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Exploring Federal Programs for Student-Loan Repayment

chuckkStudent-loan borrowers can choose from several repayment plans to fit their situations. In a guest post, Chuck Knepfle offers some advice for picking the right one. Mr. Knepfle, director of financial aid at Clemson University and chair-elect of the National Direct Student Loan Coalition, is scheduled to present on this topic at the annual meeting this week of the National Association of Student Financial Aid Administrators, in Las Vegas.

When students take out federal loans, they can easily be overwhelmed by the different interest rates, disbursement dates, and deferment periods. However, the complexity is only beginning, as things get even more confusing for the student borrower after graduation, as the decision about which repayment program to enroll in surfaces. As I researched this topic I found seven different loan-repayment options for just Federal Stafford Loans!

If a student does nothing, all loans fall under the government’s Standard Repayment, with the student making payments of interest and principal for 120 consecutive months. Typically this will result in the most consistent payments, with the least amount of interest paid over the life of the loan.

However, there are currently six other plans that may serve a student better. For example, if a student wants to make lower payments initially, making the assumption that her or his income will increase over the 10-year period, a Graduated Repayment Plan exists that will increase the monthly payment approximately every two years. Or, if a student’s loan balance is unmanageable, the student can choose Extended Repayment, which allows for repayment terms up to 25 years.

The real complexity, and flexibility, comes with the various repayment plans that take into account a student’s income and adjust payments accordingly. Currently, students can choose from Income Based, Income Contingent, Income Sensitive, and Pay as you Earn plans that all determine the student’s monthly payment based on her or his current income. Eligibility and length of repayment differ with each, but all but Income Sensitive offer loan forgiveness after a fixed number of years.

Although complicated, the reality is that the bevy of repayment plans is a great thing for students, and with so many options based on income, loan-default rates should theoretically plummet. Tying loan payments to income, job loss, or the inability to find a job will result in monthly payments of $0.

If a borrower navigates the system well, and asks the right questions, the multitude of options can help a student’s financial situation greatly. It is important for a student borrower to know all of the following before choosing a loan-repayment plan:

  • What is my exact loan balance, and what interest rate am I paying on each loan?
  • Who holds and/or services my loans? (Although the Department of Education holds all new Federal Stafford Loans, it contracts out the servicing of the loans to up to 20 different companies.)
  • What is my income potential over the next 10 years?
  • What kind of monthly payments will I see over the next 10 to 25 years, and how much interest will I end up paying under each plan?

Much of that information is provided to the student after graduation via exit counseling. Details about loan balances and which servicer holds a loan can be found in the National Student Loan Database System. And some information is available to borrowers even earlier. Recently the Department of Education added excellent information to its Financial Awareness Counseling tool, which will help students estimate post-college expenses and approximate future earnings.

The good news is that if a student makes a choice that turns out to be difficult to manage, there is always the option to move into a different repayment plan. A student’s loan servicer not only can help compare repayment plans but also will facilitate a student’s movement from one plan to another at any time a student wants.

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