Before we dive too deep, first let’s define some terms. We’re doing it at the beginning, just to make sure everyone is on the same page.
Loan – A sum of money you borrow from somebody, typically the federal government or a bank for the majority of student loans.
Interest rate – The rate at which a sum of money grows, usually expressed as a percentage. The higher the rate, the faster it grows. This is great for investments but equally less great for your loans. Most quoted rates are an “annual” percentage. So, a $100,000 loan at 5% APR (annual percentage rate) will accrue $5,000 in interest every year.
Capitalization – Capitalization is when the interest accrued on a loan is added permanently to the “principal” (the loan itself aka the amount that accrues interest). For example, if interest capitalizes annually, then a forbeared/unpaid $100,000 loan with a 5% interest rate accruing $5,000 in unpaid interest would become a $105,000 loan accruing $5,250 the following year. Capitalization is commonly referred to as “compounding” when it works in your favor, such as in an investing account.
The following events trigger capitalization:
- End of grace period / beginning of repayment
- End of a period of forbearance or deferment
- Change in repayment plan or consolidation
- Loss of partial financial hardship in IBR or PAYE
- Failure to submit IDR annual income certification on time
- Loan Default
Income-driven repayment (IDR) – An umbrella term for the government’s multiple payment plans which tie your monthly payments to your income, which include income-based repayment (IBR), pay as you earn (PAYE), revised pay as you earn (REPAYE), and income-contingent repayment (ICR). The term IBR is sometimes also confusingly used as a stand-in for IDR programs in general, but IBR is actually a specific program under the IDR umbrella.
We’ll compare & contrast the IDR programs in detail later, but in brief:
Income-based repayment (IBR) – Monthly payments for most borrowers are calculated to be 15% of discretionary income and are capped to never be greater than the amount you would pay monthly on the standard 10-year plan when you first entered repayment. Loans are forgiven after 25 years of payments.
Pay as you earn (PAYE) – Monthly payments for most borrowers are calculated to be 10% of discretionary income and are capped to never be greater than the amount you would pay monthly on the standard 10-year plan when you first entered repayment. Loans are forgiven after 20 years of payments.
Revised pay as you earn (REPAYE) – The new late 2015 addition to the IDR pantheon. Monthly payments are capped at 10% of your discretionary income like PAYE, but half of the unpaid interest left over after your monthly payment is also forgiven (the unpaid interest subsidy). This sounds better than PAYE, and it often is, but REPAYE also closes some loopholes that make PAYE a better choice for some folks. Undergraduate loans are forgiven after 20 years, but anyone with graduate loans (e.g. medical school) has to wait 25 years like IBR.
Income-contingent repayment (ICR) – An antiquated nearly irrelevant program. ICR is only really relevant for older students who have older FFEL loans or parents who hold Parent Plus loans. Using ICR to pay off Parent Plus loans that have been consolidated into a Direct Consolidation loan is generally considered the only way to get forgiveness for these otherwise inflexible loans (note: the qualifying nonprofit work in that edge case is the parent’s, not the student’s).
Discretionary income – The income amount used to calculate your IDR payments. Discretionary income is calculated as your adjusted gross income (total income before taxes minus deductions) minus 150% of the poverty line. You can find your AGI on your taxes. The poverty line varies by family size (as well as lower 48 vs Hawaii/Alaska). As an example, the 2016 poverty line for an individual was $11,880.
Subsidized loans – Subsidized loans used to be given to graduate students prior to 2012. Now they’re reserved for undergrads. Subsidized loans do not accrue interest during school or any other deferment period. Any unpaid interest that accrues during the first three years of IDR after graduation is also completely covered. Subsidized loans are only relevant for recent graduates if they also have loans from college.
Unsubsidized loan – The classic student loan that likely makes up the vast majority of your debt. Interest accrues from the day you take out the money.
Private refinancing – These days the vast majority of student loans are given out by the government as part of the Direct loan program (because they’re given “directly” by the government as opposed to given by banks but guaranteed/insured by the government, as used to be the case). Some companies do offer student loans, but these are generally less good than the federal offerings. But some offer private refinancing/consolidation, whereby they pay off your existing student loans in exchange for a loan with a lower interest rate. You can save money, sometimes a lot of money, but you also lose the benefits/flexibility/protections of federal loans including possible forgiveness.
Cosigner – A person who applies for a loan with you in order to help you qualify for a loan you otherwise wouldn’t get or help you get a better rate. The cosigner is responsible for the loan just like you and is on the hook if you don’t follow through. In some circumstances, companies have programs to remove a cosigner from a loan after a period of on-time payments.
Public service loan forgiveness – A program that (currently) offers unlimited tax-free loan forgiveness to those working at qualifying non-profit organizations after ten years of on-time monthly payments. The very first crop of forgiven loans was eligible in October 2017, but relatively few have made it through the forgiveness gauntlet so far. The future of this program is unknown and frequently discussed, especially by people who don’t know what they’re talking about.
Deferment is the ideal way to temporarily not pay off your loans. In a deferment (as opposed to forbearance, covered below), no monthly payments are due on your loans and no interest on subsidized loans accrues. In practice, the only deferment you are going to get is the one you have while you are enrolled at least part-time in school. In the past, residents were eligible for an economic hardship deferment. That is no longer the case.
Forbearance is how you can temporarily not make payments on your loans. Most people can only forbear loans for three years, but residents have the use of an unlimited in-training forbearance, so you are never obligated to make payments on your federal student loans while a resident if you feel it’s financially unfeasible (though you have to apply annually). The downside is that interest continues to accumulate and then capitalizes at the end of the forbearance period, so your debt balloons more the longer you delay making payments. New attendings who are finally ready to start tackling their student loans are often horrified to see how much their debt has grown after a few years of neglect.
Grace period is the mandatory 6-month period after graduation before you enter repayment. Consolidation and PLUS loans do not have grace periods. Perkins loans have a 9-month grace period.
Repayment is the period during which you make monthly scheduled payments toward your loans after your six-month grace period.
Delinquency is when you miss making a payment, even by one day. Reported to credit agencies. This is one great reason to sign up for autopay.
Default is when you don’t handle your delinquency. The entire balance is due immediately. At this point, your credit score is shredded for at least seven years and the government comes after you to get its money. This includes things like penalties and fees, garnishing your wages, seizing social security, and taking your tax refunds. This should never happen (particularly since you can always forbear as a resident). What many defaulting borrowers fail to realize is that IDR payments can be reduced quickly if income falls; bankruptcies from medical illness aside, the payments are designed to never be totally undoable. If your income is low, your payments are low.