The truth about student loan repayment

Larry Burchett, M.D., remembers graduating from medical school in 2006, excited that he’d matched to his preferred emergency medicine program and begin training.

“But that first year, it’s hard, man,” says Burchett. “I didn’t expect that; $42,000 doesn’t go very far in California.”

Burchett graduated medical school with about $160,000 in federal student loans, which he still carries today because his rates were fixed at nearly 2% in 2010.

Fast forward to today, where a debt load of roughly $200,000 is the average for physicians graduating from a public medical school, and often well over $250,000 from private or osteopathic programs. With fixed rates as high as over 7%, it’s easy to surmise that Burchett’s profile would be envied by most medical graduates today.

But fortunately for those who are keeping up on an ever-evolving and complex student loan repayment marketplace, relief is available for early-career physicians today.

Evolving options

Increasing physician debt levels and available federal and state repayment and forgiveness options have dramatically changed the economics of becoming a physician, and these factors are beginning to impact the career decisions of young doctors.

Jared Wenn, D.O., is one such graduate; the surgeon is the sole breadwinner supporting his family of four on a training salary.

“I needed to borrow more money than I thought I needed through school,” Wenn says, resulting in federal student loan debt of more than $400,000.

Now, with five years of residency ahead and possibly up to four more years of fellowship, Wenn could reduce his out-of-pocket student loan payments by over $350,000 by pursuing the Public Service Loan Forgiveness Program. Burchett, by comparison, didn’t have this program available when he graduated in 2006.

Medical trainees today can uniquely position for this program by using an Income-Driven Repayment plan while training with a non-profit hospital.

The repayment landscape

For graduates entering training, going into a standard or extended-term payment plan at today’s average debt level and rates isn’t affordable ($200,000 on a 10-year plan is roughly $2,250 monthly), so early-career physicians often seek payment relief throughout training.

REFINANCING

Refinancing is an option for many graduates today. Simply explained, refinancing means a private lender or bank pays your federal student loan debt, and you’re committed to paying a set amount monthly for a set term, at hopefully a lower rate than your federal loans.

When federal benefits such as reduced payments, interest subsidies and loan forgiveness become no longer available, that’s the point when many physicians today can and should lower the cost of their debt by refinancing if possible.

The issue comes with how to leverage the market to find the best rate. Most lenders advertise the same broad range of rates, but the only way to get firm offers is to go through the application and underwriting process, which can be cumbersome and often involves a hard credit pull.

Refinancing products, rates and participating banks have evolved rapidly over the past few years, so it’s important that you have a good understanding of the current marketplace, or have a reliable advocate who can assist with the process and help determine when refinancing is suitable.

INCOME-DRIVEN LOAN REPAYMENT

Now let’s spend some time on the newest and most complex of the federal repayment options today: income-driven loan repayment (IDR).

Of the five income-driven repayment plans available today, there are really three that are most suitable for today’s house-staff and early-career physicians with federal student loan debt: Income-Based Repayment (IBR), Pay As You Earn (PAYE), and the newest available program, Revised Pay As You Earn (REPAYE). Where the term IDR is used below, it is a reference to all of these programs.

INCOME-BASED REPAYMENT

IBR was launched in 2009 and is a federal repayment program that limits monthly loan payments to 15% of your discretionary income.

To be eligible, a partial financial hardship must exist, which means that this 15% of your discretionary income, calculated on a monthly basis, is less than what you’d be required to pay on a 10-year standard repayment plan.

This hardship exists for most trainees with federal student loan debt, as 15% of the discretionary income for a single resident with a $50,000 salary would result in roughly a $400/month payment. The 10-year standard monthly payment on $220,000 of debt, by comparison, would cost about $2,500/month. Clearly, a hardship exists.

IBR is also a qualifying repayment plan for the Public Service Loan Forgiveness (PSLF) program. Taxable loan forgiveness is granted through IBR after 25 years of repayment. However, payments in IBR are capped at the 10-year standard payment amount established when the borrower entered IBR. Because of this cap, many attending physicians would pay off their loans through IBR before the 25-year forgiveness period expires.

IBR is least used by today’s graduates with the introduction of these next two options.

PAY AS YOU EARN

PAYE was launched in 2012.PAYElimits payments to 10% of a borrower’s discretionary income (instead of 15%), and taxable loan forgiveness would be granted after 20years of repayment.

The payment cap is also the borrower’s 10-year standard repayment amount, and PAYE is a qualifying repayment plan for PSLF as well.

Only borrowers who have no outstanding balance on a federal student loan issued prior to October 1, 2007, and who took out a federal student loan on or after October 1, 2011, are eligible.

REVISED PAY AS YOU EARN

REPAYE become available in December of 2015, and it may make sense for continuing house staff to consider entering it. It offers:

• 50% of accruing interest paid by government (unsubsidized loans become partially subsidized!)
• 10% of discretionary income required (just like PAYE), and also PSLFeligible. If you switch into REPAYE from IBR, the 10-year forgiveness clock won’t reset (unless you consolidate)
• Household income will be used regardless of how you file taxes
• 25-year taxable forgiveness for graduate students
• No cap to payments (10-year standard in IBR& PAYE)

Once you enter one of these IDRs, you cannot be removed from it (although you can switch between them as appropriate), even if the hardship that qualified you does not exist after training. (Hopefully the hardship does not continue, and you have an increase in income!)

Therefore, a critical part of your repayment strategy is to perform an analysis and determine the best course of action based on your salary and sector of employment after training.

Paying more

I’m often asked, “If I can afford to make larger payments than required in an IDRwhile I’m in residency or after, should I?”

This is an important question, and my answer is somewhat counterintuitive. I generally believe you should NOT pay more than required through an IDR during training, because those overpayments likely compromise both your subsidy savings and potential loan forgiveness.

In addition, unlike in forbearance, interest is not capitalized while you’re in training and have the hardship that qualifies you for these programs.

Instead of overpaying on your loans, I would suggest placing that extra in a money market or savings account. Even if you get 1% return on these funds, it’s actually outperforming the accruing interest on your loans because the interest isn’t capitalizing during your training.

If your employment after training no longer positions you for significant loan forgiveness, you’ll be able to apply this savings toward the repayment of accrued interest before it capitalizes.

If you remain employed by a non-profit or government entity after training, this savings can be retained and allocated to other vehicles.

PUBLIC SERVICE LOAN FORGIVENESS

Often the most generous federal program young physicians can leverage today is the Public Service Loan Forgiveness Program (PSLF).

Approved by Congress in 2007, this program provides tax-free loan forgiveness for anyone employed by a federal, state or local government organization, or directly by a 501(c)(3) nonprofit.

For a majority of medical graduates, full-time qualified employment combined with 120monthly payments (10years) under an income-driven repayment plan (IDR) can result in a much lower out-of-pocket cost than the amount borrowed.

Many medical graduates begin pursuing this program at the onset of training, as their residency years usually count as public service, and the IDR plans make economic sense during that time. As a result, there are an increasing number of physicians who are seeking PSLF-qualified job opportunities post-training today.

Due to an evolving legislative climate, recent and proposed changes may impact the appropriate action plan to maximize PSLF, and understanding this marketplace can only help you.

Understanding your salary equivalent

An overlooked yet critical consideration for medical trainees today is what I call the “PSLF salary boost.”

Though it’s understood that academic positions typically offer lower salaries than private practice roles, “the gap between academic and private salaries is closing,” says anesthesiologist Mike Greenberg, M.D., who graduated from St. George’s University in 2014 and transitioned to an academic position at Johns Hopkins after four years of PSLF-qualified training.

“For me, pursuing PSLF was a no-brainer,” Greenberg says. But several years ago, misinformation and a lack of education at medical school graduation left many graduates unaware or misinformed about how to maximize this opportunity. Greenberg took it upon himself to learn about the PSLF program and eventually found Doctors Without Quarters (DWOQ) to guide him while he focused on his training.

As Greenberg can attest, student loan savings should be factored into the economic analysis of any PSLF-qualified job. This can often make nonprofit roles more economically attractive than for-profit opportunities.

In the chart above, the salary “boost” is represented for a graduate who had $250,000 in debt at graduation, did four years of training with a PSLF-qualified employer, and then was offered two jobs: one with a nonprofit at $175,000 in starting salary, and one with a for-profit at $200,000.

For the six years following training, the nonprofit salary was worth an additional $73,000 per year when PSLF savings was contemplated as a pre-tax salary boost.

The risks of repayment plans

Recent headlines about 99% of Public Service Loan Forgiveness applications being denied have created unnecessary alarm for many graduates pursuing PSLF. These headlines certainly do not inspire confidence for those purposely paying the least amount possible with hopes of having their debt forgiven tax-free, but these headlines were no surprise to this author.

The PSLF program was introduced 11 years ago with little media attention and even less guidance from the U.S. Department of Education and their loan servicers. Borrowers likely pursued PSLF without reading the details of how the benefit worked. Here’s a quick list of the reasons PSLF applicationsare denied:

• Ineligible loans: Only federal direct loans are eligible for PSLF. Federal Family Education Loans (FFEL), Perkins, private and other types of loans are not eligible.
• Insufficient payments: People applied for forgiveness prior to making the necessary number of payments, thus increasing the number of denials.
• Wrong repayment plan: We have seen many new clients using extended and graduated repayment plans that are not PSLF eligible.
• Paperwork errors: Of the denied applications, 28% were due to missing or incomplete information.

By using the Employment Certification Form for PSLF, available from the Department of Education, graduates with direct loans using an IDRwhile working full-time for a qualified employer receive confirmation of qualified payments along the way.

Regarding future changes to PSLF, borrowers at nonprofit programs should be reassured by a few things. For one, the Master Promissory Notes you signed to borrow each loan for medical school included language about PSLF and your right to utilize the program.

Thus, a legal contract between you and the federal government says you borrowed under the assumption that you’d be able to utilize the PSLF program under the terms of the program at the time you took out the loan.

Secondly, if you’re actively working towards repaying your loans through the PSLF program and have made economic decisions based on the program’s details, you’ve demonstrated a reliance on the terms as they exist today. As such, the federal government may be obligated to grandfather you and others in the same situation through any changes to the laws.

Even if you do everything right in the pursuit of PSLF, there’s still risk associated with waiting 10cumulative years before applying for this tax-free forgiveness.

For example, a client of ours who was six years into practice with a 501(c)(3) hospital was recently notified that his employer was being bought by a for-profit organization. Through no action of his own, once his paycheck is being issued by the hospital’s new owner, he’s no longer PSLF-eligible and would need to change jobs to remain on track for forgiveness.

Physicians should always be saving money to grow alongside accruing interest while they are making reduced loan payments through an IDR in the case of unforeseen circumstances that disqualify them from loan forgiveness.

Navigating the complexities

If you’re not staying abreast of your options as you progress in your career, be sure to identify and work with an advocate incented to help you maximize your savings vs. those who may have a conflict of interest, such as a lender or servicer.

Also, take note that traditional financial advisors, including those with CFP designations, are usually not trained on the concepts covered in this article.

The student loan repayment marketplace has become much more complex over the past decade. And though debt levels are high, unique and often substantial opportunities for savings exist for those who navigate the marketplace strategically.