With federal student loan payments resuming on October 1st, you may be stressing over how you will afford the payments. If you aren’t sure how much you owe, check out last week’s post. Once you’ve figured out how much you owe, if the monthly payments feel beyond feasible, you may want to look into a Direct Consolidation Loan. Even if you’ve explored them before, it’s worth looking into them again. A lot may have changed for you (different income, different family size, etc.), and there is a new Direct Consolidation Loan program (SAVE) that, for many people, will drastically reduce their monthly payments.

What is a Direct Consolidation Loan?

A Direct Consolidations Loan is when you combine 2 or more federal student loans into a new Direct Consolidation Loan. Typically, this is done to reduce your monthly payments or to make you eligible for certain federal forgiveness programs.

This is different than refinancing a student loan, which means taking a federal loan and moving it to a private lender, ideally for a lower interest rate.

How do Direct Consolidation Loans work?

There are a variety of different Direct Consolidation Loan (DCL) programs available. With the most popular ones, your monthly student loan payment is based on your current income. So if you have a low income, these options may be particularly attractive. However, lower payments sometimes mean that you end up paying more over the life of the loan. In some cases, the amount you are paying each month is less than the amount of interest accrued that month. This means your debt balance can actually be growing, even if you are making your agreed-upon repayments.

For example, let’s say your Income-Driven Repayment amount is set at $200 per month, and you have a $50,000 loan balance at a 6% interest rate. In this case, you’d accrue $250 in interest next month, but you are only paying $200. In this scenario, your outstanding balance would actually be increasing each month.

Most of these plans have a capped number of years, after which your loans are forgiven. So even if your lower payments mean that you aren’t effectively reducing the overall balance, there is still an end in sight. Once you have made a certain number of monthly payments, your debt balance is forgiven. And in some situations, your qualified monthly payments might be as low as zero.

Another potential drawback to income-driven repayment plans is that while it can be helpful to keep your monthly payments lower when you are lower income, as your income grows, so will your monthly loan payments. And with some of these loan programs, if your income goes up enough, your monthly payments could be much higher than if you’d stuck with the standard 10-year re-payment plan.

What is the new SAVE Plan?

The education department is rolling out the SAVE (Saving on A Valuable Education) plan this fall, which will replace the current REPAYE plan. Throwing yet another option into the mix may make it feel more daunting to determine which option is best for you, but the intention with replacing REPAYE with SAVE is actually to make the options less complicated.

Key features of the new SAVE program:

More favorable income calculations
Payments set at 5% - 10% of “discretionary income”
Any interest beyond the minimum payments does not accrue
Lower repayment terms (as low as 10 years) for smaller original balance loans

How is the SAVE plan different?

There are two particularly attractive changes to this new program.

1. More favorable minimum payment calculations

2. Any interest beyond the minimum payment does NOT accrue.

SAVE Plan likely to result in lower monthly payments

The SAVE program has 2 factors that will help more people qualify for lower payments, and the payment reductions will be more significant. The income calculations for this program are different. As with other CLR programs, your monthly payments are calculated based on your discretionary income.

With the older plans, discretionary income is defined as any income over 1.5 times the federal poverty line. So that means if you are a single person earning $80,000 a year, you’d then subtract $21,870 (1.5x the 2023 federal poverty line for the lower 48 states) to get your discretionary income. Your student loan minimum payment is then calculated as a percentage (10-20% depending on which plan) of that discretionary income.

The SAVE plan calculates your discretionary income based on 2.25x the federal poverty line. So if you are earning the same $80k as in the above scenario, now you are subtracting $32,805 (2.25x the federal poverty line) to get your discretionary income. From there, your payments would be calculated at 5% of your discretionary income if your loans are for undergrad loans (10% for graduate loans, or an average of the two if it’s a mix of both undergrad and graduate loans).

Minimum Payment Calculations based on an $80k income.

Your discretionary income is calculated on your Adjusted Gross Income (If you have last year’s tax returns, look at line 11 to find your most recent AGI) and the number of people in your family. NerdWallet has a helpful calculator to determine what your discretionary income is.

With the SAVE Plan interest does not accrue

The other major benefit of the SAVE plan is that any monthly interest that exceeds the monthly minimum payment does not accrue. So if you have that $50k loan balance, which based on a 6% interest rate would accrue $250 in interest per month, and based on your income you owe $200, instead of your balance growing to $50,050, on the SAVE program, your balance stays flat at $50,000. As long as you are making your minimum monthly payments, your balance won’t grow. If you had a low enough income, you could potentially owe nothing each month, and your balance would stay the same. Eventually, at the end of your loan period, the full balance will be forgiven.

Forgiveness happens sooner

On the older DCL plans, loan forgiveness occurs after 20-25 years of qualified payments. This means that if you’ve made all of your required minimum payments, and still have a balance at the end of the time period, the remaining balance is forgiven. On the SAVE plan, borrowers with lower balances ($12,000 or less) will receive forgiveness after 10 years of qualified payments. The repayment period increases by 1 year for every additional $1,000 borrowed. So if you borrowed $15,000 any remaining balance would be forgiven after 13 years of qualified payments.

How do I evaluate the best fit for me?

If you have a high income (or anticipate having a high income in the near future) and don’t envision qualifying for loan forgiveness, sticking with the traditional 10-year payment plan will likely cost you the least over the life of the loan. But if you have a lower income (and especially if you anticipate a lower income for the foreseeable future), a DCL may cost less long term, even if it extends the life of the loan, once you factor in the lower monthly payments and potential forgiveness.

Determining the best student loan plan isn’t a one-size-fits-all approach. It’s important to think about what your goals are in considering a DCL. A few key questions to ask yourself include:

Do you want to reduce your monthly payment?
Do you want to reduce the total amount you pay over the life of the loan?
Do you want to pay the loan off in the shortest time possible?
Will you be eligible for Public Service Loan Forgiveness (PSLF)?
Is your income likely to change significantly in the next few years?

There are some online calculators to help you compare what your monthly payments and long-term interest amounts will look like. Check out this calculator from Student Loan Planner.

How do I enroll?

You can enroll for the SAVE program through your student loan servicer or by going to the Student Aid website. It takes about 10 minutes to complete the application.

If you are already on the REPAYE plan, your loan will automatically be rolled over to the SAVE plan.

With student loan payments starting up again in October, this is a great time to evaluate your cash flow. Do you need to make some changes to be able to cover the new monthly loan payments? If the idea of this added expense is sending you into a panic, perhaps you’d benefit from some support in managing your money. Schedule a free call with Sarah to learn more about how one-on-one coaching can help take the stress out of personal finances.

What is the new student loan SAVE program?