How Does a Repayment Plan Work?

How Does a Repayment Plan Work? article image.

A repayment plan is a way to pay back a loan over an extended period of time, generally by making fixed monthly payments.

Repayment plans operate differently depending on the loan type. Federal student loans, for instance, come with multiple repayment plans to choose from, some of which tie your monthly payment amount to your income. When paying a mortgage, a repayment plan is a program lenders offer when you've fallen behind on payments and want to catch up.

Read on for more about how repayment plans work, and how to choose the best one for your needs.

How a Repayment Plan Works

For many types of loans, a repayment plan refers to the monthly payment and loan term a lender assigns you. The amount you pay per month depends on how much you borrowed and the interest rate. Here are some examples:

  • Federal student loans: Federal student loans come with a range of repayment plan options. In most cases, you'll receive a grace period of six months after you graduate or leave school when you won't be required to make payments.
    Once you begin repayment, the standard repayment plan breaks up the amount you owe into 10 years' worth of fixed payments. But you can also choose the 10-year graduated repayment plan, which starts with lower payments and increases every two years; the 25-year extended repayment plan; or one of four income-driven plans, which limit payments to a percentage of your income and provide forgiveness on the remaining balance after 20 or 25 years.
  • Private student loans: Banks and online lenders that provide private student loans generally do not offer the same scope of repayment plan options. Not all private loans offer a grace period, and income-driven plans are not common. You'll typically make fixed payments over five, 10 or 15 years, and the amount you pay corresponds to the interest rate you receive based on factors such as your credit score.
  • Personal loans: Similar to private student loans, you'll generally repay personal loans in fixed monthly amounts, at an interest rate that depends on your credit score. Personal loan terms are often two to five years.

A repayment plan on a mortgage, by contrast, helps you get back on track after a period of missed payments. While your mortgage lender already charges you a fixed amount per month, a repayment plan adds a portion of the past-due amount to your bill for a period of several months until you're caught up.

It's a strong option if you're now in a better financial situation and you're motivated to avoid falling further behind. You'll need to demonstrate to your lender that you can afford the repayment plan, which may incorporate late fees.

What Are the Benefits of a Repayment Plan?

The right student loan repayment plan can make your payments more affordable while you search for a job and navigate life after graduation.

If you opt for a graduated repayment plan, for instance, you'll make lower payments to start, allowing for some flexibility in the first few years of repayment. An income-driven repayment plan can keep your bills manageable if your loan balance is high compared to your income and you need a long-term affordability solution.

A mortgage repayment plan can be beneficial if you'd otherwise be at risk of foreclosure. If you're coming back from a short period of financial hardship, perhaps due to job loss or medical bills, choosing a repayment plan can get your mortgage back into good standing.

Even if you can't afford to enter a repayment plan now, you may be able to put your mortgage into forbearance until you can. Let your lender know if you're expecting a bonus from work or another additional source of income, and the lender may let you pause payments and start a repayment plan when your income increases.

Is a Repayment Plan the Right Option for You?

Every student loan borrower must sign up for a repayment plan, but it's up to you to choose the one that matches your lifestyle and financial resources. You can compare federal student loan repayment plan options using the government's Repayment Estimator tool.

When deciding whether to opt for a mortgage repayment plan, first consider whether it's possible for you to refinance your mortgage. If you're only just starting to struggle to make payments, you may qualify to refinance to a new loan with a more affordable monthly payment. You'll avoid missed payments appearing on your credit report, and you'll be able to steer clear of foreclosure.

If you don't qualify to refinance, however—particularly if you've already fallen behind on payments—a mortgage repayment plan could be for you. While your negative payment history to date will show up on your credit report, foreclosure would be more damaging. A repayment plan could be the difference between losing and staying in your home, and it's a worthwhile option if you meet the requirements.

The Bottom Line

A repayment plan's terms and benefits depend on the loan it's attached to. When you choose the right repayment plan for your circumstances—and if you opt for a mortgage repayment plan to get back in good standing—you can ensure that paying back a loan won't jeopardize your ability to meet the financial goals that matter most to you.