The term repayment program refers to how the monthly payments are calculated for someone who is no longer in college. The term is often confused with loan cancellation and loan forgiveness programs, which I talk more about in the next chapter.

Federal repayment programs are not necessarily programs run directly by the government, but are formulas that government lenders are required to use to calculate how much you pay and when. If your funds were loaned to you indirectly through a corporate lender who was participating in a government student loan program, you’ll be sending your money to that lender. If your funds were provided under a Direct loan—which represent the smaller portion of loans made—then you’ll be sending your checks to the Department of Education. Either way, if your loan was a Stafford, Perkins, or PLUS loan, your options are set in stone.

To help illustrate the various repayment options, I’ll be using the same imaginary graduate, Ima Graduate, with $40,000 in student debt at 6.8 percent, for each scenario. That way, you’ll be able to see side-by-side how these programs stack up and what college will really cost when you get around to paying for it. All calculations are pulled directly from the Department of Education’s student loan calculator, which can be found at www.ed.gov.

The Standard Repayment Plan requires the student to make equal monthly payments over 10 years, or 120 monthly payments. However, this plan also requires a minimum payment of $50 per month, which means loans below $4,500 (at 6.8 percent) will actually have to pay more than the calculated repayment amount, resulting in a payoff that is actually faster than 10 years.

Of all the repayment plans, the 10-year Standard Repayment Plan costs the most each month but the least over time. In other words, because the graduate is putting a large amount toward her loan each month, it greatly reduces the opportunity for additional interest to grow on the amount that is owed.

For Ima, our hypothetical student with $40,000 in student loan debt at 6.8 percent, her monthly payment under the Standard Repayment Plan will be $460.32. Over 120 payments, this means she will pay a total of $55,238.40, or $15,238.40 more than she originally borrowed.

For students with more than $30,000 in student loan debt, the government offers an extended repayment plan option. This option can be repaid over 25 years instead of the standard 10 years.

Under the basic Extended Repayment Plan, the monthly payment amount remains the same every month during that 25-year period. Naturally, breaking up a loan over 25 years is going to give you substantially lower monthly payments than breaking it up over 10 years. However, it is also going to give the loan much more time to accumulate interest, resulting in a much larger total cost over time.

For our student with $40,000 in loans at 6.8 percent, she can expect to pay $277.63 per month, compared to $460.32 under the Standard Repayment Plan. However, over the life of her loan, her total repayments will be $83,289, compared to $55,238.40 under the Standard Repayment Plan. That’s roughly $28,000 more and twice what was originally borrowed!

In addition to the Standard and Extended Repayment Plans, the government allows students to add a “Graduated” option to these plans. Under the Graduated option, the monthly payment starts at a lower amount and then increases every two years. In fact, under both the Standard Graduated and the Extended Graduated, the initial monthly payment amount starts significantly lower and ends significantly higher than the level repayment options for those same plans.

Even though that might seem like it all balances out in the end, the Graduated options actually do end up costing a borrower slightly more in the end. In the case of a 10-year Graduated repayment, it increases the total cost of borrowing by approximately 5.5 percent. Under the 25-year Graduated plan, it increases the cost of borrowing by just under 8.5 percent.

In real numbers, that means that someone with $40,000 in loans at 6.8 percent will pay $58,222.23 (instead of $55,283.40) under the Standard Graduated Plan (10 years), broken down as shown in the following table.

Monthly Payment Under the Standard Graduated Plan (Based on $40,000 at 6.8%)

Under the Extended Graduated Plan, that same $40,000 in loans at 6.8 percent will cost $90,216.18, with payments starting at $226.67 in years 1 and 2, ending at $396.60 in year 25.

Over the years, the government has introduced a number of repayment plans designed to take into account what a borrower actually earns when calculating her monthly payment. These plans, which are only available to taxpayers earning typically below $50,000 to $75,000, use complicated formulas to determine the payment a household can afford without taking too much away from their quality of life. Borrowers participating in these plans either have their payments lowered or the payments remain the same as they would have under the Standard or Extended Repayment Plan they would have otherwise qualified for. Participating in these plans requires the ongoing submission of certain documentation, namely information from your tax return, to calculate the appropriate payment for a borrower’s coming year.

Three income-based plans are currently available, all of which result in roughly the same monthly payment amounts. These plans, which are commonly referred to by their initials, are Income Based Repayment (IBR), Income Contingent Repayment (ICR), and Income Sensitive Repayment (ISR). The newest of these plans, IBR, is considered the most generous of the plans and is the one that students should consider. The largest single difference that makes this plan stand out from the older ICR and ISR plans is that there is the potential for loan forgiveness after as few as 10 years (more on this in Chapter 7).

The downside to all three of the income-based plans is similar to the Extended Repayment Plans. By paying a lower monthly amount and stretching these loans out as long as 25 years, many borrowers will pay much more over the long run than they would with a 10-year Standard Repayment Plan. This trade-off needs to be examined closely before someone settles into an income-based repayment plan because it is money that could have be used to reach other financial goals.

Because all repayment plans tied to income end up in the same monthly payment ballpark, I’ve included the calculations for the newer IBR program. Because this calculation also requires a borrower to provide her income level and family size, I’ve run it assuming our hypothetical student (with $40,000 in debt at 6.8 percent) is single and earning between $10,000 and $60,000, in $10,000 increments. Remember, under the original Standard Repayment Plan, the monthly repayment amount was $460.32 and the total cost at payoff was $55,238.40.

Comparison of IBR Plan at Different Income Levels for a Single Person with a $40,000 Loan at 6.8%

Did you notice anything interesting? If a borrower ends up earning very little money as a graduate, it’s actually possible that she will have to pay back far less than she borrowed, even if the loan is not forgiven until its 25th year. On the flipside, if a person ends up earning more than $50,000, the monthly payment and total cost isn’t much different from the Standard Repayment Plan because it is paid off in roughly the same amount of time. Most peculiar, though, is the person who earns somewhere between the extremes, whose total cost for the loan ends up being just over $76,000!

Before you get angry and think that this is some type of scam to bilk middle-income students out of what little money they have, you have to see the IBR for what it is. At its core, all it really does is move a borrower back and forth between three different programs based on her income level.

For those earning very little, it costs very little and eventually forgives most of the balance (making it a welfare program of sorts). For those people earning a moderate level of income, it essentially puts them on the Extended Repayment Plan, in fact costing them slightly less than that option. For those earning higher levels of income, it moves them toward a standardized, 10-year repayment plan. Best of all, it makes the changes for you as you go, simply by submitting your annual documentation.