Taking out private student loans or refinancing current student loans is a popular option for students. When considering loans or loan refinance, many borrowers initially focus on either the interest rate of the loan or how much their monthly payments will be. This makes sense because they determine how much a borrower pays back over the life of a loan. However, the interest rate and expected monthly payments are determined by several factors. These factors include credit history, current financial situation, future earnings potential, lender costs and desired profit margin, and selected loan repayment options.
Let’s take a look at the repayment options available. Knowing your options can help you when deciding to take out a student loan or to refinance your existing loans.
Standard repayment is far and away the most common repayment plan for private student loans. In Standard repayment, your monthly payments are a set amount. That means you pay off your loan in equal installments over the remaining term of the loan.
With an Interest Only repayment plan, you begin making interest-only payments over a short period of time. Later, you revert to Standard repayment. With interest-only plans, you pay more in interest than with a Standard repayment plan. Also, your monthly payments are higher than a Standard repayment plan when your loan reverts to full principal and interest payments.
With a Partial repayment plan, your initial payment amount is set for a period of time. It then reverts to Standard repayment for the remainder of the loan term. The total cost of a Partial repayment plan will also be higher than with a Standard repayment plan.
Deferred repayment is when you start making payments at a specified time in the future. Most lenders let you defer payments while you are in school and for six months after you leave school. Deferred repayment is the most costly, since interest accrues while you are deferring your payments. That interest is then added to the principal balance of your loan before you enter your repayment period.
While not very common for private student loans, Graduated repayment starts with lower monthly payments that increase over time. With Graduated repayment, you pay more for the loan than with Standard repayment. This is because interest accrues on a higher principal balance over a longer term.
Tip: When lenders offer a choice of repayment plans, they generally charge lower interest rates for Standard and Interest Only repayment. They charge a higher interest rate for Deferred repayment to compensate for the added risk. Choosing to make full principal and interest payments under a Standard repayment plan is the least costly repayment plan available. If you cannot afford to make full principal and interest payments, consider paying at least some amount each month. Whether you make interest-only payments or partial payments, it reduces your overall cost of borrowing.
By exploring your repayment plan options or considering loan refinance, you can find the best option for your financial situation. In Part II of Choosing Your Private Student Loan Repayment Options, we’ll discuss interest rates and repayment terms. These also affect your total amount paid.