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College Students and Recent Grads

Why You Should Think Carefully Before Applying for Income-Driven Repayment

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Income Driven Repayment

If you have federal student loans, then you’ve surely heard about income-driven repayment plans. Income-driven repayment plans, a collection of federal programs that allow graduates to lower their monthly student loan payments to a level that is manageable relative to their income, are understandably one of the most well-known features of federal student loan repayment.

While these plans can be reassuring, there are income-based repayment disadvantages worth considering before you decide to apply. Here’s what you need to know to determine if an income-driven repayment plan is truly right for your student loan situation:

When an income-driven repayment plan can be a life raft

If you really can’t make your monthly payments, income-driven repayment can be a great option. I took advantage of income-driven repayment back in 2009, when I had $28,000 in student debt and (thanks to the recession) the only job I had been able to find after graduation paid me a whopping total of $18,000 a year.

My standard monthly payments would have been several hundred dollars, a huge percentage of my take-home pay. However, income-driven repayment allowed me to bring this amount down to $98 a month. This was still a lot of money, but it was manageable, and I remember feeling grateful and relieved that I could make my payments and also pay rent and buy gas and groceries.

In situations where you feel like you’re drowning in student loan payments, an income-driven repayment plan can act as a life preserver.

Income-based repayment disadvantages to consider

There are income-based repayment disadvantages that you should know about before deciding on a plan. Just because you qualify for an income-driven repayment plan doesn’t necessarily mean you should sign up for one.

Let’s say you owe $50,000 in federal direct student loans and make $50,000 a year. You can calculate your options for income-driven repayment using student loan calculators available at MagnifyMoney. The calculator asks for the amount you owe, your current monthly payment, your interest rate, your adjusted gross income (AGI), your family size, your state of residence, your estimated annual income growth and your marital status. In addition to the debt and AGI details, I entered an interest rate of 6.8%, a family size of one person and selected “Continental U.S.” for state (for Massachusetts). According to the calculator, if you were in this situation, your standard loan payment would be $575 a month.

However, you would also be eligible for four types of income-driven repayment: Revised Pay As You Earn (REPAYE) repayment plan, Pay As You Earn (PAYE) repayment plan, Income-Based Repayment (IBR) plan and Income-Contingent Repayment (ICR) plan. While each of these plans differs a bit from the others, each one would allow you to start off with a monthly payment that’s lower than the standard $575. ICR, for example, would lower your starting monthly payment to $485. REPAYE would lower your starting monthly payment even further, bringing it down to $266.

At first glance, this looks great. After all, who wouldn’t want to have their monthly payment temporarily lowered by several hundred dollars? That’s more money in your pocket, right? Not so fast.

The importance of understanding how interest works

Taking a look at the bigger picture through the calculations above shows income-based repayment disadvantages.

Your monthly payment isn’t the only thing that income-driven repayment adjusts. Selecting a lower starting monthly payment will also change the total amount you will pay over the entire period of loan repayment, as well as how many months it will take you to repay the loan.

While income-driven repayment options may seem like the best choice right now, they do not stop interest from accruing. Over time, this interest can add up in a major way.

Deciding if an income-driven repayment plan is right for you

It is therefore worth thinking carefully about how much you can realistically afford to pay each month. If you’re making $50,000 a year, then your take-home pay, depending on your federal and state withholdings and contributions to benefits, might be somewhere around $2,800 per month. By applying for income-driven repayment, you would basically be saying that you cannot live off of $2,225 per month (that’s $2,800 minus the $575 standard monthly payment).

But is that really true? Can you really not live off of $2,225 per month? And, more to the point, is having a few hundred extra dollars in your pocket each month worth paying potentially thousands of dollars more in interest over the course of your repayment?

Instead, you could consider lowering your living expenses a little. Perhaps you can go out to eat less, quit your gym membership or get a roommate, all of which could save you money in the long run.

And what if you can live off of even less and make bigger payments? For example, if you lived extremely frugally and paid $1,000 per month toward your loans, you’d be debt-free in about 58 months and would only end up paying $58,000 in total. A payment of $1,000 per month may sound like a lot of money — and it is. But if you can make it work, you’ll be saving yourself thousands of dollars in the long run.

In short, while income-driven repayment plans can be a good option in some situations, it’s important to remember that they do not keep interest from accruing. The bottom line is, the bigger the payments you can make on your loans, the sooner they will be paid off, and the less you will have to pay in total over the lifetime of the loan.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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What to Do When Parents Won’t Pay for College and FAFSA Won’t Provide Aid

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When you’re applying for financial aid to attend college as an undergraduate, the amount of need-based aid you qualify for is usually based on your parents’ income and assets. The Free Application for Federal Student Aid (FAFSA) calculates your expected family contribution (EFC), and individual colleges and universities then use your EFC to determine how much need-based student aid you are eligible to receive. If it is determined that your parents can reasonably cover 100% of the cost of college, you may not qualify for any need-based aid at all.

However, this process of determining need-based aid is based on the assumption that if your parents can afford to make a substantial contribution to your tuition, room, and board, they will be willing to do so.

But what if your parents simply aren’t willing to make that contribution?

If you don’t qualify for need-based aid (or only qualify for partial need-based aid) and your parents simply aren’t willing to contribute, you may feel like college is not an option. And it’s true that tuition, room, and board can be very expensive—tens of thousands of dollars per year in many cases. However, don’t give up right away. There still may be ways for you to attend college even if your parents won’t help you out financially. Here are ways to start:

1. Check the current guidelines for dependent vs. independent students

All students applying to college are considered either dependent or independent by the federal government. If you are a dependent student, your parents’ income and assets are taken into account when determining need-based aid, but if you are an independent student, only your own financial situation (and that of your spouse, if you are married) is taken into account, which means you may qualify for more need-based aid. There are several ways to qualify as an independent student, including being married, being older than a certain age, having dependent children, or being a veteran of the U.S. armed forces. The FAFSA can help you determine if you are dependent or independent. More information is also available here.

2. If you haven’t already done so, fill out the FAFSA

Even if you are a dependent student and your parents have already told you they’re not willing to contribute to college costs, you should still absolutely fill out a FAFSA. You may find that you are eligible for more aid than you think. In particular, you may have the option of taking out student loans that would help you cover the cost of college yourself, without your parents’ help. Student loans should only be taken out under careful consideration, as they can take many years to repay, but if they are the only way you are able to go to college, they may be a good option for you. 

3. Remember that need-based aid isn’t the only type of aid available

There are many merit-based scholarships and grants available that you may be able to apply for. The school(s) you’re considering attending may offer merit scholarships; check with the admissions office for details and to determine whether or not you need to submit an extra application for these awards. You can also search online for grants and scholarships that are funded by external organizations and thus can be applied to the cost of any school. Apply for as many of these grants and scholarships as possible.

4. Consider asking for help from other relatives

Is there anyone else in your family who might be willing to help you out with college costs, perhaps through a personal loan? If you do take out a personal loan from someone you know, be sure to sit down with them and draw up a written agreement about interest and repayment so there are no misunderstandings.

5. Attend a state or community college

Tuition costs vary widely from school to school, so make sure you’re considering schools at the least expensive end of the spectrum. Many state colleges offer an excellent education at a much lower cost than private schools, and community colleges in some states even offer four-year degrees.

6. Consider taking a year off to work and save money, and apply next year instead

If your parents are open to it, you might be able to live at home while working and save even more money.

7. Look into supporting yourself through college by working full-time or part-time

Carefully calculate how much it would cost you per year to attend the least expensive school possible, taking tuition, fees, books, and living expenses into account. Is there any way you could pay for this yourself, either by going to school full-time and working part-time or (more likely) by working full-time and going to school part-time?

8. Look into applying for jobs at colleges that offer free/reduced tuition to employees

Some colleges and universities allow their full-time employees to take classes for free or at a reduced cost. However, note that this may vary widely by school, and there may also be a requirement that you must work a certain number of months or years before these benefits kick in. Not having a college degree yet may also limit the number and type of jobs you are able to apply for. However, this option is worth looking into.

Combine several of the above strategies

Putting together enough money to cover the cost of college yourself can be very challenging, but you may be able to make it work through a combination of merit scholarships, personal and/or federal loans, choosing an inexpensive school, saving money before you begin, and working while you’re enrolled in classes.

Already have student loans and looking to refinance? Check out our top picks for refinancing your student loans.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Will You Get Charged a Student Loan Origination Fee?

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Student Loan Origination Fee
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Most people know that when you’re considering borrowing money for your education, it’s extremely important to take interest rates into account. But did you know that in addition to interest rates, some types of student loans also carry origination fees?

What is an origination fee?

An origination fee is a one-time fee collected at the time the loan is disbursed; it is typically a percentage of the total loan amount. This means that instead of receiving the entire amount that you borrow, you receive the amount that you borrow minus the loan origination fee.

Origination fee rates

Most types of federal student loans, with the exception of Perkins loans, carry an origination fee. The current loan origination fees in 2016 for federal subsidized, unsubsidized, and PLUS loans are as follows:

Federal Direct Subsidized Loans: 1.068%

Federal Direct Unsubsidized Loans: 1.068%

Federal PLUS Loans: 4.272%

Decoding the cost

This means that if you take out, for example, a $10,000 unsubsidized loan from the federal government, the loan origination fee will be $106.80. So instead of receiving the full $10,000, you will only receive $9,893.20.

Similarly, if you take out the same $10,000 using a federal PLUS loan, the loan origination fee will be $427.20. In this case, you’ll only receive $9,572.80.

However, in both of these cases you will still be required to pay back the full $10,000. Additionally, interest will accrue on the full amount you borrowed and not just the amount you received.

Note also that the fees listed above are the current fees for new loans and are valid until October 1, 2016, at which time they may be adjusted. Additionally, if you took out a federal student loan prior to October 1, 2015, your fee may be different. You can find more information about origination fees on federal student loans at the StudentAid.gov website.

Private lenders don’t always charge origination fees

In contrast to the federal government, many top private lenders, such as Discover, Sallie Mae, and PNC, do not charge origination fees for loans that are applied toward study at undergraduate or graduate colleges. However, keep in mind that there may be other disadvantages to borrowing from private lenders, such as higher interest rates or a lack of the types of loan forgiveness, income-driven repayment plans or forbearance and deferment programs that are available through the federal government.

Always crunch the numbers

Origination fees are important to be aware of when considering taking out student loans. When you take out a loan with an origination fee, you will always be paying back the total amount that you borrowed, rather than the amount you received after the origination fee was subtracted, and interest will also accrue on that total amount. Although origination fees are one-time fees, they’re important to factor into your overall financial and loan repayment plan.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Disclaimer

Student Loan
Laurel Road Bank

Refinance with Laurel Road Bank

Refinancing rates from 1.89% APR. Checking your rates won’t affect your credit score.