High Level Summary of this Post:
No one knows what will happen to the public service loan forgiveness program (PSLF). Regardless, you should absolutely select the best income-driven repayment plan for you, from among PAYE/REPAYE/IBR and keep making the smallest possible payments (thus maximizing the forgiveness potential) on loans which are eligible for forgiveness AS IF PSLF will be around.
Yes, minimizing your payments will increase the length of your loan and result in more overall interest due if PSLF goes away. But that’s not a problem, if you take the extra cash flow from the reduced loan payments and save or invest the difference, such as using the extra cash to pay down private loans or other loans which do not qualify for PSLF, or perhaps contribute to your 401k or Roth IRA. But if you use the extra cash from the reduced loan payments to increase your spending, you risk a substantial future financial shock should PSLF be reduced or disappear.
Don’t forget that there are benefits from using a PSLF qualifying plan which do not depend on PSLF. For example, there is the possibility for immediate “forgiveness” (for example, via an ongoing subsidy using REPAYE) on at least a portion of the interest. That’s essentially money you get to bank today, regardless of what happens to PSLF.
[Note, I am not going to describe the PSLF, what loans are eligible, etc. A future post (hopefully) will briefly summarize the pros and cons of the 3 income-driven plans you should consider using under PSLF. For details on PSLF, the Department of Education’s website on this is excellent. And everything you need to know is compiled here.]
Full Post
[DISCLAIMER: The details of the various repayment plans can get quite involved. Despite the time I’ve put into researching these, I would not yet call myself an expert. I have talked with self-proclaimed experts who disagree on the some of the details. Please don’t make any decisions based on the information below without independent verification!]
I often get asked my opinion about whether the PSLF will be available to those who recently started making qualifying payments and work for an eligible institution, as is the case with most medical residents. The short answer is “I have no idea”, and neither does anyone else. The law which sets the rules for PSLF can be changed at any time. People currently eligible for PSLF may get grandfathered into the current rules, or they may not.
The PSLF program is very expensive, and the people who will benefit most are those with the largest loans, which include physicians. Loan forgiveness for “rich” doctors does not enjoy broad-based public and bipartisan political support. In fact, many of the Obama administration’s previous budgets had proposed capping PSLF to about $60,000, but these budget proposals were not enacted by congress. PSLF remains a ripe target for termination or substantial modification.
So how should you plan your finances given this uncertainty?
If you are contemplating taking out new student loans, you should certainly not make any borrowing or career decisions based on PSLF. If you are currently a medical or other professional student, I urge you to consider your career options with the assumption that PSLF will be gone. That is, you absolutely need to assume none of your loans will be forgiven. PSLF should certainly not be used as a method to borrow more than you (or your future you) can afford. I know medical residents with over $500,000 in student loans who are pursuing relatively low paying academic jobs in, for example, general academic pediatrics or neurology. If they don’t get substantial loan forgiveness, their financial success is tenuous. An analogy I often use is this: you would never borrow a million dollars to open a cozy corner coffee shop and have any hope of paying off the debt. Unfortunately for most medical students, the debt is “on the books” long before they have any idea what kind of job they may want and the resultant salary.
If you are a medical resident who has already taken out large loans and are about to start repayment or are currently in repayment, what should you do? There are two main possibilities: 1) choose a standard 10-year repayment plan and/or pay off the loans as aggressively as possible or 2) choose an income-driven repayment plan where the “underpayments” below the 10-year repayment amount will (potentially) qualify for forgiveness.
Let’s take a hypothetical borrower, who is a first year medical resident, single, with $200,000 in qualifying loans at a 6% interest rate, and who has an income of $60,000. Then at the end of residency, assume he/she will accept a job making $200,000. Over half the residents at the programs I am affiliated with have $200,000 or more in debt, so this is certainly not an atypical situation.
For this resident, paying back the loan under a standard 10-year plan will cost $2,200/month or (rounding) $26,000 per year. That’s a huge monthly payment with a salary of $60,000. I would say that few residents can afford these payments at all. So there may not be a choice of whether to use income-driven repayment. But assuming it’s possible, after 10 years the loan will be paid off and you will have paid a total of $66,000 in interest, and the loan is not eligible for PSLF (due to no remaining balance to forgive).
Suppose instead the resident chooses one of the three income-driven plans which qualify for PSLF: Pay As You Earn (PAYE); Revised Pay As You Earn (REPAYE), or Income-Based Repayment (IBR). [Note, there is a fourth, Income-Contingent Repayment (ICR) but most of you should not select this option]. PAYE and REPAYE (and for recent borrowers, IBR) limit the payments to 10% of discretionary income. For this resident making $60,000, the payments under PAYE and REPAYE will be only $277/month or (rounded) $3000/year. Compared to a yearly payment of $26,000, this results in putting $23,000 less dollars towards the loan, which then makes $23,000 potentially “available” for loan forgiveness. Under the PAYE program, this $23,000 is guaranteed to be forgiven in 10 years regardless of future income. With the REPAYE however, loan forgiveness from early underpayment has the potential of being “undone” if income is very high later on, relative to the loan balance. PAYE would seem to be the best option to select if your loans qualify for PAYE. However, there is one big advantage of REPAYE which I describe later. [Also, it is usually possible to select REPAYE early on and then SWITCH to PAYE, which for many borrowers is the optimal plan.]
When salary jumps to $200,000 after a three-year residency, the loan payments under PAYE jump to about $1500/month, or $18,000/year. This is still less than the $26,000/year in payments under the standard 10-year plan. Thus, an additional $8000 per year is eligible for loan forgiveness. In total, the resident will have paid $135,000 in total (compared to $266,000 with the standard plan). That’s a “savings” of $131,000. Which is a LOT of money. Note that the savings is actually going to be much higher, because I’ve ignored the fact that in the first year of residency, the income used to calculate payments will be zero (and thus the payments zero) due to lack of income during medical school. Then the next year, the income is only half of $60,000, due to only having worked July-December of the PGY-1 year. Furthermore, there is a delay between the time of your raise and when your loan payments are re-calculated. Altogether, your total payments under an income-driven program are likely to be much less (and forgiveness much higher) than the estimates above.
So we finally get to the main question, WHAT IF this resident chooses an income-driven plan and then, just before getting forgiveness, PSLF completely disappears with no grandfathering?
The consequence of a vanished PSLF is that you will have essentially been paying 6% interest on every dollar not put towards the loan. Which means all of your spending during that time was similar to putting it on a credit card charging 6% (with perhaps some small tax deduction for the student loan interest). Would you borrow at 6% to pay the rent, go on vacation, eat out?
But what if you did not use the reduced payments to subsidize your everyday spending? If you used that extra money to pay back private loans, which can have interest rates of anywhere from say, 5% to 10%, then you are really no worse and have even come out ahead, regardless of PSLF. Alternately, the savings could have been used to contribute to a 401k, which reduces your taxes, or contributed to a Roth IRA. Either way, you may have “borrowed” at 6% to make those investments, but that money is still there. So while your loan balances may be higher, you have gotten a head start on retirement savings. And depending on how your investments do or have done, you may even come out ahead (not that I advocate intentionally borrowing in order to invest).
The summary is that PSLF represents a potentially massive benefit to you, so you should assume it’s going to be there for you. If PSLF is legislated away (which I don’t believe is even possible!), or if perhaps you do not end up with 10 years of payment in a qualifying job, it’s not a tragedy. The upsides are huge, and the downsides are minimal.
But it is important to note an important benefit of choosing among the PAYE or REPAYE plans which I have not yet mentioned. REPAYE, independent of PSLF, will likely result in some immediate loan forgiveness via an interest subsidy. This can be considered “money in your pocket”, which no one can take away. PAYE also has a subsidy of sorts which affects capitalized interest. These two plans are all slightly different when it comes to the interest subsidy, so I’ll go through them each.
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