What is a grace period for student loans? When you graduate from your degree program, leave school or drop below half time, you get six months where you don’t have to make any payments on your loans. While that sounds like a good thing, in reality, it almost never makes sense to use up your entire student loan grace period.
Notice I said almost, as there are some exceptions. We’ll show you how to best use your student loan grace period for maximum savings below.
Interest keeps growing during the student loan grace period
Only Direct Subsidized Loans accrue no interest during your grace period. If you have these kinds of loans, they’re probably tiny in comparison to your other kinds of student debt.
Direct Unsubsidized, Grad PLUS, and Parent PLUS Loans all accrue interest during your six-month grace period. Those loan types are usually where I see the largest balances as a student loan consultant.
Note that PLUS Loans don’t have a grace period, technically. These are supposed to enter repayment right after disbursement. That said, virtually everyone I talk to utilizes a deferment applied by their loan servicer where the grace period functions the same way as it does for Direct Stafford Loans.
Why your $0 payments during the grace period aren’t that good
Here’s a secret that the loan servicers don’t want you to know: As soon as you graduate and your school updates your information to show that you no longer have an “in school” status (this takes a week or two after you get your diploma sometimes), you’ll be able to consolidate your federal student loans.
If you apply before you receive your first pay stub, you can use your prior-year tax return, which likely shows a $0 income.
That means your payments under either the 20-year Pay As You Earn (PAYE) plan and 25-year Revised Pay As You Earn (REPAYE) plan would be $0 a month for the first year after certification.
If you utilize your entire grace period, you might feel too guilty to use your prior-year tax return, which means you’d be paying 10% of your income instead when you certify. That simple decision could cost you thousands of dollars in the first few months after graduation.
Remember when I said you get charged the full interest amount during your grace period? If you use REPAYE with this $0-a-month payment strategy, your interest will be subsidized at a 50% rate on all Stafford Unsubsidized and Grad PLUS Loans.
Pretend you plan to pay back your $200,000 debt from medical school, and the current interest rate is 7%, or about a $14,000 yearly interest hit. On REPAYE with a $0-a-month payment, you’d only have half the $14,000 accrue in the first year, or $7,000.
If you need to pursue filing taxes separately to exclude your spouse’s income from the payment, you might do the PAYE plan instead.
Either way, you’re getting credit toward forgiveness at rock-bottom payments. That might change at some point in the future, but it’s currently the way the servicers certify your payments.
When should you use the student loan grace period?
I can only think of three scenarios where you’d want to actually use your student loan grace period:
1. You have Perkins or Stafford Subsidized Loans or health professions student loans that accrue 0% interest during the grace period
Did you know that if you have student loans issued to you at a 5% interest rate, they’re probably Perkins Loans or health professions student loans administered by the Health Resources and Services Administration? Another dead giveaway is if that debt is at a 5% rate and it’s managed by Heartland ECSI.
These types of loans typically have a 12-month grace period after you graduate, during which period you accrue no interest. You would want to consolidate and forgo that subsidy if you plan to use the federal loan forgiveness program instead of paying it all back.
2. You earned an income the prior year and literally can’t afford your income-driven payments.
Say you somehow earned $100,000 in school and graduate but also have a bunch of private loans. In that case, it might make sense to use the six-month grace period to focus on the private debt since you’d have to pay 10% of your past year’s income on the federal debt.
3. You want to preserve the Standard 10-year Plan as a repayment option
If you consolidate, you get rid of the Standard 10-year Plan, which becomes a 30-year Standard Plan instead. Note that the Standard 10-year Plan qualifies for Public Service Loan Forgiveness (PSLF) while the 30-year Standard Plan does not. In most cases, borrowers with consolidation loans can use PAYE or Income-Based Repayment (IBR) to get their payment capped at the Standard 10-year amount. However, sometimes I see people on REPAYE whose payments are much higher than the Standard 10-year.
This is incredibly specific and really doesn’t apply that often.
Do private loans have a student loan grace period?
It depends on the lender. Most private lenders recognize that you’re in school and presumably not making an income to pay them. So they’ll put you in a deferment period while you’re enrolled full time.
When you graduate, my experience is that most lenders give you a similar grace period up to six months before asking you to set up automatic payments. You might have to request this, though. Federal loans give you that grace period automatically.
You should probably just consolidate instead
Given that there aren’t many cases where you’d want to use the student loan grace period, I’d avoid it and just consolidate instead for most borrowers.
Payments of $0 a month are much better when they’re counting toward forgiveness or getting interest subsidies under REPAYE or PAYE.
Mistakes using the student loan grace period are widespread, so if you want our help to customize your approach, we’d love to help.