Refinancing vs. Consolidating

“Should I refinance my loans? Should I consolidate my loans? What is the difference between the two?”

These are some of the most common questions I get whenever I talk to somebody about their student loan debt.  These terms are thrown around somewhat loosely, but they mean very specific things and it’s important to know the difference.

Refinancing is swapping out your current set of student loans with new, privately-held loans, often at a lower interest rate.  If you are refinancing federal loans into private loans, you will save on interest but you will lose federal benefits along the way.

The process is similar to refinancing a mortgage.  You have your existing loans (usually federal loans) at a certain average interest rate.  Because these are federal loans, you have the whole suite of federal benefits including deferment, forbearance, income-driven repayment options, and possibly even public service loan forgiveness.  By refinancing, you have a third party private company pay off your existing debt to the government, leaving you with a new debt owed to this third party, likely at a lower interest rate.

Unlike others in the student loan industry, I do not maintain any financial or business connections with any private refinancers.  I never recommend one private refinance company over another to my clients.  In fact, I rarely recommend private refinancing unless my client has a high risk tolerance and has a high-earning job that will allow them to pay off the loans on a short time horizon.

By contrast, consolidating your loans refers to the simplifying of all your federal loans into one or two consolidated federal loans.  You will not save on interest but you will keep your federal benefits.

Consolidation is a term of art in the world of federal student loans.  It refers to the process of simplifying all of your federal loans.  Unless you have some very old variable-rate federal loans, you will not get a lower interest rate — your new consolidated loan will merely have the weighted interest rate of all your previous loans.  But you will end up having to make only payments to a single servicer.  If you have federal student loans scattered across many companies, this can make your monthly bill-paying much easier.

Consolidation is very useful for student borrowers.  Sometimes borrowers have loans like Perkins loans that are not eligible for income-driven repayment plans.  By consolidating a Perkins loans, you make the entire loan balance eligible for the repayment plan of your choice.  Moreover, a consolidated loan is a Direct Loan, which means it is eligible for public service loan forgiveness.  This also make consolidation appealing to borrowers who have non-PSLF-eligible FFEL loans.

The one thing to be careful about is consolidating a Parent PLUS loan.  Always get advice from an expert before you consolidate a Parent PLUS loan with your other federal loans.  Consolidated loans that repay a Parent PLUS loan have a variety of limitations and you could be losing benefits on all the loans in the pool.

To summarize: refinancing is creating a new loan with a private lender.  You may save interest but you will lose federal benefits.  Consolidating is just creating a new federal loan to simplify your old federal loans.  You will not save on interest, but you can keep (and sometimes even get new) federal benefits.

DISCLAIMER: THIS BLOG POST IS NOT LEGAL ADVICE AND DOES NOT CREATE AN ATTORNEY-CLIENT RELATIONSHIP BETWEEN THE READER AND MAURER LAW LLC.  SEEK LEGAL ADVICE IF YOU HAVE PARTICULAR QUESTIONS ABOUT YOUR STUDENT LOANS

Student Loan Repayment Plan – Part 6, RePAYE

We have covered PAYE and IBR and now we turn to Revised Pay As Your Earn or RePAYE 

1. Percentage of discretionary income owed over the course of the year: 10% of your discretionary income.  (If you don’t remember how to calculate discretionary income, check out the original post on IDR plans).  There is no cap on RePAYE, so even if 10% of your discretionary income is over the 10-year standard repayment plan, you will not be kicked out of the program.

2. Eligible loans

Any Direct Loan made to an eligible borrower is eligible for the RePAYE Program except for: (1) a defaulted loan, (2) a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower, (3) or a Direct Consolidation Loan or Federal Consolidation Loan that repaid a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower.

Perkins loans or FFEL loans are eligible if consolidated into a Direct Loan.  However, take care not to consolidate a Parent loan along with them.  Consolidating a Parent loan taints the entire consolidation and makes it ineligible.

3. Eligible borrowers

 

Any borrower with eligible federal student loans can make payments under this plan.

4. Forgiveness opportunities

Much like under PAYE and IBR, there is an opportunity to have your balance forgiven, regardless of your employment.  This differs by the purpose of the loans.  If you took out loans for undergraduate study only, the balance will be forgiven in 20 years.  If you took out loans for graduate or professional school, the balance will be forgiven in 25 years.

If you are eligible for Public Service Loan Forgiveness (for which RePAYE is a qualified plan), your loans could be forgiven after 120 payments or 10 years.

5. How the plan handles spousal income

Regardless of whether you file separately or jointly, RePAYE considers you and your spouse’s income jointly.   This makes RePAYE distinct from IBR and PAYE where filing separately allows your servicer to look at you and your spouse’s income separately.

6. Interest benefits

RePAYE has a more substantial interest subsidy if you end up with a low enough payment that you do not pay off the interest that accrues ever month.  For subsidized loans, the government will pay the full amount of unpaid accruing interest for the first 3 years and 50% of the difference after that.  For unsubsidized loans, the government will pay 50% of the difference throughout the process.  By comparison, the IBR and PAYE programs do not have an interest benefit for unsubsidized loans.

Student Loan Repayment Plan – Part 5, IBR

We began our deep dive into income-driven plans with PAYE.  Now we turn to Income Based Repayment or IBR.   Most notably, IBR is split into two different categories — IBR for new borrowers (those who had no federal loan balance when they took out loans after July 1, 2014) and IBR for everybody else — what I call IBR for old borrowers.

1. Percentage of discretionary income owed over the course of the year:

New borrowers: 10%

Old borrowers: 15%

(If you don’t remember how to calculate discretionary income, check out the original post on IDR plans)

2. Eligible loans

Any Direct Loan or FFEL made to an eligible borrower is eligible for the IBR Program except for: (1) a defaulted loan, (2) a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower, (3) or a Direct Consolidation Loan or Federal Consolidation Loan that repaid a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower.

Perkins loans are eligible if consolidated into a Direct Loan.  However, take care not to consolidate a Parent loan along with them.  Consolidating a Parent loan taints the entire consolidation and makes it ineligible.

3. Eligible borrowers

New Borrower: you’re considered a new borrower if you had no outstanding federal loan balance when you received a Direct Loan on or after July 1, 2014.

Old Borrower: Anybody else who has eligible loans, regardless of when you took them out.

4. Forgiveness opportunities

Much like under PAYE, there is an opportunity to have your balance forgiven, regardless of your employment.  This differs by the type of borrower.

New Borrower: 20 years

Old Borrower: 25 years

If you are eligible for Public Service Loan Forgiveness (for which IBR is a qualified plan), your loans could be forgiven after 120 payments or 10 years.

5. How the plan handles spousal income

If you and your spouse file taxes as married filing separately, your servicer will only count your income when calculating your monthly payment.  If you are married filing jointly, both of you and your spouses income will be used in calculating monthly payments.

6. Interest benefits

If you have as Direct Subsidized loan or a consolidated loan with a subsidized portion, you may be eligible for some interest benefits for the first three years you are enrolled in the IBR program.  In particular, if your monthly payments do not cover the accrued interest, the Department of Education will waive the remaining interest, meaning the interest will not accumulate.

Student Loan Repayment Plans – Part 4, PAYE

Repayment Options, Pt. 4: Pay as You Earn Income-Driven Plan

Now that you know all about income-driven plans and how to calculate discretionary income, we begin the deep dive into each of the available plans.  We begin with the PAYE plan — Pay As You Earn 

1. Percentage of discretionary income owed
Under the PAYE plan, 10% of your discretionary income is owed.  However, if 10% of your discretionary income is greater than what you would have paid under the 10-year Standard Repayment Plan, you are ineligible for PAYE plan.  This means you must show partial financial hardship to enroll in PAYE

2. Eligible loans

Any Direct Loan made to an eligible borrower is eligible for the PAYE Program except for: (1) a defaulted loan, (2) a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower, (3) or a Direct Consolidation Loan or Federal Consolidation Loan that repaid a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower.
Perkins and FFEL loans are eligible if consolidated into a Direct Loan.  However, take care not to consolidate a Parent loan along with them.  Consolidating a Parent loan taints the entire consolidation and makes it ineligible.
3. Eligible borrowers
To qualify for the PAYE Plan you must also be a new borrower as of Oct. 1, 2007, and must have received a disbursement of a Direct Loan on or after Oct. 1, 2011.  In other words, to be a new borrower you had to have no outstanding Direct Loan or FFEL Program loan balance as of October 1, 2007.

4. Forgiveness opportunities
Regardless of your employment, after 20 years on the PAYE plan, your remaining balance will be forgiven.  Usually this means 20 years of payments but, according to Studentaid.ed.gov, “periods of economic hardship deferment, periods of repayment under certain other repayment plans, and periods when your required payment is zero will count toward your total repayment period.”

If you are eligible for Public Service Loan Forgiveness (which PAYE is a qualified plan for), your loans could be forgiven after 120 payments or 10 years.

5. How the plan handles spousal income

If you and your spouse file taxes as married filing separately, your servicer will only count your income when calculating your monthly payment.  If you are married filing jointly, both of you and your spouses income will be used in calculating monthly payments. 

6. Interest benefits

If you have as Direct Subsidized loan or a consolidated loan with a subsidized portion, you may be eligible for some interest benefits for the first three years you are enrolled in the PAYE program.  In particular, if your monthly payments do not cover the accrued interest, the Department of Education will waive the remaining interest, meaning the interest will not accumulate.
Disclaimer: This blog post is not legal advice and does not create an attorney-client relationship between the reader and Maurer Law LLC.  Seek legal advice if you have particular questions about your student loans.

Student Loan Repayment Plans – Part 3, Introduction to Income-Driven Plans

Parts 1 and 2 covered balance-driven repayment plans.  These are the backbone of the repayment options, and should be familiar to anybody who has figured out the repayments of another type of loan like a mortgage.
In recent years, the Federal Government has expanded the options of so-called income-driven repayment plans.  (We can’t call it the more normal-sounding income-based repayment plan, because income-based repayment plan is a specific repayment plan.  Income-driven repayment is the umbrella term to cover all the income-driven options.)
There are technically six types of income-driven repayment plans
  • Income-based repayment (IBR) (old borrowers)
  • Income-based repayment (IBR) (new borrowers)
  • Pay as you earn (PAYE)
  • Revised pay as you earn (REPAYE)
  • Income-contingent repayment (ICR)
  • Income-sensitive repayment (ISR)

However, ICR and ISR are rarely used for most borrowers, and everybody who is eligible for IBR for new borrowers can benefit from the PAYE or REPAYE plan.

So, how do these plans work? Well, the main idea is that these repayment plans make borrowers pay some percentage of their discretionary income each month towards their loans, regardless of how much money they owe.  So long as you meet certain requirements, the amount you pay on $50,000 worth of debt is the same as what you would pay on $250,000.

How do you calculate discretionary income? Your discretionary income is the amount of money you have left after subtracting 150% of the poverty guideline for your household size.  The poverty guidelines for 2018 are:

  • $12,140 (1 person household)
  • $16,460 (2 person household)
  • $20,780 (3 person household)
  • $25,100 (4 person household)
  • $29,420 (5 person household)

Which makes 150% of these guidelines:

  • $18,210 (1 person household)
  • $24,690 (2 person household)
  • $31,170 (3 person household)
  • $37,650 (4 person household)
  • $44,130 (5 person household)

So, let’s say you are on a payment plan that requires you to pay 10% of your discretionary income towards  your loans.  If you make $50,000 per year and are single, your discretionary income is $50,000 – $18,210, or $31,790.  10% of that is $3,179.  If you have to pay $3,179 over the course of the year, that makes your monthly payment $265 ($3,179 divided by 12 is $265).  So, no matter how much you owe, your monthly payment under a 10% income-driven repayment plan will be $265.

Okay, now that we have that building block in place, we will spend the next few parts taking a deeper dive and comparing the income-driven repayment plans.

These plans can differ in numerous ways:

1. Percentage of discretionary income owed
2. Eligible loans
3. Eligible borrowers
4. Forgiveness opportunities
5. How the plan handles spousal income
6. Interest benefits
 
We will take a look at each one of the plans in turn.

Student Loan Repayment Plans – Part 2, Graduated Balance-Driven Plans

Graduated Balance-Driven Plans

If you recall from Part 1, repayment options on federal loans are split into two categories: income-driven plans and balance-driven plans.  Balance-driven plans are the type where your monthly payment depends on how much you owe.  In Part 1, we talked about one kind of balance-driven plans — standard fixed plans where you pay the same amount for the term of the repayment plan.  For instance, you make the same payment every month for 10 years.  At the end of 10 years your loan is paid off.  Today we’ll talk about the other kind of balance-driven repayment plan, graduated plans. 

Under graduated plans, the amount you pay begins lower than under a standard plan, but increases every two years until it ends up higher than under the standard plan.  In the end you pay off the loan over the same number of years, but in the beginning you have lower payments.  Because the payments start off so low, you will end up paying more over the life of the loan than under a standard repayment plan. 
 
As with standard, fixed plans, there are 10-year and 25-year graduated plans for most federal loans.  For consolidated loans, the term depends on the amount you’ve taken out.  For consolidated borrowers whose loans entered repayment on or after July 1, 2006 the term of the graduated plans are as follows, 
  • If you owe less than $7,500, you may repay on a graduated 10-year plan
  • If you owe between $7,500 and $10,000, you may repay on a graduated 12-year plan
  • If you owe between $10,000 and $20,000, you may repay on a graduated 15-year plan
  • If you owe between $20,000 and $40,000, you may repay on a graduated 20-year plan
  • If you owe between $40,000 and $60,000, you may repay on a graduated 25-year plan
  • If you owe more than $60,000, you may repay on a graduated 30-year plan.
 
So, how much will your repayment be under a graduated plan?  We can’t know for sure until you apply through your servicer.  The formulas for calculating the graduated plans are not publicly available.  You can use the federal repayment estimator to get an estimate.  There is no guarantee that your servicer will match these numbers, however.  (Fun fact: I once e-mailed somebody who had done a lot of student loan calculator work, and he said that the formulas were not public but that he used the “Newton Raphson Method” to make his own estimates.  Personally I don’t think you should need to know advance combinatorics to determine your anticipated loan repayment, but that’s just me) 
 
According to the repayment estimator, if you have $100,000 in eligible student loan debt at 6% interest, a graduated 10-year plan will start at $635/month.  You will pay $635/month for the first two years, but every two years will increase until in the end you pay $1905/month.  You will pay $142,000 over the life of the loan under this plan.  
 
By comparison, a standard fixed 10-year plan would cost $1,110/month and you would pay $133,000 over the life of the loan. 
 
If you did an extended graduated plan, you would start at $500/month and get up to $970 at the end of the 25-year term.  In the end you would pay $210,000 to repay the same $100,000 student loan debt under this plan.  By comparison, a standard fixed 25-year plan would cost $644/month and cost $193,000 over the life of the loan. 
 
Graduated plans can be costly.  However, if you make too much to benefit from income-driven repayment plans, or if your loans do not qualify for an income-driven repayment plan, the extended graduated plan will start you at the lowest amount possible.  

Student Loan Repayment Plans – Part 1, Fixed Balance-Driven Plans

Federal direct loans are eligible for a variety of different repayment plans.  Navigating the repayment options is confusing for many people.  This multi-part series will summarize the main repayment options for direct federal loans.  Perkins loans and old FFEL loans have their own repayment options that will be discussed later.

As always, you can find out what of loans you have by looking up your federal loans in the National Student Loan Database System. If you have private loans, your contract with your lender will determine your payment options.

There are two buckets of repayment plan options for direct federal loans: (1) balance-driven plans and (2) income-driven plans.  The amount you pay under a balance driven plan depends on how much you owe.  The amount you pay under an income-driven plan depends on how much you make.  This is why income-driven plans can be an affordable option for people who owe a lot of money but do not make very much.  Balance-driven plans, however, can be appealing to some because they offer a structured, fixed repayment amount every month without any need for annual recertifications.

There are two types of balance-driven plans: those with fixed amounts and those wth graduated amounts.  This post covers the the fixed balance-driven plans.

On the Standard 10-Year Fixed repayment plan, you will pay the same amount every month for 10 years and at the end you will have paid off the entire principal balance.  In the beginning you will pay more interest and less principal, but every month you will pay slightly more principal until you pay off the loan entirely.  (For you math nerds out there, this is an amortizing loan where the monthly payment is determined by the standard mortgage formula).

The Extended 25-Year Fixed repayment plan is available for many borrowers who have $30,000 or more in direct or FFEL loans.  The idea is the same, but instead of paying off the loan over 10 years, you pay it off over 25.  This means your monthly payments will be lower, but the amount you pay over the life of the loan is higher.

If you have direct consolidated loans, the term for your fixed repayment differs based on the amount you owe:

  • If you owe less than $7,500, you may repay on a fixed 10-year plan
  • If you owe between $7,500 and $10,000, you may repay on a fixed 12-year plan
  • If you owe between $10,000 and $20,000, you may repay on a fixed 15-year plan
  • If you owe between $20,000 and $40,000, you may repay on a fixed 20-year plan
  • If you owe between $40,000 and $60,000, you may repay on a fixed 25-year plan
  • If you owe more than $60,000, you may repay on a fixed 30-year plan.

Next up, we will describe the other type of balance-driven plan: graduated plans.