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If you are a typical college student, you will find after graduation that you have an unwelcome surprise waiting for you at the end of the aisle you walked to receive your diploma – a new monthly bill for repayment of your college loans. College loan repayments can sneak up on a student very easily – you aren’t expecting that $10,000 borrowed here and there would add up so quickly, but there it is, and you find that your lender is now, six months after you graduate, wanting an obscene-seeming amount of money each month for the next ten years as repayment. Is there any other way?
An income-based repayment program for college loans allows you to adjust over time how much you will be paying for your loan each month, rather than the standard even payments over 10 years time. This repayment option is best for those students who have legitimate reason to expect that their income will increase drastically once they advance in their career after a year or two, such as law school graduates who receive a position clerking for a judge for a couple of years before going into practice, or medical students who are interning before starting their practice. Situations like these put students in an uncomfortable position of not making much early on, but extraordinary potential for loan repayments later once they get more established in their careers. Lenders (both private and government), understand this situation and have created the idea of an income-based repayment program as a benefit to both parties. The benefit to the lender is that you will pay more interest over the life of the loan if you spend too much time in the lower levels of repayment.
How much you will have to pay each month on an income-based program is determined when you sign up for it. Most programs expect a minimum interest + 1% of your annual gross salary, which will be regularly verified by the lender. While that may not sound like much initially, consider that at even $50,000, per year, on a 6% loan, you are paying a total of 7% of your salary, which represents $3,500 per year to be repaid, or just under $300 per month – enough for a car payment. Still, that may be significantly less than paying on the standard 10 year, equal payment plan that most graduates face – especially if you are graduating with a good deal of debt. Also keep in mind that on an income-based loan plan, you may have prepayment penalties with some lenders, in case you run into a windfall and want to try to pay off a large chunk of your loan early, you may not be able to without paying penalties.
Income-based loan repayment is not for everyone, and should be carefully considered (preferably with a finance/math wizard handy if you aren’t one), before signing up for one. Don’t just look at the bottom line of your monthly repayment, but consider carefully the overall payments you will have to make on the loan.
