Question

Not surprisingly, Tarek still has several thousand dollars in student loans outstanding. When he graduated from college, he had federal loans of $48,100, with an average APR of 5.40%. Six months after graduation, he started making payments using the standard repayment plan. How much is his monthly payment? If all his student loans were subsidized and if he wants to minimize his monthly payment to increase his financial flexibility, what repayment schedule would be best for Tarek? What will be his new maximum monthly payment if his federally calculated discretionary income is $4,810 per month?

As per Standard repayment plan Tarek's monthly payment is. $.......

The best repayment schedule for Tarek would be .... ? Income-Sensitive Repayment PlanPAYE PlanStandard Repayment Plan. Tarek's

maximum monthly payment will be $ ..............

Answer 1

A] Standard Repayment Plan: -

Principal amount to be repaid = $ 48,100

APR = 5.40%

Standard repayment tenure = 10 years ~ 240 months (10*12) (assumed)

So, the monthly repayment (EMI) of Tarek will be : -

EMI = P X R X [{(1 + R)^N} / 1 {1- (1+R)^N}]

In the given question, P = 48,100, R = 5.40/12 = 0.45%, N = 240

So, the EMI will be = $ 328.16

B] The best repayment schedule: -

The best repayment schedule refers to the schedule where interest payment will be the minimum. This can be achieved by either minimizing the repayment schedule or lowering the interest rates. Now, since the loan is already availed we cannot change the interest rate. So, the only factor in our hand is minimizing the repayment schedule. Most of the banks have a minimum repayment schedule of 10 years. So, assuming that to the best available option, the best repayment schedule will be the same as calculated in part [A] i.e. APR = 5.40%, N = 10 years & EMI = $ 328.16.

If a lower repayment tenure is available then that will be the EMI shall be calculated using the formula stated in the part [A] & that will be the best-case scenario for Tarek.

C] Income-Sensitive Repayment Plan (PAYE - Pay As You Earn): -

Under PAYE plan, your EMI can be set between 10% to 20% of your discretionary income. The tenure is extended up to 20-25 years. The balance amount left at the end of the tenure will be forgiven; however, you have to pay taxes on the amount forgiven.

Tarek's discretionary income is $ 4,810 p.m.

In the standard repayment plan, the EMI was falling at $328.16 which is just 6.82% of the Tarek's discretionary income. If he wants to go with the PAYE plan, he might end up paying higher monthly repayment amount ranging between $481 to $962.

So, it's best for Tarek that he opts for the standard repayment option only which not only reduces his monthly repayment amount but also lowers the total interest repayable at the end of the tenure.

Happy learning!