Which Student-Loan Repayment Plan Is Right for You?

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It’s almost fall, which means recent college graduates soon must choose a plan to start repaying their student loans.

More than one million student-loan borrowers will make their first student loan payment between Thanksgiving and Christmas, according to an analysis of government data by Mark Kantrowitz, the publisher of Savingforcollege.com. The slew of repayment programs offered by the government means that there is likely a manageable repayment plan available for most borrowers.

But the myriad options among plans can be confusing.

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Basic choices include a standard repayment plan, in which the borrower agrees to repay his or her debt within 10 years at a fixed rate; extended plans, which can be stretched to 25 years and beyond; and income-driven plans, which base a borrower’s monthly payment on how much he or she earns. A rule of thumb that holds true for all plans, however, is the longer the schedule for repayment, the more the borrower will end up paying.

Also complicating matters: Both political parties are proposing changes to the student-loan repayment system, including eliminating some types of income-driven plans.

Below are some questions borrowers should ask themselves to help decide which repayment plan is best for them.

How much money do I owe, and to whom?

Borrowers should determine their total loan balance and who they must pay before they receive their first bill. Erin Lowry, author of “Broke Millennial,” a personal-finance book geared toward 20- and 30-somethings, suggests a few sources to help with this.

The National Student Loan Data System can help borrowers figure out how much they owe the federal government, Ms. Lowry says.

For those who borrowed from private lenders, she suggests obtaining credit reports from the big three credit-reporting companies— Equifax Inc., Experian PLC and TransUnion —to identify all of the lenders who must be repaid. Individuals can get a free copy of their credit report from each of these companies every 12 months by using annualcreditreport.com. Your credit report may not tell you all of the details of your loans, but it will tell you where they are so you can reach out to your servicer directly.

How much will I have to pay, and how much can I afford?

Because parents may have taken on debt in their own names to help finance their children’s schooling, Ms. Lowry recommends that recent graduates talk with their parents about whether they’re expected to repay these loans as well.

The two most important questions to ask before selecting a repayment plan, according to Mr. Kantrowitz, are: What will my monthly payment be, and how much will I pay over the lifetime of the loan?

For federal student loans, the standard repayment plan is 10 years. Mr. Kantrowitz suggests borrowers use that repayment plan if they can afford the monthly payments. But first, he suggests borrowers prepare a detailed budget to see how much money will be available to pay their student loan. If the monthly payment is more than 15% of monthly income, that is “really high,” Mr. Kantrowitz says.

Another tale-tell: “If your total debt at graduation is greater than your annual income, that is an indication that you’ve graduated with excessive debt,” he says. In such a case, under the 10-year standard plan, “you might not be able to afford your monthly payments unless you adopt an austere lifestyle.”

Borrowers in this position may want to consider a so-called safety-net plan. These come in several forms. Graduated payment plans make loan repayments more affordable by setting up a ladder where payments start out relatively low and increase every couple of years, ideally (though not necessarily) tracking increases in income. Extended repayment plans reduce the amount owed each month by extending the loan term. Income-driven repayment plans allow borrowers to repay their loan as a percentage of their income.

Income-driven repayment programs can help make student loans more manageable by capping a borrower’s monthly payment at a relatively low percentage of their discretionary income. But they also extend the life and the total cost of the loan.

Borrowers can use the repayment estimator offered by Federal Student Aid to get a sense of how their payments will vary under different plans. Mr. Kantrowitz recommends borrowers choose the plan “with the highest monthly payment they can afford because that will save the most money over the lifetime of the loan.”

Do I work in a job that qualifies me for loan forgiveness?

Government and some nonprofit workers may qualify for Public Service Loan Forgiveness, or PSLF, a program that allows public servants to have federal student loans forgiven after 10 years of payments.

The requirements are specific: Borrowers need to have the right type of loan (made under the Direct Loan Program) and be making payments under the right type of plan—extended repayment and graduated repayment don’t qualify. They also must have the right type of public-service or military job. To see eligible jobs, go to myfedloan.org, click on Borrowers, then scroll down to “Do You Work in Public Service?” or “Are You in the Military?”

Do I have all of the information I need to make an informed decision and to stay current on my plan?

The requirements for income-driven repayment plans and forgiveness programs can be complicated. For example, borrowers need to recertify their income every year to avoid being removed from the plan.

Student loan servicers—the companies hired by the government to facilitate repayment of federal student loans—can be a resource for borrowers when determining which plan is right for them. But Ms. Lowry suggests consulting the government resources available, including studentloans.gov, for an impartial sense of the ins and outs of repayment options.

Should I consolidate my loans?

Though borrowers can’t refinance their loans through the federal government, they can combine all of their federal loans into one new loan through consolidation. There are a number of reasons why borrowers may want to consider this option.

For one, borrowers interested in taking advantage of PSLF, but who have the wrong kind of federal loan—such as those made under the Federal Family Education Loan Program—can consolidate their debt into Direct Loans, which qualify for PSLF.

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Borrowers who are unhappy with their servicer may also want to consider consolidating their loans. Consolidating offers borrowers the opportunity to choose a new servicer. In addition, borrowers who are frazzled by having several different federal loans, perhaps in different places, may want to consolidate into one new loan to simplify their loan picture.

But there are downsides to consolidating. The new interest rate will be the weighted average of the old loans, rounded up to the nearest 1/8th of a percentage point—in other words, higher than some of your lowest interest rate loans before consolidation.

“If you have one high rate loan and a bunch of low-rate loans, consider whether you’d be better off accelerating repayment of the highest interest loan instead of consolidating,” Mr. Kantrowitz says.

Should I refinance my federal student loans?

Some borrowers may be eligible to refinance their student loans on the private market to get a lower interest rate. But Mr. Kantrowitz suggests borrowers evaluate these offers closely before committing. In some cases, refinancing may save a borrower money over the lifetime of their loan, but only a fraction of that savings is due to a lower interest rate, according to Mr. Kantrowitz. Instead, the bulk of the savings may actually come from a higher monthly payment and a shorter loan term, he says.

What’s more, when borrowers refinance federal loans into private ones, they lose all of the “superior benefits” of federal loans, Mr. Kantrowitz says, like repaying the debt as a percentage of their income.

Ms. Berman is a reporter at MarketWatch. Email her at [email protected]