Student Loan Refinancing vs. Income-Driven Repayment PlansNovember 18, 2020
Student loans can be a real budget killer, with the average student loan payment being $393 per month. Over time, you may want to lower your monthly payment to make it more manageable or to put your savings toward other financial goals. Depending on the types of loans you have, you may choose to pursue income-driven repayment or student loan refinancing.
If you have federal student loans, you may be eligible to select an Income-Driven Repayment plan. Alternatively, for private and federal loans, student loan refinancing could be a better choice. To figure out whether you have federal student loans, check the Federal Student Aid site where all the information on federal loans will be available. To determine whether you have private student loans, request your credit report to see any reported private loans.
Once you know the types of loans you have, here are a few options that may reduce your student loan payment:
Student Loan Refinancing
When you refinance your student loans, you obtain a new loan with a different lender, often a bank, credit union or third party. You can refinance your private or federal student loans, or a combination of both. Your refinanced loan will have a new interest rate, term length and monthly payment. Here are a few important things to know about student loan refinancing:
To qualify for student loan refinancing, you must meet certain eligibility requirements.
Most lenders require:
- A minimum credit score in the high 600s
- Stable employment with proof of income
- A minimum student loan amount
- Debt-to-income ratio of less than 50%
One benefit of refinancing your student loans is that you may earn a reduced interest rate, which can save you thousands of dollars. Here’s how it works:
If you have $65,000 in total student loan debt, a 15-year term and an interest rate of 6.8%, your monthly payment will be approximately $577. When you refinance, if you keep the 15-year term and qualify for an interest rate of 3.77%, your payment will be reduced by $104 per month. This results in $18,000 in interest savings over the life of the loan!
In addition to potentially reducing your interest rate, another benefit of refinancing student loans is you have more control over the terms of your repayment. You can select a fixed or variable interest rate, choose the loan provider that best meets your needs, and choose the amount of years of the loan.
If you want to pay your loan off more quickly, you can select a shorter student loan repayment term, although this will most likely increase your monthly payment. If you want to reduce your monthly payment, you can lengthen your student loan repayment term, but this may result in paying more in interest over the life of the loan. Try ELFI’s Student Loan Refinance Calculator* to see how much you could save.
Income-Driven Repayment Plans
These plans are only available for federal student loans. There are four Income-Driven Repayment (IDR) plans offered, and with each plan, the payment is based on income and family size. Here are a few important things to know about Income-Driven Repayment:
To select an IDR plan, you must apply through your loan servicer. Once an IDR plan is established, you’ll be required to recertify each year by submitting documents to prove your income and family size.
Types of Income-Driven Repayment Plans
Once you recertify the monthly payment can go up or down depending on your income. The IDR plans available are:
Revised Pay As You Earn (REPAYE)
The payment is always based on your income and family size. Your payment can increase to be higher than your payment on the standard repayment plan if your income increases significantly. The term length is 20 years for undergraduate loans and 25 for graduate loans.
Pay As You Earn (PAYE)
The payment is 10% of your discretionary income but your payment cannot increase to be more than the payment on the standard 10 year repayment plan. The term length is 20 years for all loans.
Income-Based Repayment (IBR)
The payment is 10% or 15% of your discretionary income, depending on when you borrowed the loans. Your payment will never be more than the 10-year standard repayment amount. The term length is 20 or 25 years depending on when you borrowed the loans.
Income-Contingent Repayment (ICR)
The payment can be up to 20% of your discretionary income and the loan term is 25 years.
Student Loan Refinancing vs. Income-Driven Repayment
To determine which option is best for you, it is helpful to evaluate the differences between student loan refinancing and income-driven repayment plans:
Although either option may reduce your monthly student loan payment, the major difference between Income-Driven Repayment and student loan refinancing is the interest rate change.
Income-Driven Repayment will not lower your interest rate. Rather, it will remain the same throughout the life of the loan. Student loan refinancing, on the other hand, may reduce your interest rate for the remaining life of the loan.
With IDR plans, you are still eligible for federal benefits such as deferment, forbearance and forgiveness, although some private lenders also offer deferment and forbearance options.
There is no cost to refinance, and you may even save on interest costs if you qualify for a lower rate. With an IDR plan, there is no cost to apply for a plan, but your loan balance may actually increase on certain plans. This can happen when your minimum payment based on your income is not large enough to cover the interest costs that are accumulating. The interest costs can be added to your loan and your loan amount will actually increase rather than decrease.
When you refinance, you have the option to select a fixed interest rate, as opposed to a variable rate, that will keep the payment the same throughout the life of the loan. On an IDR plan, there is uncertainty to what your payment amount will be each year, since you are required to update your income and family size. Your payment can change each year and your budget must account for it.
When you want to lower your student loan payment, evaluate the options and decide which works best for your financial plans. Both options can make your payment more manageable, but each have different long-term outcomes.