Anyone who graduates with massive student debt has some tough choices to make. Refinance with a seemingly cheaper private loan? Keep your federal student loan and pay it off in the usual way? Take advantage of forbearance to defer payments? A look at three new doctors, each facing $ 250,000 in debt, highlights shocking differences between each choice.
As their cases illustrate, the best option is often not the most obvious, and one repayment method could save nearly $ 200,000 over the life of the loan.
In my previous article on private student loans, I pointed out that students should consider taking out federal student loans before taking out private loans. Federal student loans offer protections and benefits that private student loans probably do not have. Federal loans can be canceled if the borrower dies or becomes totally and permanently disabled. In addition, borrowers can have access to income-tested repayment plans (IDRs) and loan cancellation programs.
Sarah was my example in this article. She is a physician and earns $ 250,000 per year and has a federal loan balance of $ 250,000 with an interest rate of 6% and monthly payments of $ 2,776 over 10 years. Sarah learned that she could reduce her payment to $ 2,413 per month by privately refinancing her federal loans, saving her $ 43,000 over 10 years. But are there any advantages for Sarah to keeping her loans in the federal system?
What if she thought about starting a family and possibly working part-time in a few years? If she refinanced with a private loan, her payments would be stuck at $ 2,413 per month even if her income temporarily declined while she was working part-time.
If she kept her loans federally, Sarah would have some flexibility in how much she has to pay each month. First, she can pay more than her minimum monthly amount in any repayment plan if she wants to pay off her loans faster. She may also have the option of signing up for an income-based repayment plan and making much lower payments when and if her income declines.
Under iIncome-Based Repayment Plans (IDR), the borrower’s minimum monthly payment is calculated based on part of his income. The borrower may not be required to repay the full loan amount. This is different from the standard federal repayment plan or private loans, which require the borrower to pay the principal and interest on the loan in full over a fixed term. For example, if Sarah got married, had a child, and her income temporarily dropped to $ 150,000, she may be eligible for one of the IDR plans, such as the Pay As You Earn (PAYE ). Then her minimum monthly payment could be reduced to $ 978.
So, for Sarah, the possibility of saving $ 43,000 with a private loan may not be as good as it seems at first glance. The flexibility of the federal loan for changing life circumstances may be worth it for her.
To see how Income Based Repayment Plans (IDRs) and forgiveness programs work together, let’s take a look at another example. Jimmy is a recent medical school graduate who earns $ 60,000 a year in a residency program with $ 250,000 in federal student loans. He estimates that it would be difficult to pay $ 2,776 per month in the standard 10-year plan or $ 2,413 per month after refinancing. He wonders if he should seek forbearance from withholding payments until he can afford the high payments as an attending physician, just like one of his medical school classmates, Tom, decided to do it after graduation.
My answer to this question is no. Instead of asking for a forbearance, Jimmy should consider signing up for an IDR plan (just like Tom). For example, in the Revised Pay As You Earn (REPAYE) repayment plan, he would be required to make monthly payments based on 10% of his income for up to 25 years, and the remaining balance would be canceled and taxed. as an income. If Jimmy’s loans are REIMBURSEMENT eligible, his monthly payment would start at $ 337, freeing up $ 2,439 per month compared to the standard plan!
But why should Jimmy choose to make payments when he has the option to suspend payments using medical residency forbearance? This becomes evident when you consider how forgiveness programs work. To see how much they could potentially save with one of the forgiveness programs, let’s say Jimmy and Tom will be working for a nonprofit or government employer while they pay off their loans, making them candidates for the forgiveness. public service loans. (PSLF).
Under the PSLF program, Jimmy would only make 120 payments in an IDR plan (REPAYE in his case) based on his income and get the remaining balance tax-free, meaning he would have to try to pay it back. the least possible. Assuming he receives his monthly payments calculated on the basis of his resident salary of $ 60,000 for five years before starting to earn $ 250,000, he can be done with his loan repayments after 10 years of payments totaling approximately $ 141,000!
Compared to the standard 10-year repayment plan – in which he pays a total of $ 333,061 including principal and interest – he would save over $ 190,000 by continuing to forgive the civil service loan.
Because Jimmy started his eligible PSLF payments based on his lower salary as a resident, he gets his loans canceled sooner and pays less in total than Tom, who opted out and waited to enroll. to an IDR plan and to continue PSLF until after the residency. Assuming Tom had the same loans and circumstances as Jimmy but made all of his eligible PSLF payments based on a salary of $ 250,000, Tom would pay a total of around $ 263,000, or over 121,000. $ more than what Jimmy paid in total.
As you can see, it’s important to explore your options if you have student loans (especially Federal Student Loans) and have a strategy that aligns with your life and career plans. It can save you tens or hundreds of thousands of dollars.
Perhaps more importantly, knowing that you have a plan and that you are in control of your debt can help you prepare for life’s events and give you peace of mind. However, it is a complicated process full of pitfalls. If you don’t know what to do with your student loans, contact a student loan professional!