When taking out private student loans or refinancing current student loans, many borrowers focus on either the interest rate of the loan or how much their monthly payments will be. This certainly makes sense, as these are two important elements that determine how much a borrower will end up paying back over the life of a loan. However, what most borrowers don’t realize, is the interest rate and expected monthly payments are determined by several factors, including the borrower’s past credit history, current financial situation and future earnings potential, the lender’s costs and desired profit margin, and the loan repayment options the borrower selects.
This article will focus on your loan repayment plan options. This is a key decision you control at the exact time you decide to take out a student loan or to refinance your existing student loans.
When it comes to private student loans and student loan refinancing, a lender may offer more than one repayment plan to choose from. Below are the most common plans you will encounter:
- Standard: Standard repayment is far and away the most common repayment plan for private student loans. With a Standard repayment plan, your monthly payments are a set amount, so you pay off your loan in equal installments over the remaining term of the loan.
- Interest Only: With an Interest Only repayment plan, you begin by making interest payments over a short period of time and then revert to Standard repayment. Not only will you end up paying more in interest with an Interest Only plan than you would with the Standard repayment plan, when your loan reverts to full principal and interest payments, your monthly payments will be higher than what they would have been with a Standard repayment plan.
- Partial: With a Partial repayment plan, your initial payment amount is set for a period of time and 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: Deferred repayment is when you start making payments at a specified time in the future. Most lenders will let you defer making payments while you are in school, and then for a six-month grace period after you leave school. Deferred repayment is the most costly, since interest accrues while you are deferring your payments and is then added to the principal balance of your loan before you enter your repayment period.
- Graduated: While not very common for private student loans, Graduated repayment allows you to start with lower monthly payments that increase over time. With Graduated repayment, you’ll end up paying more for the loan than with Standard repayment because interest accrues on a higher principal balance over a longer term.
Tip: If a lender offers a choice of repayment plans, they will generally charge a lower interest rate for Standard and Interest Only repayment, and 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, paying at least some amount each month, whether it is Interest Only payments or Partial payments, will reduce your overall cost of borrowing.
By exploring your repayment plan options, you can find the best option for your current and future expected financial situation. In Part II of Choosing Your Private Student Loan Repayment Options, we’ll discuss interest rates and repayment terms, which will also affect your total amount paid.