Prepaying Student Loans? Federal Income Driven Repayments Plans May Still Benefit You

By: Joseph Reinke, CFA, CEO of FitBUX

Federal income driven repayment (“IDR”) student loan plans are often discussed by many students and recent graduates.  However, those who want to get out of debt as soon as possible and plan on prepaying their student loans often exclude themselves from this conversation as they do not feel they can benefit from IDR plans

We often hear, “those repayment plans are only for those who can’t afford their monthly payments."  However, if you are currently prepaying or planning to prepay your loans early when you graduate and happen to qualify for an IDR plan, there is a hidden benefit you can take advantage of: increased financial flexibility.

At FitBUX, we often stress the importance of developing a strategy to pay-off your student loans.  One of the key components of a sound financial strategy is to arm yourself with as many options as possible.  Why?  Simply put, you never know what life is going to throw at you. 

This article illustrates one easy to implement strategy that will increase the flexibility of your student loan repayment plan by getting the most out of Federal IDR plans.

Who Should Consider This Strategy?

As a student or recent graduate, you will generally fall into one of three categories: 1) you don’t qualify for an IDR plan, 2) you qualify for an IDR plan but instead want to pay-down your loans as quickly as possible and believe IDR plans are of no benefit to you, or 3) you want to pay-down your loans but your salary won’t allow you to pay-off your debt and the lower required monthly payments of an IDR plan make sense at this time in your life. 

This article specifically pertains to the 2nd category: you qualify for an IDR plan but instead you want to pay-down your loans as quickly as possible. 

The Scenario: Prepaying vs. Income Driven Repayment

Let’s assume that you are a student planning a repayment strategy or recently graduated and deciding on potential strategies.  At a high level, you have two choices: 1) live frugally for a few years and pay-off your student loans as quickly as possible so that you can get out of debt or 2) use a Federal IDR plan to reduce your required monthly payments.

For this example, let’s assume the following:

  1. If you choose the 1st option, your required monthly payment is $1,000 and you elect to make an additional, not mandatory, $500 monthly prepayment.  Your total monthly payment adds up to $1,500.
  2. If you choose the 2nd option, your minimum required payment is $400.

Most individuals who want to get out of debt faster will go with the 1st option and move on with their lives.  However, this also means that they’re giving up additional flexibility provided by IDR plans if used strategically as we will detail below.

Enjoy Additional Flexibility. For Free!

The often overlooked “trick” is that the minimum payment on a Federal IDR plan is just that, a minimum.  Nothing prevents you from making higher payments.  Therefore, you can sign-up for an IDR plan and still implement the 1st option of prepaying your loans aggressively.  You do not gain a monetary benefit from doing so but instead gain the benefit of additional flexibility in your repayment strategy.

Imagine that you’ve implemented option 1 and are paying $1,500 per month and also qualify for an IDR plan.  If life throws you a proverbial “curve ball” and you happen to find yourself tight on cash, you can reduce your monthly payment to the required monthly payment of $1,000 and free up $500 to cover unexpected expenses.

Now let’s say that you elected to go with an IDR plan and are making additional voluntary monthly prepayments of $1,100, for a total of $1,500 in monthly payments.  Your total monthly payment is now the same as option 1 above.  However, since your required payment is only $400, in the case of an emergency, you can drop your monthly payment to $400 and free up $1,100 per month for unexpected expenses!  Remember, flexibility is good as it brings you more choices.  And best of all, you’re getting this incremental flexibility for free!

Next Steps

At FitBUX, we are helping students and recent graduates navigate the maze of student loans options and implement strategies that take full advantage of little known benefits similar to the one covered above.  We’ve also covered more helpful topics in our Knowledge Center.

Core to our approach is a proprietary online platform we’re currently testing with a limited set of users.  If you would like to sign up for our beta program, we would love to hear from you.  In addition, we’re always happy to answer specific questions you may have regarding different strategies based on your personal situation.  Just shoot us an email at info@fitbux.com.

 


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