What You Need to Know About Flexible Student Loan Repayment Plans

In the U.S. if you have federally backed student loans you have a myriad of repayment options available to you including some flexible repayment options dependent upon your income.

With the average amount of student loan debt on the rise, and the recession still affecting starting salaries the federal government recognized (especially after so many people defaulted) the inability of graduates to pay back their loans on the standard repayment plan. Flexible student loan repayment options were introduced to help alleviate the burden of repayment. There are currently six different flexible student loan repayment options to repay your loans besides the standard repayment plan.

Of course, with any of flexible student loan repayment plans, you will ultimately be paying more over the life of the loan. Even so, there are great reasons to take advantage of flexible student loan repayment plans.

But, before you get too carried away there are some downsides too, and the possibility for some outright scary results.

Flexible Student Loan Repayment Plan Options

Here is a quick overview the repayment plans available. You can find out more at the Federal Student Aid Website.

Graduated Repayment

What it is: monthly payments start low and increase every two years, for ten years.

Qualification: Certain types of loans including Direct Subsidized and Unsubsidized Loans, Federal Stafford Loans, and PLUS Loans

Upside: The monthly payment will never be lower than the amount of interest that accrues between payments. The monthly payment won’t be more than three times greater than any other payment plan.

Downside: If your salary doesn’t increase regularly, making those payments will get harder and harder.

Extended Repayment

What it is: fixed or graduated repayments up to twenty-five years

Qualification: Certain types of loans, loans taken out after October 1998 and more than $30k in outstanding Direct Loans and/or over $30k in FFEL loans. To qualify you must have over $30k in loans for the type of loan, 10K in Direct Loans and 20K in FFEL loans won’t qualify. If you have 10K in Direct Loans and 30K in FFEL loans, you would qualify for your FFEL loans but not your Direct Loans.

Upside: Fixed monthly payment or graduated amount that is lower than payments under the Standard or Graduated Repayment plans.

Downside: The only potential downside is if your salary cannot keep up with the payments, there is no loan forgiveness under this plan.

Income Based Repayment

What is it: Maximum monthly payment is fifteen percent of your discretionary income, up to twenty-five years.

Qualification: Have a partial financial hardship, generally you would qualify if your loan debt is higher than your annual discretionary income, be a new borrower as of October 2007.

Upside: Affordable monthly payment, loan forgiveness after 20-25 years (depending on when borrowed). Payment will not exceed the amount of standard repayment plan.

Downside: The forgiven amount after 25 years of payments constitutes taxable income. You will pay a lot more interest over the course of the loan. You could be looking at a very large tax bill after twenty-five years of loan payments. Additionally, you have to submit qualification on an annual basis or be automatically enrolled in the standard repayment plan.

Pay as You Earn (PAYE) Repayment

What is it: Maximum monthly payment is ten percent of your discretionary income, up to twenty years

Qualification: Only certain loans are eligible, must have a partial financial hardship, new borrower as of October 2007

Upside: Less time than IBR repayment plan, affordable monthly plan, loan forgiveness after twenty years. Payment will not exceed the amount of standard repayment plan.

Downside: Pay more interest over the life of the loan. Due to loan forgiveness, you could have the same tax issues as under the IBR repayment plan. Also requires annual submission of qualification.

Income Contingent Repayment

What is it: Payments are calculated on a yearly basis depending on your AGI, family size, and amount of your loans, up to twenty-five years

Qualification: Only Direct Loans are eligible unless consolidated.

Upside: Remaining loan balance is forgiven after twenty-five years. No initial income requirement.

Downside: Payment could exceed the amount you would pay under the standard repayment plan.

Revised Pay as You Earn (REPAYE) Now SAVE

What is it: 5%-10% of your discretionary income which the SAVE plan changes from 150% of the Poverty line to 225%, up to 20 years for undergraduate study, 25 years for graduate study.

If you only have undergraduate loans your payment will be 5% of your discretionary income, if you have graduate student loans it gets a bit more complicated depending on how much you borrowed for undergraduate vs graduate and your payment would be a weighted average landing somewhere between 5-10% of your discretionary income.

Another big win with the SAVE plan is that it “eliminates 100% of remaining monthly interest for both subsidized and unsubsidized loans after you make a full scheduled payment.” Which means so long as you are making payments, your balance won’t grow which was/is a huge issue with other income based repayment plans.

Qualification: Direct loans, and FFEL loans IF consolidated into a direct consolidation loan.

The following loans do no qualify for the SAVE plan:

• Direct PLUS Loans made to parents
• Direct Consolidation Loans that repaid PLUS loans made to parents
• FFEL Program Loans (some types can become eligible if consolidated)
• Federal Perkins Loans

Upside: Can increase or decrease year to year depending on income.

Downside: Amount forgiven is considered taxable income.

The Good

How taking advantage of flexible student loan repayment options, can help with your overall finances

Taking out student loans has almost become a right of passage to anyone wanting to get a college degree and while having to borrow money is not ideal. The flexible student loan repayment options out there allow you to still pursue your life while paying down your debt.

The general gist of the flexible student loan repayment options is that you will have a lower monthly payment than if you were to do a standard (think ten-year) repayment plan.

Typically these plans are also only available to those who cannot, given their income afford the standard repayment plan monthly payment.

Assuming you are on point with your budget, this lower monthly payment will allow you to pursue other financial goals, giving you ample reason to take advantage of the lower payment. What other things might you want to do before focusing on paying off your student loans?

Pay Off Higher Interest Rate Debt

If you have any other debt with a higher interest rate, such as credit card debt, car loans, or a mortgage. You should get those higher interest loans paid off asap; they likely cost you more on a daily basis than your student loans (depending on the amount of student loans you have).

Unlike your student loans, credit cards, automobile loans, or mortgages typically have a required monthly minimum payment regardless of your income. Having a lower student loan payment should allow you to make the minimum payments and hopefully a little extra to get it paid off sooner.

I know finding “extra money” to pay off your debt quickly can be difficult. But there are apps and tools out there that can help.

Build Up an Emergency Fund

An emergency fund is the first step to being debt free. Reason being, if or rather when an emergency comes up, you will have the cash on hand to take care of it without digging yourself further into debt.

A good rule of thumb is that housing and transportation should account for no more that 50% of your budget. Other life expenses such as food and fun should account for 25%, and 25% should be going towards debt and other financial goals.

In 2024 this rule of thumb might not be as applicable as it once was, do your best to get as close as possible to these percentages, but don’t beat yourself up, if at the moment it’s not possible.

If your flexible student loan repayment is only 5% of your budget, then you should have at least 10% (and ideally 20%) of your income available to stash away in an emergency fund.

How much you will want in your emergency fund will depend on you. Personally, I like having enough for more than a single emergency. The amount that you are comfortable with is the amount you should aim for, and then once you have it, you can focus more on your debt.

One of the ways I continually add to my emergency fund is by saving with Chime. Chime automatically rounds up your spending from your Chime Debit Card and transfers it to a savings account and gives you a 10% bonus. It’s easy to get started with Chime; just apply at Chime, the process takes about 5 minutes. Using Chime makes building savings, super easy.

Save for a Big Life Change

Are you about to get married, have a baby, or move? All of these life changes are both exciting and costly. Not having a huge chunk of your income go towards your student loan repayment means you can save for these things and get through them without accruing more debt.

Target Your Student Loans One at a Time

Chances are you have more than one student loan; there is also a good chance that they have different interest rates. By having a lower monthly payment, you can choose which loans to pay down quicker with extra monthly payments.

Once you have determined which loan to target, all extra money should be going towards paying down that loan.

Keep in mind, that for payments beyond the minimum payment, you can choose how that payment is applied. To get the biggest bang for your buck, make sure your loan servicer is applying the extra money to the principle first, this will lower the amount of interest that accrues.

Some loan servicers make this easy; others will require you to call to ensure the payment is applied correctly. Calling may be a pain, but it could save you tons of money.

The Bad

Why taking advantage of flexible student loan repayment options should be a temporary and not a twenty to twenty-five-year plan

Having a lower monthly payment may allow you to have a semblance of a life now. However, if you don’t at some point focus to pay your loans off, you may be sacrificing having the means to take care of yourself financially when you are nearing retirement.

You will be paying more over the life of the loan often at the expense of your retirement. Here are just a few of the problems you could face if you stick to the income-based repayment plans for the entire life of your student loans.

You Could End Up Paying Twice as Much

Literally, not figuratively. I’m pretty sure when you took out your loans, you weren’t anticipating paying just as much in interest as what you borrowed initially. However, when interest is accruing for up to twenty-five years (on all plans except the SAVE plan which doesn’t apply to interest accrued before 2023), that is indeed a possibility.

Even if you eventually move to a payment plan that covers the interest each month, if that isn’t until year 15 you could easily end up paying twice as much as you initially borrowed.

You Will Be Taxed on the Amount Forgiven

If at the end of the twenty-five years you make $50k a year, having started out with $100k in loans and paid off $70k, $30k would be forgiven.

However, it would be considered taxable income, meaning, that year you would be taxed as if you made $80k that year, owing approximately $28k in taxes, that is more than half your income! You would likely have to make arrangements with the IRS to avoid having your wages garnished, or liens being placed on your property.

Minimum Payments Go to the Interest First

Your monthly payments are applied to the interest first. Hopefully, how much you owe and what you make means that each month on your repayment plan you are at least (AT LEAST) covering the interest so that your balance doesn’t get bigger.

Under these flexible repayment plans, over the course of your loans, you could end up paying only interest without ever touching your principle balance.

It is Taking Away From Your Ability to Save for Retirement

It is simple, the more money you have to put towards paying back your past, the less you have to set aside for the future. No one wants to wait until they’re 50 to start seriously saving for retirement.

A Piece of Paper Isn’t a Roof Over Your Head

Having more time to pay back a loan may seem tempting. After all, a lot of people take out 30-year mortgages for a house. The difference is that a mortgage is putting a roof over their heads. A twenty-five-year payment plan for your student loans is putting up a piece of paper on your wall. It isn’t going to protect you from any kind of storm be it actual weather or a financial storm. If anything, it is going to make weathering any kind of financial storm that much more difficult.

The Ugly

The Worst Case Scenario of Flexible Student Loan Repayment Options

I’ve already touched on some of the worst case scenarios above but taking advantage of a flexible student loan repayment option could get downright ugly depending on the amount of loans you have.

While the average college graduate graduates with $30k in student loans, graduate students tend to graduate with a lot more.

Whether it is a Masters, Juris Doctor (law degree) or Ph.D., the cost of many graduate programs can easily be twice as much as an undergraduate degree. Meaning these students can easily accumulate anywhere from $75-200k in student loan debt.

I am one of those graduates. Admittedly I kept my head in the sand for far too long. I hope you start to tackle your debt a lot sooner than I did.

Income-Driven Plans Don’t Always Cover the Interest

I got my undergraduate degree at a pretty low cost. Then somehow forgot to care about how much my graduate degree would cost. I was swept up in my dream of accomplishing this goal that I had for so long, in the idea that “everyone did it” and that everyone made it out with the debt just fine.

Needless to say, these turned out to be bold-faced lies. Even if they weren’t though, never before had I been ok with doing something just because everyone else was. So I’m not quite sure why I stopped paying attention to what was right for me as an individual. In the end, my debt was my doing.

When I finished school back in 2011, I had about $193k in student loan debt. Today that number is over $235k because my income is so low (in proportion to my debt) so my IBR payment doesn’t even cover all the interest. Now, each month as I continue to make payments, my debt continues to grow. At this rate, I’m in for an unmanageable tax bill in 23 years, and retirement would be an impossibility.

Learn from My Mistakes

While I’m certainly not proud of my mistakes, I think others could learn from them. I intend to pay off my debt in less than 23 years by working hard to make extra money on the side while living frugally. It’s not always fun, but that is why I think I should share it.

Right now I think too many graduates are taking advantage of these Flexible Student Loan Repayment plans, just glad they can afford the payment. Then they continue to eat out three times a week. They don’t take into account the financial consequences down the line.

So while flexible student loan repayment options are great if it really is all you can afford, it shouldn’t really be a long term solution. I think you should strive to get everything paid off as soon as possible, regardless of the minimum payment. You’ll keep more money in the long run when you aren’t paying tons of interest.

Wrapping it Up with a Bow on Top

Flexible repayment plans can be great for now to get ahead on things like an emergency fund and higher interest rate debt but try not to make them your long term plan. Especially, if you have a significant amount of student loan debt.

You don’t want to end up with a gigantic tax bill because you planned on having your loans be forgiven, do what you can to get your loans paid off as soon as possible. The sooner you have your debt paid off, the more of your money you get to keep.

What about you, do you have any experience with flexible student loan repayment options or some advice to share? Let me know in the comments!