How To

Take Charge of Your Student Loans: Choosing the Best Repayment Plan

At college campuses throughout the country this month, new graduates are throwing their hats in the air. The jubilation is followed by the reality that when their hats fall back to the earth — Splat! — student loan payments will soon come due.

As a recent graduate, how can you manage federal student loan payments while job hunting or working entry-level positions?

Relax.

Everyone gets six months before federal student loans are due to decide which payment plan is right for them.

You must start repaying your loans after six months. But if you have difficulty doing so, there are plenty of options to defer payments for months, or even years.

And contrary to what many graduates think, high student loan debt will not eliminate your eligibility for mortgages or car loans. Creditors generally care more about your student loan payment amounts compared to your income — not the total amount of your debt. This is unlike credit cards where how close you are to your limit will greatly affect your credit score.

Choose your repayment plan

There are three main types of repayment plans: standard repayment, consolidation, and income-based repayment (IBR).

The standard repayment plan is the default option you enrolled in unless you request one of the others. You pay off your loans in ten years, but to meet that shorter payoff time, your payments are higher than what you could pay with a consolidation loan or IBR.

With a consolidation loan, your loan servicer combines all your loans into one single loan, with an extended repayment period of generally 15 to 30 years —depending on the amount you owe. For instance, my $60,000 in student loan debt has a 30-year repayment term, while my friend who owes $35,000 must repay his loans in 20 years. The positive side to consolidation is that you have just one, smaller loan payment to take care of each month.

You can also request the most seductive repayment plan to date: Income-based repayment. Under this plan, payments adjust on a yearly basis based on your family size and adjusted gross income (AGI).  (Your AGI is calculated by subtracting certain adjustments to your gross income, such as deductions and credits. You can find it on line 37 of your tax return if you filed Form 1040; line 4 if you filed 1040EZ.)

Lower payments are among the most attractive features of IBR plans: your monthly payment cannot be higher than it would be on the standard ten-year repayment plan. And if you haven’t paid off your federal student loans after 25 years, all your remaining debt is forgiven.

However, income-based repayment isn’t always the best option. Why? IBR generally works best if your adjusted gross income is low enough compared to your debt that your IBR payment would be lower than a consolidation loan payment. This can be tough to maintain since your income is likely to rise as you climb past entry-level positions.

For many grads, IBR will never work out. According to the National Association Colleges and Employers Salary Survey, the average starting salary offer for 2010 college graduates with Bachelor’s degrees is $47,503. The average undergraduate student loan debt load, meanwhile, is $23,118, according to the latest survey by the National Center for Education Statistics. An unmarried graduate with these income and debt amounts would likely be ineligible for income-based repayment.

Our graduate would likely have to owe around $31,500 plus to qualify for the income-based repayment (IBR) plan – and the payment would be over $100 more than the payment on a 20-year consolidated payment. However, if his student loan debt level was $100,000, IBR could be a great deal.

Recent legislation will widen the net for who benefits from income-based payment. New standards for income-based repayment cut the maximum repayment term to 20 years and lowers payment amounts. The caveat is the sweeter deal only applies for loans issued after July 1, 2014.

Explore All Options

To find out what plan works best for you, enter your loan and income information into the various calculators on GraduationDebt.org.

If you get a job with the federal government or a non-profit business, you may be eligible for public service loan forgiveness. No matter what your education debt level or payment plan you choose, the remainder of your debt could be forgiven after 10 years – as long as you meet all requirements.

Having federal student loan debt doesn’t have to block any big decisions in your life. Finding the right repayment plan is the first step for budgeting in a way that is less stressful than finals.

Find more details and tips for managing your student loans and living your life in CliffsNotes Graduation Debt.

Reyna Gobel is the author of Graduation Debt: How To Manage Student Loans and Live Your Life.