standard plan, there's nothing to forgive.

Who Shouldn't Consider Income-Driven Repayment?
If you aren't eligible for the PSLF plan, consider your other options. While income-driven repayment plans offer lower payments, they have drawbacks.

  • You pay more interest over the life of the loan
  • You owe taxes on any portion of the loan that is forgiven

If you don't qualify for PSLF, move on to Step 2.

Step 2: Look at Graduated Payments or Extended Terms

The DOE offers two more options. You don't have to qualify for them, but you do have to apply for them.

  • Graduated Repayment Plans: This plan allows you to start off with low payments that gradually increase as time goes on. The increases occur every 2 years. They do not increase according to your income, as income-based repayment plans do. You must be sure of your capability of paying the higher payments every 2 years. You pay the loan off in 10 years with this plan.

  • Extended Repayment Plans: If you have more than $30,000 in student loans, you can extend the term. The standard term every graduate receives initially is 10 years. Not everyone can afford that. By extending the term as much as 25 years, you can lower your payment significantly.

Who Should Consider a Graduated Repayment Plan?
Graduated payment plans don't offer loan forgiveness. Borrowers who think they can afford to pay more down the line may benefit from these plans, though. Waiting for loan forgiveness after 20 or 25 years means a lot of interest paid up to that point. The graduated repayment plan pays your loan off in 10 years.

Graduates who work or plan to work in a field with increasing income are good candidates. If you know you'll start at the bottom of the barrel but have good income potential, this plan may work well.

Who Shouldn't Consider a Graduated Repayment Plan?
There are risks involved with the graduated repayment plan. It doesn't take your income into consideration. Your payment increases every 2 years no matter what. If you can't afford the higher payment, you may have to restructure the debt again. If you don't, you risk default on your student loans.

Who Should Consider an Extended Repayment Plan?
Borrowers with more than $30,000 in student debt and who have high standard loan repayments are a good fit. Extending the term may be a more affordable option. With the longer term, you have a lower payment. It's not based on your income, and the payment doesn't change. The benefit is you don't have to reapply for the program. Your payment is fixed for the chosen term (usually 25 years).

Who Shouldn't Consider an Extended Repayment Plan?
Longer terms mean more interest paid. If you don't see yourself making larger payments down the line, consider other options. The extended term gives you lower payments now, when you need it most. It also ensures a lower minimum payment if you meet hard times. If you never pay more than the minimum, though, you pay a lot more interest over the life of the loan.

If you aren't a good candidate for either plan, move onto Step 3.

Step 3: Consider a Loan Consolidation or Refinance

You may consolidate your loans even if you qualify for PSLF. It doesn't make sense to make standard loan payments if you do qualify for PLSF. You wouldn't have a loan balance at the end of 10 years to forgive. Loan consolidation offers the benefit of organizing multiple student loans into one big loan. Only federal loans apply. But Parent PLUS loans don't qualify.

Loan consolidation is free and it is NOT a refinance. Your loan servicer combines your loans and charges you a weighted average of your existing interest rates. If you want to extend the term, you can ask at the time of consolidation.

If you do nothing else, you pay fixed payments for the chosen term. But you can go back to Step 1 and apply for an income-driven repayment plan. Again, this may lower your payments and make you eligible for loan forgiveness after 20 to 25 years.

Student loan refinancing, on the other hand, pertains mostly to private student loans. Any of the above programs don't apply to these loans. If you have high interest rates, you may benefit from refinancing. This requires you to apply and qualify for a new loan. The lender pulls your credit and looks at your current debts.

Who Should Consider Loan Consolidation?
Borrowers eligible for loan forgiveness are great candidates for loan consolidation. It makes each of your loans eligible for forgiveness down the line. It also helps keep your loans organized. Having multiple loan servicers can make keeping them straight overwhelming.

If you haven't take advantage of any income-driven repayment plans yet, considering consolidation first may be a good option.

Who Shouldn't Consider Loan Consolidation?
Borrowers who already made qualifying payments towards the PLSF shouldn't consider loan consolidation. If you consolidate your loans, the tally on your qualifying payments starts over again. Let's say you already made 20 payments towards your 120 required payments for loan forgiveness. If you consolidate, those 20 payments don't exist. You start at payment number 1 again.

In addition, if you have any Parent PLUS loans, consider leaving them out of the consolidation. If you include them, you will be ineligible for any income-driven repayment plans with this loan.

Who Should Consider Student Loan Refinancing?
Refinancing student loans best serves those with private student loans. If you needed more money than the government provided, you may have private loans. Check out your interest rates and see how they compare to today's rates.

If you had poor credit when you took out the student loans, but have a better score now, this may be a good option as well. Lenders often charge higher interest rates to riskier borrowers. A higher credit score may make you a less risky borrower now.

Who Shouldn't Consider Student Loan Refinance?
Borrowers with federal student loans shouldn't consider refinancing. If you do, you lose any federal benefits, including income-driven repayment or forgiveness options.

The Bottom Line

Paying student loans back can feel like a nightmare with no way out. But you can find a way through it by looking over the various programs that can make your payments less stressful. What if you really can't afford your payments? The best thing to do is reach out to your loan servicer. Be honest about your situation and see where you stand.

Try not to base your choice on the lowest payment. Instead, look at the big picture. Think about your future plans and choose wisely. If you qualify for Public Service Loan Forgiveness, choose a program you can afford. If you change programs after making qualified payments, the payment counter starts over again.

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