Which student loan repayment plan is best? It’s one of two.

The Two Paths: Lowest Total Cost or Lowest Monthly Payment

Your first federal student loan bill arrives and the payment is higher than your car payment. It is a shock. You look for other options on the Department of Education’s website and find a confusing list of acronyms: SAVE, PAYE, IBR, ICR. They all promise a lower payment, but the details are dense. You have one decision to make, and it forces a choice between two competing goals.

You can choose to pay the least amount of money over the life of the loan. Or you can choose to have the lowest possible monthly payment right now. You cannot have both.

The best plan for you is the one that aligns with your financial reality. For those who want to be debt-free fastest and pay the least interest, the choice is simple. It is the Standard Repayment Plan. For everyone who needs breathing room in their monthly budget, the choice is also simple. It is the SAVE plan. All the other plans are now mostly footnotes for special cases.

The Default Plan That Costs the Least

Unless you choose a different option, the government puts you on the Standard Repayment Plan. The mechanism is straightforward. Your total loan balance is amortized over 10 years. You will make exactly 120 fixed monthly payments, and then you will be free of the debt.

This plan forces you to pay the loan off relatively quickly. The result is that you pay less in total interest compared to any other plan. That is its only goal. The shorter the repayment period, the less time interest has to accumulate.

The downside is obvious. It has the highest monthly payment of any federal plan. The calculation does not consider your income or your ability to pay. It only considers your balance, your interest rate, and the 10-year deadline. If your income is high and stable, and you can afford the payment without strain, this is the most financially efficient way to eliminate your student debt. For many people, it is simply unaffordable.

The SAVE Plan: A New System for Monthly Payments

The Saving on a Valuable Education (SAVE) plan is the newest income-driven repayment (IDR) plan, fully available since the summer of 2023. It replaces older plans by offering significantly better terms for most borrowers. It usually provides the lowest monthly payment of any option.

SAVE works by decoupling your payment from your loan balance. Instead, your payment is based on your income and family size. This is why it is called an income-driven plan.

Here is the two-part mechanism:

1. It redefines discretionary income. Older plans considered your income above 150% of the federal poverty guideline to be available for payments. SAVE raises that protection to 225%. For 2024, the poverty guideline for a single person in most states is $15,060. The plan protects 225% of this amount, or $33,885, from being considered. You only pay on the income you earn above that level.
2. It sets a payment based on that income. Your monthly payment is set at 10% of your discretionary income. If you only have undergraduate loans, this will drop to 5% in July 2024. If you have both undergraduate and graduate loans, your rate will be a weighted average between 5% and 10%.

For many borrowers with low or moderate incomes, this calculation results in a $0 monthly payment. That payment still counts toward eventual loan forgiveness.

The Most Important Feature: The Interest Subsidy

The single biggest change with the SAVE plan is how it handles unpaid interest. This is the primary reason it makes older plans obsolete. On older IDR plans, if your monthly payment was not large enough to cover the interest that accrued that month, the unpaid interest was added to your loan balance. This caused many borrowers’ balances to grow, even as they made payments every month. This is called negative amortization.

SAVE eliminates this. If your calculated monthly payment is less than the amount of interest your loan accrues, the Department of Education pays the difference. For example, your loan accrues $150 in interest this month. Your payment on SAVE is calculated to be $40. You pay the $40. The remaining $110 of interest is waived. It does not get added to your balance.

Your loan balance will not increase as long as you make your monthly payments. This is a profound shift. It allows you to benefit from a low payment without the penalty of a ballooning balance. The trade-off is a longer repayment period. Your loan term is extended to 20 or 25 years. Any remaining balance is forgiven after you have made payments for that long. Under current IRS rules as of early 2024, this forgiven amount is not considered taxable income, a policy extended by the Consolidated Appropriations Act, 2021, through the end of 2025.

How SAVE Works for Public Service Loan Forgiveness

Public Service Loan Forgiveness (PSLF) is a separate program that cancels federal student loan debt for people who work in public service jobs. To qualify, you must make 120 qualifying payments while working full-time for a government agency or a qualifying non-profit organization.

Those 120 payments must be made on an income-driven repayment plan. The goal for a PSLF seeker is to pay as little as possible each month until they reach 120 payments. The less they pay out of pocket, the more debt is left to be forgiven.

The SAVE plan provides the lowest monthly payment. Therefore, it is the best plan for anyone pursuing PSLF. By minimizing your monthly payments, you maximize the financial benefit of the forgiveness program. Every dollar you do not have to pay is a dollar that will eventually be forgiven.

The Complicated Case of Parent PLUS Loans

Parent PLUS loans are a major exception to all of this advice. These are loans taken by parents to pay for their child’s undergraduate education. The rules for these loans are less generous.

Parent PLUS loans are not directly eligible for the SAVE plan. Or PAYE. Or IBR. The only way to get a Parent PLUS loan onto an income-driven plan is to first consolidate it into a Direct Consolidation Loan. After consolidation, the loan becomes eligible for only one IDR plan: Income-Contingent Repayment (ICR).

ICR is the oldest and least favorable IDR plan. It calculates your payment as 20% of your discretionary income. That is double the rate of the SAVE plan. It also has a less protective definition of discretionary income. For parents who need a lower payment on their PLUS loans, this is a significant disadvantage. It is the only option available after consolidation, but it is a much worse deal than what their children get for their own loans.