How to Lower Your Student Loan Payments

on April 24, 2017

There are many reasons why borrowers might want to reduce their student loan payments. Some of the more common reasons include saving money, dealing with financial difficulty, freeing up money in their budget and reducing debt-to-income ratios to help qualify for a mortgage.

 

There also are many ways of cutting student loan payments. The monthly payment on a student loan is based on the loan balance, interest rate, repayment plan and repayment term. Changing each of these can result in a lower monthly payment.

 

But, there is a big caveat. Although reducing the student loan payment can be perceived as saving money, it also can increase the total payments and total interest paid over the life of the loan. Short-term financial flexibility may lead to a long-term increase in costs.

 

Reducing the Loan Balance

 

There are no prepayment penalties on federal and private student loans, so borrowers can make extra payments on the principal balance of the loan. Normally, this yields a lower loan balance without changing the monthly loan payment. The lower loan balance means more of each payment is applied to principal and less to interest. This will pay off the loan quicker and save money on interest. The lender, however, might be willing to reamortize the loan, which can lead to a lower monthly loan payment.

 

Other ways of reducing the loan balance include loan forgiveness and student loan repayment assistance plans (LRAPs). Student loan forgiveness cancels all or part of the remaining debt, often in exchange for working in a specific occupation, such as teaching in a national need area or working in a public service job. (Teacher loan forgiveness and public service loan forgiveness are tax-free under current law.)

 

LRAPs are similar, but the repayment assistance is provided on a monthly basis by an employer or an educational institution. Employers like LRAPs because they help with recruiting and retention of millennials. Tufts University provides a LRAP that meshes well with public service loan forgiveness to encourage their alumni to pursue public service jobs.

 

There also are loan discharges for extreme situations where the borrower is unable to repay the debt or repudiates the debt. These include loan discharges for death, disability, closed schools, false certification, unpaid refunds and, rarely, bankruptcy.

 

Crowdsourcing from friends and family (and sometimes strangers) might help you raise money to pay down debt, especially if your story is compelling. You can also ask them to help you pay off your student loans instead of giving birthday and holiday presents. (If they still give you gifts, you can sell them on eBay to raise money to pay off your student loans.)

 

Reducing the Interest Rate

 

Borrowers often think that reducing the interest rate has a bigger impact on the monthly payment than it really does. Cutting the interest rate in half does not cut the monthly payment in half. For example, cutting the interest rate on a 10-year loan from 8 percent to 4 percent reduces the monthly loan payment by one-sixth, not one half. Nevertheless, if a borrower can reduce the interest rate by more than a percentage point or two, it can be financially worthwhile to refinance a student loan.

 

But, before refinancing your student loans, compare the new interest rate with the interest rates on the individual student loans. If the new interest rate is higher than the interest rates on all but one or two of your loans, you might be better off accelerating repayment of the loans with the highest interest rates to pay them off quicker. In this scenario, refinancing the student loans will reduce the interest rates on just the highest-rate loans and increase the interest rates on all the other loans. Once you consolidate your loans, you will no longer be able to target the highest-rate loans for quicker repayment.

 

Note that consolidating federal education loans does not cut the cost of the loans. It just combines the loans into a single loan with an interest rate equal to the weighted average of the interest rates on the individual loans, rounded up to the nearest one-eighth of a percentage point.

 

A private consolidation loan, on the other hand, is similar to refinancing a loan. It yields a new loan with a new interest rate based on the credit scores of the borrower and cosigner, if any. If several years have passed since you obtained the loans and you have been managing your credit responsibly, making all payments on all debts before the due dates, you might be able to qualify for a lower interest rate on your private student loans.

 

A word of caution about refinancing federal student loans into a private consolidation loan: Federal student loans have superior benefits, such as deferments, loan forgiveness and income-driven repayment that are not available with private student loans. So, you need to consider the tradeoff between a lower interest rate and the loss of the better benefits on the original federal student loans. Once you refinance federal student loans into a private student loan, you cannot undo the transaction.

 

Avoiding Multiple Minimum Payments

 

Consolidation replaces multiple loans with a single combined loan. Although this does not directly reduce the monthly loan payment, it can sometimes cut the total monthly loan payment by avoiding multiple minimum payments.

 

The Federal Stafford loan has a minimum monthly payment of $50. If a borrower has one or more small Federal Stafford loans, the monthly loan payments on each loan will be increased to $50 if the calculated loan payment is lower. For example, if a Federal Stafford loan balance at the start of repayment is less than $4,000, the calculated monthly loan payment will be less than $50.

 

When these loans are consolidated, however, the loan balances are combined. This potentially increases the calculated monthly loan payment above the $50 minimum payment amount. Even if it does not, it reduces the number of monthly loan payments that are rounded up, thereby yielding a smaller monthly loan payment than the sum of the previous monthly loan payments. 

 

Changing the Repayment Plan

 

Federal student loans start off with a standard 10-year level repayment plan, where each payment is the same. Increasing the term of the loan by choosing an alternate repayment plan will generally reduce the monthly payment. However, reducing the monthly payment usually increases the total payments during the life of the loan, increasing the cost of the loan.

 

Borrowers can choose a different repayment plan at least once a year. Most often borrowers change the repayment plan when they consolidate their loans.

 

Alternate repayment plans include extended repayment, income-driven repayment and graduated repayment.

  • Extended repayment is like standard repayment, but with a longer repayment term, often 20, 25 or 30 years. The longer repayment term reduces the monthly payment.
     
  • There are four income-driven repayment plans: Income-Contingent Repayment (ICR), Income-Based Repayment (IBR), Pay-As-You-Earn Repayment (PAYER) and Revised Pay-As-You-Earn Repayment (REPAYER). Each of these repayment plans base the monthly payment on a percentage of discretionary income (10 percent, 15 percent or 20 percent), not the amount owed. The remaining debt is forgiven after 20 or 25 years in repayment. This forgiveness is taxable under current law, substituting a smaller tax debt for the education debt. Monthly payments will increase as income increases. Except for borrowers who live under 150 percent of the poverty line, most borrowers will pay off their loans before reaching the 20- or 25-year forgiveness point.
     
  • Graduated repayment starts off with low monthly loan payments, barely above interest-only payments, and increases the monthly payments every two years. No monthly payment will be more than three times any other payment.

In some cases, borrowers might be able to choose a shorter repayment term. This increases the monthly student loan payments, but reduces the total interest paid over the life of the loan, saving money.

 

Temporary Suspension of the Repayment Obligation

 

Deferments and forbearances are temporary suspensions of the repayment obligation. Interest continues to accrue and will be capitalized (added to the loan balance) if unpaid.

 

With deferments, the federal government pays the interest on subsidized loans. Interest on unsubsidized loans remains the responsibility of the borrower. The economic hardship deferment and in-school deferments are examples of deferments. With forbearances, the borrower is responsible for the interest on both subsidized and unsubsidized loans.

 

Deferments and forbearances are best for short-term financial difficulty. It is not wise to use them long-term, as interest continues to accrue, increasing the size of the debt. Deferments and forbearances are subject to a three-year limit for federal loans. Forbearances on private student loans are usually subject to a one-year limit.

 

Some private student loans offer partial forbearances. A partial forbearance requires the borrower to make payments of at least the new interest that accrues. This prevents the loan from growing bigger.

 

Discounts and Rebates

 

Many lenders offer auto-debit discounts, which reduce the interest rate by 0.25 or 0.50 percentage points in exchange for the borrower agreeing to have the monthly loan payments automatically transferred from their bank account to the lender. Auto-debit discounts save the borrower money, but usually do not result in a lower payment.
 

There also are rebating programs, like Upromise, where a borrower can earn rebates based on the products and services they buy. The rebates are automatically applied to the borrower’s loan balance, reducing their debt.

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