You did it! You finally graduated from college. No longer will you work nights and weekends for minimum wage in an attempt to not further your outstanding student loan debt. Your life, until this point, has revolved around classes, homework, and your GPA. You’ve reached the pinnacle of your education. Now, you’ve started your “real world” job and begun to receive “real world” paychecks. Then one day your email inbox contains what you’ve been dreading…..your student loan repayment information.
You create your online account and then your estimated monthly payment appears. What you decide to do next is paramount.
If you have federal student loans you’ll be given several different options for repayment.
The most common repayment options are:
- Standard Repayment: A fixed payment over the life of the loan. Your loans will be paid off in 10 years.
- Graduated Repayment: Your payment will increase every two years. However, your loan (in most cases) will still be paid off in 10 years.
- Extended Repayment: Loans will be paid off within 25 years
- Income-Based Repayment: Monthly payment equates to 10 or 15 percent of your discretionary income. If a balance remains after 20 or 25 years (depending on the loan) the remainder balance is forgiven.
I’m here to prevent you from making a very common mistake, which is paying the least amount per month possible. The longer it takes to pay off your student loans, the more cash you’re going to shell out over time. Period. Comparing a monthly payment on a 10 year repayment plan to a 25 year repayment plan might tempt you to choose the 25 year plan (if you qualify). But looking at the total cost over time should sway you right back in the opposite direction.
Let’s look at an example:
Say you went to a 4-year Private, For-profit. As a result, you have a total loan balance of $34,722. For this example, we will also assume an interest rate of 3.9%.
- Monthly payment = $350/month for 120 months (10 years)
- Total paid ~ $41,988
- Interest paid ~ $7,266
- Monthly payment = $181/month for 300 months (25 Years)
- Total paid ~ $54,409
- Interest paid ~ $19,687
While the $181/month payment might be more appealing now, over the long term you’ll pay far more for the same 4-year degree. The extra $12,400(ish) in interest could buy a reliable new-to-you car or fund a downpayment on a house.
“But, I cannot afford the $350/month payment right now”
For many, this is the legitimate truth. Sometimes your student loan payment is just not in the budget. You’re at the beginning of your career and your salary might reflect just that. But what choice do you have? You can’t go back in time and take out less loans. On the other hand, the idea of making this monthly payment for a quarter of a century sounds less than appealing. So what can you do?
First, do not assume you cannot afford your payment if you haven’t sat down to run the numbers. Your student loan payment should be deducted from your net income before you budget the remaining categories. If you’re unsure of how much you should be allocating for things like rent, transportation, or food you can download our Ideal Budget to help determine the affordability of your student loan payment.
If your payment is truly unaffordable, you can then apply for an Income Driven Repayment Plan. This repayment plan ensures your payments do not exceed a set percentage of your income. You’ll be required to recertify your income annually. This recertification will ensure you increase your payment as you increase your annual income. There are a select few circumstances where I would encourage a borrower to only pay the minimum payment on their loan. This list pretty much begins and ends with “those trying to qualify for Public Service Loan Forgiveness.” As for everyone else, I’m likely going to encourage you to pay as much “extra” as you can each month on your loans.
I sympathize with wanting to pay less. Short of seeing a decrease in your outstanding balance there is nothing rewarding about selling out hundreds to your student loan servicer. However, if you can keep the end goal in mind you’ll be free of this obligation years ahead of your other payment options.
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