One of the first questions that students are faced with after graduating with student debt is “Should I refinance?” So what are the pros and cons of a private loan versus federal loan? And which one did I choose and why?

In this post, I will go through my experiences with different repayment plans and my journey of how I came to choose the repayment plan that was right for me.

Private Loan

The biggest perk of refinancing to a private loan is the low interest rate. It is arguably the only reason to refinance to a private loan and you will see why once I talk about the perks of federal loan.

The interest rate reduction that private loan offers is a huge incentive to refinance. It is possible to cut interest rates as much or even more than half by refinancing. This incentive was so enticing that I wanted to refinance as soon as I graduated.

I graduated with $171,000 worth of federal student loans with interest rates varying from 3.4% to 6.84%. My initial strategy was to use the 6 months grace period that federal loans offered to get my bearings then promptly refinance.

In fact, it wasn’t that long ago that I mentioned my goal of refinancing my loan with First Republic Bank who has been known to offer the lowest interest rates for people with high debt.

They offer rates as low as 1.95% for a 5-year term and 3.35% for a 10-year term. So you can see why I was so eager to refinance. Those rates are amazing!




My goal was already to pay off my loans in less than 5 years (the dream is to pay it off in 3 years) and I calculated that by refinancing, I would save between $17,300 – $ 23,400 depending on if I choose to go with a 5-year or 10-year repayment plan. This refinance calculator is what I used to calculate my savings if I refinanced my loans to a private loan.

If like me, you have loans with different interest rates, I used this calculator first to calculate the average interest rate of all my loans, then plugged the numbers into the refinance calculator.

I found that my average interest rate was 5.71% so if I refinanced, I would be slashing my interest rate by more than half!

The only reservation I had was, unlike federal student loans, private loan offers no assistance if ever you were unable to meet your monthly payment.




If I refinance to the 5-year term, I would have to make a monthly payment of $3,000. Going with the 10-year term was more doable with the $1,700 monthly payment.

However, if I were to become unemployed, I would still be responsible for those monthly payments no matter what.

This is unlike federal loans which offer a 6 month grace period after graduation and in the case of unemployment, allows you to apply for deferment or forbearance to halt student loan payments without damaging your credit history.

I knew that once I refinance to a private loan, there’s no turning back. I would have to give up all the perks of a federal loan. That reservation and the strict application criteria offered by First Republic Bank held me back from applying right away.

I wanted to wait out the 6 month grace period offered by federal loans to get my credit score up just to make sure I would qualify for a refinance.

During that time, I decided to dive into researching other repayment options.

 

Reevaluating Other Options

I had a lot to think about during my six-month grace period. On one hand, I was finally working full time and my debt repayment history demonstrated my ability to pay $1700/month that would be required of the 10-year repayment plan if I decided to refinance.

However, I just could not take my mind off the fear that for 10 years I had to make sure I had enough money to pay each month’s bill no matter what.

The risk of unemployment just weighted on my mind when I think about the monthly payments that I could never miss. What about unforeseen emergency expenses? What about when I want to buy a house?

The stake was high but it felt that much higher for someone knee-deep in six-figure debt like me.




My six month grace period gave me a lot to think about and at the end of my grace period, I realized I was not ready to refinance. By that time, I had only worked full time for 3 months in a job I was not satisfied with.

So by the time minimum payments were due on my federal loan, I shifted my gear to find the best federal loan repayment option for me.

This led me to a new debt repayment strategy.

 

Federal Loan

Besides having a grace period and deferment option, a big perk of federal student loan is that it offers an array of choices when it comes to repayment options.

Federal loan repayment options is a topic all on its own and it is a post that I will make very soon. This time, I want to focus on the repayment option I ended up picking, which is the REPAYE (Revised Pay As You Earn) Program.

So let’s take it back to December 2017 when my first payment on student loans was due.

The 2 big umbrellas of federal student loan repayment plans are term-based repayment and income-based repayment plan.

At this point, I had been so set on refinancing to private loan that I had not really explored the income-driven repayment plan options especially when it required extra steps of verifying your income to apply for the plan.

I thought income-driven repayment plans were geared towards people with such high student debt that they are looking to make minimum payments for 20-25 years until the rest of their loan is forgiven.

Although I don’t consider my debt small by any means, I made the calculations that with my $171,000 student debt, I would end up paying more if I were to pay 10% of my income for 25 years.

Based on my salary projection, I would not only be paying more with a 25-year payment schedule, I would also end up not having any debt forgiven at the end.

Add to my distrust of what the future holds 25 years from now, I had already decided I wanted to pay off my loans ASAP and therefore mistakenly placed the idea of an income-driven plan on the backburner at the time.

WIth income-driven plan out of my mind, this left me with choosing one of the term-based payment options.




My debt repayment strategy at this point was to make the minimum payments across all loan groups and only allocate extra payments to the individual loan with the highest interest rate every month.

Long story short, when my grace period ended, I decided to go with the Extended Graduated repayment plan because out of all the term-based payment options it allowed me to make the lowest monthly payment of $571 per month for the next 2 years.

Now, this minimum payment does even cover my interest every month so I obviously was not planning on sticking with this plan for the long-term. But I thought this payment plan would hold me over until I could refinance to a private loan.

In the meantime, I was making extra payments on my loan with the highest interest rate.

So what changed my mind and led me to ultimately switch to the income-driven REPAYE (Revised Pay As You Earn) Program?

 

REPAYE Program

First, what is REPAYE? REPAYE is an income-driven repayment plan that in my opinion is an upgrade of PAYE (Pay As You Earn) and IBR (Income-Based Repayment) programs.

While older income-driven plans like IBR and PAYE are more restrictive in who can qualify, anyone with federal loans can qualify for REPAYE regardless of when they took out the loans.

The nice thing about REPAYE is that it caps the monthly payment to 10% of your discretionary income which is your adjusted income – 150% of the poverty line for your state and family size.

The other perk of REPAYE is that your loan is forgiven after you make 20 years of eligible payments on undergraduate loans or 25 years for graduate loans.

Personally, I don’t plan on making only minimum payments for 25 years for my graduate loans to be forgiven. I still plan on making extra payments so these next 2 perks that were actually the main reasons I switched over to REPAYE.

 

1.   I was able to score $0 monthly payment for an entire year!

When enrolling in REPAYE, your monthly payment is determined by your previous year’s income or current pay stubs if you did not file taxes or did not work the previous year. This is especially beneficial for people who just graduated because even if you are making high salary after graduation, your payment will still be based on the previous year’s salary.

In 2017, I was making close to nothing seeing as I was in school for half the year and only started making money the last 3 months of the year.

This is how my minimum payment comes out to $0. And that minimum payment calculation lasts for a year, so until 2019, I am able to make no payments on my loans without defaulting.

2.   I was able to receive interest subsidy on all my loans!

The biggest question for me with entering REPAYE had to do with interest (aka my arch-nemesis). Won’t interest continue to accrue even if I’m not obligated to make payments? Well, that’s the other perk to REPAYE.

With REPAYE, if your monthly payment is not enough to cover the monthly interest charges, the government will actually cover the difference fully for any subsidized loan for the first three years then 50% of the interest not covered after three years.

As for unsubsidized loans, the government will cover 50% of interest charges not covered by your monthly payments for the entire duration of the loan.

What this means for me is since my monthly payment is $0, my subsidized loan will not accrue interest at all this year and my unsubsidized loans’ interests are cut in half!

With the interest subsidy, it almost evens out the playing field with refinancing through a private loan to get a lower interest rate. And without losing all the benefits of a federal loan? That’s when I decided that the REPAYE program was a better choice for me than a private loan.




My fundamental repayment plan was still to make the smallest payment possible across all loan groups so I can direct extra payments to the highest interest rate loan only. So it was a no-brainer for me to switch my term-based payment plan where I was putting in $571 per month to this one and to forego the idea of refinancing, at least until next year.

As a precaution, there are some downsides to the REPAYE program. The biggest of which is there is no cap on the monthly payment of 10% discretionary income.

I don’t foresee this being a such a huge problem for me even with the full-time year-round income that I am projecting for 2018.

Another downside is that Parent PLUS loan and private loans are not eligible for a switch to the REPAYE program. This one also didn’t apply to me as I didn’t have any Parent PLUS loan or private loans.

All in all, I am happy to have switched over to the REPAYE program. The $0 minimum payment and interest subsidy for this year alone is well worth the switch. 

It also gives me comfort to know that nothing is set in stone and that my options are still wide open and I can still refinance or change my repayment option any time with no restrictions.