Sometimes people are hesitant to refinance their federal loans – even if they can save money with a better rate – because of the protections that come with them.
But what are those protections worth? Will you be better off financially if you keep them? Let’s look at the key benefits of federal loans and if they could apply to your situation.
1. Income-driven repayment plans
If you have federal Direct student loans (rather than Perkins loans or FFEL loans, which are no longer available), you may be eligible for one of the four income-driven repayment (IDR) plans. Under these plans, your loan servicer extends your repayment term to either 20 or 25 years and caps your monthly payments at a percentage of your discretionary income.
According to Federal Student Aid, most borrowers qualify for at least one of the four IDR plans. Some people will even qualify for a payment as low as $0 due to their income and family size.
Will IDR benefit you?
If you can’t afford your payments, IDR plans can give you much-needed relief. However, it’s important to know that IDR plans can cost you a lot of money over time. Because your loan servicer extends your repayment term, you’ll end up paying much more in interest than you would under a 10-year Standard Repayment Plan.
To be on an IDR plan, you must “recertify” your income and family size each year. Depending on your income and specific plan, your payments could increase over time, in some cases to more than the amount you would be paying under the 10-year Standard Repayment Plan.
For example, pretend you have $39,400 in student loans at 5.05 percent. You have an income of $30,000 and are single. Under a Standard Repayment Plan, your monthly payment would be $420. By the time you repaid your loan, you will have paid back a total of $50,379.
If you signed up for the Revised Pay as You Earn Plan (REPAYE), one of the four IDR plans, your monthly payment would start out at just $98. However, it rises over the course of 25 years.
Toward the end of your repayment term, your monthly payment would skyrocket to $539. Worse, you’ll repay a total of $77,761. You’ll pay over $27,000 more in interest due to the longer repayment term.
Keep in mind that not all borrowers are eligible for IDR plans. If you make over a certain amount of money, you won’t qualify.
If an IDR plan isn’t right for you, refinancing can be a smart alternative. You can lower your monthly payment by qualifying for a better rate or by choosing a longer repayment term. Unlike REPAYE, where payments will grow over time, refinancing can give you one, fixed payment.
And if you’re ever in a position to put more towards your loan down the line, you could choose to make extra payments or refinance again to a shorter-term loan. That would mean you could save even more interest overall and speed up your payoff timeline.
2. Public Service Loan Forgiveness
Some borrowers with federal Direct Loans can qualify for Public Service Loan Forgiveness (PSLF). Under this program, the government will forgive your loan balance if you work for a qualifying non-profit organization or government agency for 10 years while making payments on your student loans.
Will PSLF benefit you?
PSLF sounds like a dream come true for many borrowers, but it can be incredibly hard to qualify for forgiveness. You must spend a full 10 years working for a qualifying employer while making 120 payments on your loans.
Thousands of borrowers have applied for PSLF. As of May 2019, 99% of them have been denied, highlighting how difficult it can be and why PSLF may not be a realistic option for many borrowers. To see if you qualify for PSLF and learn the steps to apply, use the help tool at studentloans.gov.
If you think you could qualify for PSLF, make sure you understand the steps you need to take to be eligible.
“Federal loans are a merry-go-round. You’re going to pay a higher rate because you have a false sense of security about them. I did the math, and I would have ended up paying more if I had stuck with them.”
– Melissa, 38, government employee and CommonBond Member
3. Deferment or forbearance
If you have trouble affording your monthly payments or are experiencing a financial hardship, such as a job loss, you can call your servicer and ask that your federal loans be put into deferment or forbearance. This allows you to temporarily postpone making payments without entering into default.
Keep in mind that interest will continue to accrue if your loans are in forbearance, and will sometimes accrue if your loans are in deferment, depending on the type of loan. You can learn more at studentloans.gov.)
Will the option to defer or go into forbearance benefit you?
The ability to place your loans into deferment or forbearance is an important benefit, especially if you’re in a volatile or competitive industry. However, keep in mind that some private loan companies offer forbearance as well. At CommonBond, you can pause payments for up to 24 months over the life of your loans in cases of financial hardship, such as job loss.
The option to go into deferment or forbearance with your federal loans may not be a significant enough reason to keep them, given the fact that other companies also offer this benefit and could allow you to save money with a better rate. Of course, you should check with your potential new lender about the protections they offer before you refinance.
It’s important to understand what giving up federal loans would mean for your specific situation. Many of the benefits can offer relief for borrowers who are struggling to make payments. On the other hand, holding on to your federal loans just because the protections seem like a good idea in theory might end up costing you in the long run. If your priority is getting debt-free as soon as possible or if you’re able to qualify for a lower rate, refinancing could allow you to save thousands and speed up your payoff timeline.