If you’re one of the millions of borrowers struggling with repaying their student loans, you may be considering a new way to manage your debt.
Two strategies you can use to potentially lower your payments are through student loan refinancing or qualifying for an income-driven repayment (IDR) plan. But each strategy does have its drawbacks.
Refinancing a federal student loan into a new private student loan involves losing certain federal repayment safeguards like loan forgiveness. IDR plans might increase the length of your loan term and interest expenditures.
Here’s what you need to know about income-driven repayment vs. refinancing student loans:
- What is income-driven repayment?
- What is student loan refinancing?
- Income-driven repayment vs. refinancing student loans
- Next steps
What is income-driven repayment?
Many borrowers enrolled in post-secondary education have the option to take out federal student loans. This type of student aid is provided by the federal government under the U.S. Department of Education and includes Direct Subsidized Loans, Direct Unsubsidized Loans, Direct PLUS Loans, and Direct Consolidation Loans.
When it comes time to repay these federal student loans, some borrowers have difficulty affording the monthly payments due to their limited income level and family size. Thankfully, certain federal student loan borrowers can qualify for one of four income-driven repayment plans, which include the Pay As You Earn Repayment (PAYE) Plan, the Income-Based Repayment (IBR) Plan, the Revised Pay As You Earn (REPAYE) Plan, and the Income-Contingent Repayment (ICR) Plan.
These plans are separate from student loan forgiveness programs and are designed specifically to help low-income borrowers repay their loans at a rate that caters to their unique income level and family size.
Pros and cons of income-driven repayment plans
If you investigate income-driven repayment plans, you’ll see that some borrowers can take advantage of benefits, including:
- The monthly payment amount is adjusted to an affordable rate.
- The monthly payment amount is potentially lowered to $0.
- The borrower can make qualified repayments towards forgiveness programs, even when the monthly payment is $0.
But even if a borrower benefits from one of these programs, there are still some drawbacks, such as:
- Some plans, like an IBR Plan, take into account the borrower’s spouse’s income when determining the monthly payment amount.
- An extended loan repayment period could increase your overall interest accrued.
- If you decide to consolidate your federal student loans into a Direct Consolidation Loan, you may lose credit for the IDR payments you’ve already made.
- Having to recertify, or update your income and family size details, annually means that your monthly payment amount could change in each new year.
What is student loan refinancing?
Student loan refinancing involves taking your existing student loans and refinancing them into a new private student loan. Most borrowers refinance their student loans to obtain a lower interest rate, a shorter repayment term, or both.
Some borrowers may opt to refinance their student loans if they cannot qualify for an income-driven repayment plan. However, a borrower doesn’t need to have income limitations to refinance. They might choose to refinance if they believe that they can save on overall interest and repay their loans faster.
If you investigate repayment options, you’ll find a number of potential benefits, including:
- The option to shop around with multiple lenders to find the best rates, including fixed options if you’d like more stability.
- A shorter repayment term, which could result in lower accrued interest.
- Lowering your monthly payment amount may lower your debt-to-income (DTI) ratio.
| Keep in mind: Refinancing is separate from a forgiveness plan, student loan consolidation, or an income-driven repayment plan. In fact, some of the downsides of refinancing are their terms. The drawbacks of refinancing your student loans include: – Both private and federal student loans can only be refinanced into a new private loan. – All federal student loans that are refinanced into a private loan lose access to federal repayment and forgiveness programs. – Your credit score may dip a bit due to the hard credit check that often takes place by a lender before approving you. |
Income-driven repayment vs. refinancing student loans
Before deciding to refinance your student loans, particularly federal student loans, it’s important to compare and contrast how the benefits and drawbacks of IDR plans and refinancing will affect you personally.
| IDR | Refinancing | |
|---|---|---|
| Can change your term | Yes | Potentially |
| Can lower your monthly payments | Potentially | Potentially |
| Can lower your monthly payments to $0 | Potentially | No |
| Disqualifies you from federal forgiveness or assistance programs | No | Yes |
| Qualifies you for forgiveness programs after a certain period of on-time payments | Yes | No |
| Requires updated information regarding income and family size each year | Yes | No |
| You can choose your lender | No | Yes |
| Approval process requires a credit check | No | Yes |
| Eliminates your debt upon approval | No | No |
Consider these common situations to determine if income-driven repayment is right for you.
- Situation 1: Your limited income and family size are preventing you from being able to pay your minimum monthly federal student loan payments.
- Solution 1: Depending on your income and family size, you may qualify for an income-driven repayment plan that could lower your minimum monthly payments.
- Situation 2: You’re taking advantage of the pause on federal student loan repayments, your federal student loans are still in good standing, and you want to remain eligible for potential future forgiveness plans.
- Solution 2: Although there’s no way of knowing if or when additional student loan forgiveness actions will be taken by the federal government, it’s likely that those with federal student loans will benefit the most. If your federal student loans are in good standing and you need some assistance repaying them, you may want to investigate IDR plans.
Now let’s examine two situations in which refinancing might be the best option for some borrowers.
- Situation 1: You have high interest student loans from a private lender.
- Solution 1: Because private student loans cannot be refinanced through the federal government, you’re already disqualified from certain federal programs like IDR plans. Refinancing through a different private lender may lower your rates and help you save on overall interest expenses.
- Situation 2: You have multiple federal student loans and private student loans that you’re having trouble paying, but don’t want to lose federal loan forgiveness eligibility.
- Solution 2: Keep in mind that you don’t have to refinance all of your student loans at once. You can choose to refinance your private student loans in an attempt to lower your interest rate while also applying for an IDR plan for your federal student loans.
Next steps
Whether you believe that an income-driven repayment plan or a refinancing strategy is best for you, you’ll need to understand what the next steps entail.
How to apply for income-driven repayment
Here are steps to take to obtain an income-driven repayment plan:
- Gather your info. You’ll need to gather details related to the income-driven repayment application. This includes employment information, family size, marital status, and proof of income.
- Fill out an application. Next, you can fill out the application by logging into your account via the Federal Student Aid website. The application can be found under the “Income-Driven Repayment (IDR) Plan Request” page.
- Wait for approval. Finally, submit your application and wait for your results. You’ll be told which IDR plans you qualify for or if you’re ineligible for these programs. Once you’re approved, make sure to maintain on-time payments and recertify your income and family size annually for continued eligibility.
How to apply for student loan refinancing
Because you cannot refinance your student loans through the federal government, you’ll need to find a private lender.
- Gather documentation. You’ll want to gather all of your current student loan information to know how much you’ll need to refinance. You’ll also need to check your credit score, as your credit history will impact your approval and affect your interest rates.
- Compare lenders. Then, you’ll want to compare multiple lenders. Each lender may offer different rates, terms, or discounts for student loan refinancing. It’s wise to compare approximately five different lenders to see which can offer you the most benefits and least expenses.
- Choose your lender. Next, you’ll choose the lender that you believe is best for your financial goals and apply for the loan. Keep in mind that adding a cosigner might increase your chance of acceptance and potentially lower your rate.
- Continue making payments. Finally, once approved, your new lender will let you know the details of the refinanced loan. It’s critical that you continue to make payments on your previous loan until you can guarantee that your old loan has been refinanced. Missing a single loan payment, even due to a misunderstanding, can cause a significant negative impact to your credit score.
When should you refinance student loans?
The right time to refinance your student loans is when you believe that the new loan will provide the most benefit to you both now and in the future. For example, if you’re able to lock in a lower interest rate than your current loan and get a shorter or similar payoff term, it might be in your best interest to refinance soon.