Student Life #02 | Interest rates and repayment options
In the previous blog, we learned about what a student loan is and how it works. If you haven’t read it yet, go ahead and read it! Well, if you’re lazy and just want a summary, you’re in luck. A student loan is a sum of money borrowed from a Government or Private lender in order to pay for their college (tuition, books, accommodation, etc.) This amount will be later repaid with interest and it is not to be confused with Scholarships or Co-op programs.
In this blog, I’ll be covering two very important points that most of us, students (or to-be students) want to know when it comes to study loans — Interest Rates and Repayment Options.
Let’s talk interest rates!
Everyone loves interest, especially if it’s the kind that makes one bill into a mountain of cash. However, when it comes to loan interest, I don’t recall knowing anyone who’s as enthusiastic about it. It leaves you dumbfounded when you realize you need to repay more than what you borrowed. If you do want to know about interest rates, you first need to know a couple of things. Bear with me.
Principal
This is the amount borrowed from the lender and also the amount of debt each student graduates with. If you need Rs 50,00,000 in order to study, Rs 50,00,000 will be your principal amount. Interest will be calculated on this and you will need to repay both.
Interest rate
This is the amount you will be paying on the loan. Yep, this is one way for the bank to earn. The interest rates on federal loans are usually fixed but may vary based on the type of loan you opt to take. On the other hand, private loans have variable interest rates based on your credit rating.
Loan repayment term
This is how long you have to repay the loan amount to the bank. Usually, it’s 10 (sometimes 30) years for federal loans. For private loans, it completely depends on your loan agreement.
Let’s take an example to show you the (not so) fun part.
Assume you borrow Rs 50,00,000 as the loan amount at 8% interest. Your principal here would be Rs 50,00,000. The interest you will need to pay on this amount will be Rs 22,79,656. So, the total amount you will repay to the bank for a span of 10 years would be Rs 72,79,656 (Rs 60,664 per month). Fun, right?
What options do you have to repay your loan?
If you do end up taking a loan that you want to dedicate 10 years of your life repaying, being a bully to your future self, here are the options you have to repay the amount.
Federal loan repayment options
- Standard Repayment Plans
Your lender provides a schedule with a set monthly payment amount. For federal loans, the plan is usually for 10 years. Private loans will vary as I mentioned earlier. - Graduated Repayment Plans
The payments start off lower, but they increase every couple of years or so. The plan is still to have everything paid off within 10 years. - Extended Repayment Plans
The loan repayment tenure was between five to seven years. This has been extended to 10 years for loans up to Rs7.5 lakh and 15 years for loans above Rs7.5 lakh. - Income-Based Repayment Plans
These plans base your payments on a percentage of your income. Usually, you’ll pay between 10–15% of your income after taxes and personal expenses are covered. The payments are recalculated every year and adjusted for things like the size of your family and your current earnings. Pretty flexible. - Income-Contingent Repayment Plans
This is similar to the income-based plan but is based on 20% of your discretionary income (that’s the amount of income you have left after your set expenses are taken care of). The rates are adjusted every year and the balance can be forgiven — and taxed — over time (usually 25 years). You might want to recheck with your bank - Income-Sensitive Repayment Plans
These are similar to the other income-related plans, but the payment is based on your total income before taxes and other expenses, instead of your discretionary income. The loan payment is calculated to be paid off within 10 years.
Private loan repayment options
The private lender makes the rules for your repayment. Check the agreement. You’ll pay a set amount each month which is a combination of the principal amount and interest, and the payments are usually set for a specific amount of time. Any changes in that plan — like a graduated-payment schedule — would need to be negotiated with the lender (you could always try bribing them with cookies or candies XD).
What happens if you can’t repay your loan?
Forbearance
Your payment is put on hold, but the loan continues to accumulate interest. There are two types of forbearance: general (where the lender decides your level of need) and mandatory (where the lender has to grant forbearance based on your situation).
Deferment
With deferment, you temporarily don’t have to make payments, and you may not be responsible for paying interest on your loan. Not everyone is eligible for deferment or forbearance, but you might qualify if you’re unemployed, serving in the military during wartime, or serving in the Peace Corps.
Student Loan Forgiveness
Not everyone qualifies for this — there are a whole bunch of different requirements, like working full time in a qualifying public service job while making payments for 10 years, teaching in a low-income school for at least five years, etc. As of May 2020, the scary thing is that only 1.3% of applications for student loan forgiveness through public service were actually approved.6 You can’t rely on this stuff though.
Default
This is what happens if you keep missing payments. Your loan is referred to as delinquent the day after you miss one payment, and if you continue to miss payments, you go into default. This means you failed to pay back the loan based on what you agreed to when you signed the paperwork, which can have serious consequences. You could be taken to court, lose the chance to get other financial aid or be required to pay the entire balance of your loan right away. Not fun at all.
Refinancing your loan
This is a fun option if you know about it. Of course, do it only after evaluating your situation. These are the points you need to look out for if you decide to refinance your loan.
- It should be completely free to refinance. Why buy something you could get without paying a dime?
- Only go with a fixed rate. Do not give your lender the power to pull your rate way up at some random future date.
- Go for a shorter loan repayment term than you currently have. We are trying to speed this process up!
- Get yourself a lower interest rate. The less interest you can pay the better!
If you want to learn about refinancing better, my colleague has made a video to help out. I’ll link it here. It talks about home loans, but the concept remains the same.
And that wraps up this blog. If you want more information to repay your loans, you can check out this article, maybe?