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Refinancing vs. Income-Driven Repayment: Which is Better for You?
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If you’re looking to adjust payments on your federal student loans, you have a few options, such as refinancing your student loans or applying for income-driven repayment. But when it comes to refinancing vs. income-driven repayment, which is the better option?
The answer depends on your financial situation and goals. In order to pick between these options, let’s examine the following topics:
Before diving into the details of refinancing loans and income-driven repayment, check out this chart that highlights the main differences between these two approaches.
|Income-driven repayment||Student loan refinancing|
|Can lower monthly payment||✔||✔|
|Can lower interest rate||✔|
|Offered by the federal government||✔|
|Offered by private lenders||✔|
|Requires a credit check||✔|
|Can end in student loan forgiveness||✔|
The Department of Education offers four main income-driven repayment plans for federal student loans:
- Pay As You Earn (PAYE)
- Revised Pay As You Earn (REPAYE)
- Income-Based Repayment (IBR)
- Income-Contingent Repayment (ICR)
Each of these plans caps your monthly student loan payments at 10%, 15% or 20% of your discretionary income while lengthening your repayment terms to 20 or 25 years. If you still have a balance at the end of your term, you could get the entire amount forgiven.
While these plans can be a useful way to adjust your student loan payments, they also come with a few drawbacks. By extending your terms, for instance, you’ll likely end up paying more interest over the life of the loan. So while these plans feel less costly in the short term, they’ll actually make your student loan more expensive in the end.
Second, you typically have to recertify your income-driven repayment plan on an annual basis. If you forget to file this form, you could get kicked off the plan.
In addition, parent PLUS borrowers don’t have access to all these income-driven plans — they’re only eligible for ICR. And finally, if you get your loans forgiven at the end of your plan’s term, you might still have to pay taxes on the final amount.
Even with these downsides, though, income-driven repayment can be an easy way to trim your student loan payments and, as a result, free up more of your income for other expenses.
Student loan refinancing can be another way to lower your monthly payments and change your repayment terms, as well as simplify repayment by combining multiple loans into one. But this strategy has some key differences from income-driven repayment.
For one, refinancing isn’t offered by the federal government. Rather, you’d refinance with a private lender, such as a bank or credit union. Since you’re refinancing privately, you’ll need to pass a lender’s requirements for credit and income (or apply with a cosigner).
If you do meet credit requirements, you could qualify for a lower interest rate than you have now. Lowering your interest rate by even a small amount could potentially save you significant money by the time you repay your loan. If you go this route, make sure to shop around carefully for your best deal.
Once your refinancing application is approved, you can choose new repayment terms, as well as a fixed or variable interest rate. By going with a longer repayment term, you can snag lower monthly payments.
But as with income-driven repayment, a longer plan means you’ll likely pay more interest overall. If you can afford a shorter term, you could get out of debt sooner and pay less interest as a result.
Be careful about sacrificing federal loan protections
Before refinancing your student loans, though, note this important downside: Refinancing federal student loans turns them private. As a result, you’d completely lose access to some useful federal programs, including income-driven repayment and forgiveness.
Some private lenders offer forbearance in the event you can’t pay your loans, but they typically don’t offer as many protections as the Department of Education. So if you’re hesitant to give up federal benefits, refinancing might not be your best choice.
On the other hand, if you understand what you’re getting into, refinancing could be a smart way to adjust your student loan bills and potentially lower the interest rate on your debt.
While both refinancing and income-driven repayment plans can make your student loans more affordable on a monthly basis, these approaches have some key differences.
Income-driven plans offer a straightforward way to adjust your federal student loan payments and potentially get loan forgiveness in the long term.
Refinancing, on the other hand, lets you simplify repayment by combining several loans (federal or private) into one and could save you money on interest.
Do your research on both options, so you can pick the one better suited to your unique financial situation and goals.
With the right approach, you might even be able to pay off your student loans faster.