Repaying student loans is painful because student loan debt can feel like a never ending burden that keeps you from your future. Yet, repaying your student loans is rewarding because it forces you to be acutely aware of your financial health. The rewarding part includes being financially responsible and having a plan to get out of debt.
Here is a step by step process that you can use to determine which student loans to repay first.
1. Organize your student loans
Separate your loans into three categories: 1) Federal loans, 2) private loans, and 3) loans with a cosigner. Each category is a bit different and should be treated that way. In general, your private student loans will be governed by the loan document that you signed when you took out your loans. Any repayment plan options are determined by these loan documents. Private student loans are completely separate from Federal loans, so do not confuse the two.
For example, if you die, typically your private loans will be due immediately. However, Federal loans are forgiven upon death. This is why it’s usually recommended to get life insurance on the amount of any private loans that you owe particularly if you have a cosigner. Your cosigner would have to repay your private student loans if you die. That’s a huge burden. This is just one example of the differences between Federal and private loans. It shows why you may consider repaying private loans or loans with a cosigner first. Whatever you decide, be aware that these loans should be considered individually.
2. Determine if you qualify for forgiveness
The Public Student Loan Forgiveness (PSLF) program is a Federal program that forgives your student loans after you work in public service for 10 consecutive years and make minimum payments on your loans during that time, based on your income. This only applies to employees in public service jobs. So, if you have a private sector job, you cannot use this program.
3. Consider refinancing
When you refinance, you convert your otherwise Federal loans into one private loan. This is because you can only refinance through a private company; you cannot refinance through the Federal government. Do not confuse refinancing with consolidation. You refinance through a private company and your Federal loans become one private loan; with consolidation, you consolidate many Federal loans into one Federal Consolidation loan with a weighted average.
If you refinance, you will have one loan that you will be required to make minimum payments on. Any additional payments will be governed by the new private loan document. If you refinance your student loans to get a lower interest rate, the process ends here.
I am not refinancing my student loans because I don’t want to give up the Federal options. If I lose my job or become disabled, I like that there are a lot of options with respect to Federal loans (income driven plans and forgiveness). I hope I never have to use any of these options, but I like having them as an option.
4. Choose a repayment plan
Once you have organized your loans and considered forgiveness and refinancing, it is time to decide on a repayment plan. Keep in mind that the repayment plan you choose only applies to Federal loans, and it will apply to all of your loans.
For example, if you have 5 student loans with different balances and interest rates and you elect the extended repayment plan, then all 5 student loans will be stretched out for 25 years and you will have a separate minimum payment for each that you must pay every month.
Generally, there are four main repayment plan options for Federal loans:
- Standard repayment (10 years)
- Graduated repayment (10 years; 30 years for consolidated loans)
- Extended repayment (25 years)
- Income driven repayment (20 to 25 years)
- REPAYE / PAYE
Each of the four plans will give you a minimum monthly payment and term (10 years, 20 years, or 25 years, for example). Within the income driven repayment category, there are several repayment options – the three most popular of which I’ve listed above.
You can change your repayment plan for your Federal loans as often as you’d like. Simply call your student loan servicer and ask to switch to a new plan.
It is important that you select a repayment plan before you decide which student loans to put additional money toward. You cannot choose to put all of your money onto 1 loan and hold off paying the remaining 4 loans. You have to make minimum payments on all of your student loans.
5. Decide which student loans to repay first
You have to make monthly minimum payments on all of your student loans. Above and beyond that, you can choose how to allocate your payments.
This step is the meat of this post. After you know what you’re going to pay as the minimum monthly payment, you can look at your budget to see how much additional money you can throw at your student loan debt.
Now, how should you decide which student loans to repay first?
Really, this is a personal decision. But it is one that you can make yourself if you’re educated on the varying factors. Here is my suggestion for you to consider.
- Private loans: Prioritize making payments toward your private loans first. There is additional risk associated with private loans. Typically, there is no forgiveness, forbearance, or deferment with private loans. Your private loan documents govern your specific loans, so be sure to read the fine print.
- Loans with a cosigner: Loans with a cosigner should be a high priority for you to repay. Someone vouched for you and that someone is obligated to pay your debt if you default. For this reason, I believe loans with a cosigner should be a high priority.
- Smallest balance loan (focuses on motivation): Focusing on repaying your student loans with the lowest balance can give you momentum to pay off your debt faster. This is the Dave Ramsey “snowball” method of debt repayment. Using this method, pay the minimum payment on all your loans and put the rest of your money toward your smallest loan. This will give you psychological gains because you will be excited to see your loans repaid.
- Lowest interest loan (focuses on math): Focus on repaying your student loans with the highest interest rate first (and pay minimum payments on the rest). This is known as the debt “avalanche” method. You will save the most money this way because you’ll pay off the highest interest rate loans first; however, you may not have the same momentum effect as the snowball method.
A Final Note!
Repaying your student loans is best done if you have a strategy in place. Consider your options (student loan forgiveness and refinancing) and get on a plan where you make monthly payments on all of your loans.
Prioritize private loans and loans with a cosigner. Then, consider whether you want to repay the smallest balance loans first, or the loans with the highest interest rates. Pay the minimum payments for all your loans and focus on putting the rest of your payment onto one additional loan at a time (either the lowest balance loan or highest interest rate).
Having a plan in place will help you stay motivated and focused on your debt repayment.
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