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You’re about to finish grad school. You probably have a sweet job lined up, and you’re ready to get into the working world. But, you’ve piled up a bunch of debt through your years of education. Student debt payback can be an overwhelming process, but certain grads might be able to take advantage of this trick to save on interest and save on monthly payments for a year while you settle into your new routine.
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What is student loan refinancing?
When you refinance your student loans, you’re obtaining a new loan at a new (hopefully lower!) interest rate with new repayment terms. It helps make both private and federal loans more affordable and simpler to deal with.
Who should refinance student loans?
If you already have private loans with higher than preferred interest rates, you can take advantage of refinancing to get a lower payment amount, longer or shorter payment term, and save thousands on interest.
If you have federal loans with high interest rates and you have a stable job in the private sector, you can refinance your loan to make it easier to pursue a more aggressive payoff strategy. However, there are downsides to refinancing federal loans into private loans.
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Who should not refinance student loans?
If you have a federal loan, it might be better to avoid refinancing if you can take advantage of income-driven repayment (IDR) plans or a loan forgiveness program. Federal loans also have greater protections including deferment and forbearance options if you can’t or don’t want to make payments right away.
IDR Plans: These plans calculate your monthly payments based on a percentage of your monthly income. These plans usually lengthen your repayment term and increase your interest overall, but can drastically reduce your monthly payments. All income driven plans can have their balance forgiven after 20 or 25 years depending on the plan. However, in most cases you will have paid off the entire balance by then. If any balance is forgiven, it is taxable to you as income.
Loan Forgiveness: Federal loans are also eligible for loan forgiveness programs available like Public Service Loan Forgiveness and Teacher Loan Forgiveness. These programs will forgive your debt in exchange for different types of public service.
If you refinance, IDR plans and Loan Forgiveness programs will no longer be available options for loan assistance.
Can Students on an F-1 Visa Refinance their Student Loans After Graduation?
Students who graduate with an F-1 Visa will be just as tempted to refinance their student loans. However, many banks and financial institutions may be wary of doing so for the following reasons:
Student loans are organized by the US government.
International students may leave the US before they are able to pay back their student loans, and the government is not able to collect on them if they default.
A borrower may not have a valid visa to stay in the US long enough to refinance their student loans.
It is inefficient for a lending company to not securitize the loans, or combine many student loans together to sell to big banks in order to make a profit from lower interest rates. Securitization requires long terms.
In addition, those on F-1 visas may not immediately receive preferential rates with US lenders for these reasons:
F-1 visas are not long-term
Job loss in any form will force them back to their home country to find new work.
Again, the government won’t be able to collect on a default.
Overall, students on F-1 visas are considered higher risk to banks and financial institutions, so it will be difficult to refinance your student loans. To alleviate these issues, consider converting to an H-1B visa after graduation to illustrate stability before you begin the refinancing process. Additionally, you can ensure that your visa is valid and renew it if needed. Your efforts may be rewarded by receiving lower rates with those same US lenders.
The following tips may also help you to be approved to refinance your student loans:
Have proof of a full-time job or job offer so that you can show you are a responsible candidate.
If you have a credit history, make sure that you are using your credit cards wisely. This means that you should pay your bills on time, in-full if possible, and avoid defaulting.
Avoid bank overdraft and insufficient fund fees because this shows that you are financially irresponsible and more likely to default on your refinanced student loan.
Put some of your earnings into savings every month to show a positive cash flow.
Why might it be beneficial to wait one year to refinance student loans?
Interest rates on all types of loans always depend on how confident the lender is that you will pay back the loan in compliance with their rate terms, and this level of confidence is based on your credit history and income.
If you wait a year after graduation to pursue refinancing you will have built up a year of paychecks and a credit history, which bodes well for you when lenders reconsider your interest rate. However, you are usually able to refinance student loans multiple times with no fees, so you might refinance as soon as you graduate and then again a year post-graduation.
Additionally, you might be able to use the income-based repayment plan REPAYE for one year and have $0 or very low payments and a valuable 50% interest subsidy which will have a lower effective interest rate than the one you would get from refinancing.
How To Use The REPAYE Trick To Get A Year Of $0 or Low Payments and Subsidized Interest On Your Student Loans
If you start on your student loan payments early and submit your tax return from your last year of school BEFORE you start working, your annual certified income will be so low that your REPAYE payments will be very low, or $0, for one year.
Since the payments don’t cover the interest, you will receive a 50% interest subsidy. This interest subsidy and low monthly payment combination will likely create a scenario where you are better off being on REPAYE than refinancing, at least for one year.
After one year, your annual certified income will be much higher and you will have built a credit history. If you have determined that refinancing is a good fit for you, you can then refinance your federal loans into private loans with a lower interest rate.
Under certain circumstances (for instance, if you work for a nonprofit or government employer, or if you have an extraordinarily high loan balance), you may want to not refinance and stay on REPAYE or another income-based repayment plan for the long-term. This will help you to stay eligible for public service loan forgiveness.
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What does “interest subsidy” mean?
When you enroll in REPAYE, you get a monthly payment based on your income. If that monthly payment doesn’t cover the interest on the principal of your loan, the government will help cover the cost of the accruing interest.
If you have a subsidized loan, the government will pay all of the interest for three years. After the third year, the assistance will cover half of the remaining interest.
If you have an unsubsidized loan, which applies to all loans for graduate school, the government will pay half of the interest that isn’t covered by your monthly payment from the outset.
If you aren’t sure if you have a subsidized or unsubsidized loan, log into your Federal Student Aid account to check.
If your required REPAYE payment does cover the interest, you will not receive a subsidy.
Quick Summary: Carl just graduated from a Masters of Engineering and has $200,000 of federal (unsubsidized and Grad Plus) student loan debt with an average interest rate of 7.5%. He’ll be starting a job at Amazon in July that pays $150,000 per year. In his last year of school, he made $0 and did not work at all.
In March before graduation, Carl chooses to consolidate his loans and signs up for the REPAYE repayment plan. Using his past year’s tax return, Carl certifies that he had no income. Because he had no income, his monthly payment under REPAYE is $0 per month (nice!)
REPAYE gives Carl a 50% interest subsidy for his first year. His annual interest for the year on his loans is approximately $15,000 (7.5% of $200,000). But Carl makes $0 in annual payments and doesn’t cover any of the accruing interest. The government will pay 50%, $7,500, of Carl’s interest through the interest subsidy. Carl will accrue $7,500 total in interest during the first year.
At the end of the first year after graduation, Carl’s loan balance will be $207,500. His balance was originally $200,000, he paid $0 in total monthly payments, accrued approximately $15,000 in interest, and the government paid approximately $7,500 through the interest subsidy.
After the first year, Carl is still at Amazon. He has gotten a raise and now makes $175,000 per year. With his much higher income, REPAYE won’t reap the same benefits. If he stayed on REPAYE, his monthly payment would be about $1,308 over an 18-year repayment term. He decides to refinance with a private student loan refinancing company at a 4% interest rate with a 10-year loan repayment term. His monthly payments will be around $2,100. And Carl has already decided that he is going to pay double so that he can pay off his loans in 5.5 years and pay $25,000 less in interest.
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Learn More | Student Loan Early Repayment Calculator
Quick Summary: Carl’s effective interest rate for his first year after graduation was just 3.75% because of the REPAYE interest subsidy. He was better off choosing REPAYE for the first year rather than refinancing right away at a 4% interest rate.
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What Are the Requirements for Using the REPAYE for One Year Trick?
1. You Must Consolidate: Your loans have to be consolidated into direct loans to use REPAYE.
Direct loan consolidation combines multiple federal loans into one loan that results in a single monthly payment.
Learn more about consolidating here.
Consolidating has consequences if you are already working towards loan forgiveness. For example, Perkins loans may be forgiven in certain circumstances and professions - you will lose that benefit if you consolidate. If you are already working towards loan forgiveness with direct loans, your number of qualified payments will start over once you consolidate. Also when you consolidate, your unpaid interest will capitalize which means it will be added to your principal balance. Future interest will be charged on that principal balance. Know the facts before you consolidate.
2. You Must Submit Income Info: You must submit income information and request to be put on REPAYE with your servicer or servicers.
This usually is done through a tax return or paystub. If you want to take advantage of the interest subsidy, your income from the previous year must be so low that your REPAYE monthly payments won’t cover all of the accrued interest.
Who should consider using the “REPAYE for One Year” Trick?
The following scenarios (or combination of) are all examples in which the one year trick can be very helpful:
You want to pursue a very aggressive student loan repayment strategy (typically the best option if you own less than 1.5x of your income in debt)
You are currently single or married to a spouse who does not work
Your income is going to rise very rapidly
You are not eligible for public service loan forgiveness
You want to refinance your student loans into private loans for a lower interest rate
So how do I do it?
It can seem complicated to take advantage of this, but it’s actually relatively simple. If you’re looking to take advantage of REPAYE’s interest subsidy and associated savings, here’s the step-by-step process:
Step 1: File your taxes by March in your last year of grad school
Step 2: File a request to consolidate your loans into a direct loan soon after you file your taxes, preferably by the end of March. Make sure that you understand the pros and cons of consolidating and check that you aren’t missing out on any loan forgiveness eligibility
Step 3: Indicate that you want to begin making payments immediately and don’t want to wait until the end of your grace period. Indicate that you want to use the REPAYE repayment plan and provide documentation detailing your income (like a tax return)
Step 4: Wait for your consolidation to complete
Step 5: Your servicer(s) will calculate your payments and they will be very low or $0. They will not cover the interest, and thus your interest will be subsidized by 50% for one year through the interest subsidy
Step 6: At the end of one year of $0 or low monthly payments, refinance your loans into private loans with a lower interest rate and pursue a more aggressive paydown strategy
Who is the REPAYE For One Year Trick NOT good for?
The trick can be super helpful, but only if you are able to take advantage of the interest subsidy to lower your effective interest rate. It won’t work in the following scenarios:
You are married to a spouse who works: Your spouse’s income will be counted in determining your REPAYE payments (even if you file separately), and you’ll get less benefit (if any) from the interest subsidy
You made a lot of money in your last year of school: If you made a bunch of money through outside employment or a lucrative side hustle, your payments through REPAYE may be higher. So high that they might cover your interest payments and thus the interest subsidy won’t apply