4 Important Things to Know About Student Loans

By Dr. Sylvia Kwan

You. Did. It. You graduated from school and boosted that earning potential. You started working — and also started paying off the debt that helped you get here. You’re not alone: Roughly 44 million Americans have student loans. And two-thirds of them are women.

4 Important Things to Know About Student Loans

For any loans with interest rates less than 5%, we usually recommend paying the minimums and focusing on investing instead. (That’s because over the long term, investing has historically earned more than 5% in returns.) But for loans with rates greater than 5%, we typically recommend going above the minimums — strategically — in order to pay them off quickly.

The idea is to make a plan to tackle your student loans in a way that helps you pay as little as possible in interest and fees. Here’s what you need to know to do that.

1. The difference between federal and private loans

Looking at all of your student debt in one place can be … less than fun, but it’s an important first step.

Start by figuring out which type of loans you have: federal, private, or both. Federal loans are given out by the US government. They make up about 90% of student debt in the US. If you have federal loans, they’ll be managed by one of a few specific loan servicing companies. Private loans, meanwhile, are given out by independent, usually for-profit banks, like Sallie Mae.

The reason this distinction matters is that federal and private loans have different repayment terms. The big difference is that federal loans give you more flexibility: Income-driven repayment plans that tie your minimum monthly payment to your salary and loan forgiveness (which eliminates remaining debt after certain types of public service) are usually only available for federal loans.

So, since private loans give you virtually no wiggle room when it comes to repayment, we often recommend focusing on those loans first.

2. The kind of interest rate you have matters

Interest rates on student loans fall in one of two categories: fixed rate or variable rate.

All federal loans issued after July 1, 2006 have fixed interest rates. Private loans, on the other hand, can have either a fixed interest rate (which doesn’t change in the middle of the loan) or a variable interest rate (which could change depending on economic conditions). That’s part of the reason why private loan interest rates can be upward of 13%, depending on current federal interest rates, your credit, and the lender — much higher than the 5% to 7% average range for federal loans.

We usually recommend the debt avalanche method of paying off your loans. First, list them from highest interest rate to lowest (prioritizing private loans, as mentioned above, when interest rates are roughly equal), regardless of their balance. Then put any extra money you can find in your budget toward the one at the top. Once that’s paid off, you can work your way down the list.

The Federal Reserve’s recent interest rate increases mean that your variable-rate loans might be getting more expensive. So keep an eye out for updates from your lenders about changes to your rates; you might need to adjust your repayment plan accordingly.

3. How income-driven repayment plans work

A standard repayment plan for federal loans lasts 10 years, and you owe the same minimum payment over those 10 years in order to pay off your loans and the interest. But income-driven repayment plans use your discretionary income — how much your pre-tax income exceeds the federal poverty line — to calculate a monthly payment for you. This can be really helpful if you have a lot of student debt and are overwhelmed by the amount you’re supposed to pay each month.

The repayment period for an income-driven repayment plan is 20 or 25 years, depending on the plan, and any outstanding balance at the end of that time is forgiven.

There are four types of income-driven repayment plans:

  • The REPAYE plan: Your monthly payments will typically be 10% of your discretionary income

  • The PAYE plan: Similar to the REPAYE plan, except your payments won’t exceed what you’d pay under the standard 10-year federal loan repayment plan

  • The IBR plan: Your monthly payments will be either 10% or 15% of your discretionary income, depending on your borrower status when you took out the loans (but also never more than the standard 10-year payments)

  • The ICR plan: Your monthly payment will be either 20% of your discretionary income or what you’d pay with a 12-year repayment plan with fixed payments — whichever is lower

4. How to lower your private loans’ interest rates

Private loans don’t offer income-driven repayment plans, so it’s worth trying to lower your interest rates and save some money. Here are a few options.


The easiest way is to sign up for auto-pay, which can often shave around 0.25% off of your interest rate, depending on your lender. OK, it’s not the world’s biggest discount, but hey — every penny counts. (Not to mention that those payments will be out of sight, out of mind.)

Loan refinancing

Another possibility is refinancing — working with a private lender who replaces your existing loans with a single new loan that has a lower interest rate. (You’d be giving up those flexible repayment options if you refinance your federal loans, though, and they’re really useful in case something unexpected happens to your income. So we usually recommend against refinancing federal loans.)

Most student loan refinancing companies offer both fixed-rate and variable-rate loans; rates can be as low as around 2% for the former or 3% for the latter, but your credit score and other financial info will affect that. You can refinance through a traditional bank, or you can go with an online lender that specializes in student loan refinancing services, like Earnest, SoFi, or CommonBond.

Loan consolidation

Loan consolidation is different from loan refinancing. Refinancing allows you to use your current creditworthiness to lower your interest rate; consolidation, on the other hand, simply averages all your existing loans’ current interest rates together.

If your credit score has improved by at least 50 points since you took out your private loans, your lender may give you a lower rate if you consolidate. In that case, it can be worth checking out. If not, though, consolidating often also means you’ll be paying off your debt for longer — and end up paying more in interest when it’s all said and done.

Now that you’ve got all the info you need to make a plan to deal with your student loans, you’re set up to start actually paying them off. Here are some concrete steps you can take to get started.


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Dr. Sylvia Kwan

Dr. Sylvia Kwan is the Chief Investment Officer of Ellevest.