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Legally Thrifty: Picking a Repayment Plan for Your Federal Loans

Scenario: The grace period is over and your federal loan is in repayment.  How much should you be paying each month towards your loan?  The answer is every possible penny, within reason of course.  What is “within reason” differs among individuals.  Some of us can only survive for so long on ramen noodles before going delirious with hunger for a better life.

In July’s episode of Legally Thrifty, we explored the options of deferment and forbearance.  If you are earning sufficient income to make regular monthly loan payments, then you need to work with your loan servicing company to figure out the best repayment plan for your financial situation.  Once you leave the grace period, your loan is automatically put on a standard repayment plan.  You may be able to afford increasing the monthly amount or you may have to request lower monthly payments. 

For those who need a lower repayment plan, this page offers a simple overview and comparison of the various repayment plans available for federal loans.  Read on for a summary of the most popular plans, Income Based Repayment and Graduated Repayment.

Income Based Repayment, known as “IBR” (not to be confused with IBS), works if your payments under a 10 year standard repayment plan would be higher than the monthly amounts required under an IBR plan.  IBR is available for almost all federal loans, with the exception of Grad PLUS loans for parents.  This plan allows you to make payments based on your income and family size and the payments are capped at the 10 year standard repayment amount.  The payments are adjusted each year based on any changes in annual income and family size.  You can calculate whether you qualify for the IBR plan here.

Like everything else, IBR has its advantages and disadvantages.  If you expect to be perpetually earning a low income in your chosen field, then IBR lets you pay 15% of your discretionary income (the difference between your adjusted gross income and 150% of the applicable poverty guideline).  Plus you get interest-saving benefits.  The interest that accrues but isn’t covered by your loan payments will not be capitalized on the principal.  In addition, the federal government will pay your unpaid accrued interest (on select subsidized loans) for up to three consecutive years from the date of starting the IBR plan if your monthly payment doesn’t cover the accumulated interest each month.  Overall, these benefits seem best for those who have a high debt to income ratio.

The biggest pro, however, is complete cancellation of the remaining balance of your loan after 25 years, though you will probably have to pay taxes on the amount that ends up being canceled.  Personally, the pessimist in me sees a dark lining in this cloud of federal debt.  Unless I planned on earning a low income forever, I wouldn’t want to carry a debt for 25 years, discharge or no discharge.  Moreover, you end up paying more interest in the long run because you’re making such small payments on your loan.  I believe that’s money wasted but if you’re patient for 25 years, it shouldn’t matter.

If you’re like me and paying your loans for 25 years sounds horrible, then consider the Graduated Repayment Plan (“GPR”).  The payments start lower and then increase every two years (or more frequently, if you choose) for a period of up to 10 years.  While you still pay more interest over time than under 10 year standard repayment plan, the total amount is considerably less than under any extended plans or the IBR.  For instance, I used this GPR calculator to see how much I would pay monthly and the total paid over time.  Please note that the calculations below are for the unsubsidized portion of my Federal Stafford loan only.

6.8% interest rate on my current outstanding balance of $43,669.45:

a) Standard repayment 120 months at a payment of $502.55 for a total of $60305.94. 

b) Extended fixed repayment 300 months at a payment of $303.10 for a total of $90929.24. 

c) Extended graduated repayment 300 months at a payment of $251.27 for a total of $97926.34. 

d) Graduated repayment 120 months at a payment of $345.07 for a total of $63563.32.

Look at the whopping difference!  Approximately $30,000 to $40,000 extra in interest accruing on the loan.  However, the difference between standard repayment and the GPR is around $3,000. 

Lastly, here’s a yummy cherry on top for those who are employed full-time in public service and will stay in public service.  If you’ve been making on-time monthly payments under IBR or certain plans, you may be eligible to receive forgiveness on the remaining balance of your loans through the Public Service Loan Forgiveness Program (“PSLF”) after 10 years. This almost makes me wish that I had been a do-gooder when I started as a bright-eyed attorney naively convinced that I would be able to earn enough to pay off my loans.  Before you jump on the public service wagon though, keep in mind that PSLF only applies to loans under the William D. Ford Federal Direct Loan Program.  You also need to check that your repayment plan qualifies for forgiveness.

So don’t sit there fretting about how you’re going to pay back your federal loans on your meager income.  It can be done and loan servicers are willing to help you get there. As am I!

P.S. - I almost forgot to add that you should also check with your law school's financial aid office to see if it participates in the Loan Repayment Assistance Program ("LRAP").  This is a great program that provides financial assistance post-graduation to alumni who are working in low income jobs.  I believe that each school differs in their conditions and requirements.  For example, my school offers LRAP to anyone employed in a legal position (where a JD was a requisite) who makes below a certain amount, not just public service attorneys.

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