By Andrew Paulson, CSLP, Lead Student Loan Consultant and Co-Founder of our partner site StudentLoanAdvice.com
With less than a month before the loan holiday was to end in May 2022, the US Department of Education has postponed federal student loan payments yet again. Direct federal student loan payments have been on hold now for more than two years dating back to March 2020, and now, those who took out loans don't have to begin paying them back until at least September 1, 2022.
There is a school of thought that says now that the student loan holiday has been extended yet again, maybe you should continue paying down your loans. I will discuss why that’s a bad idea for those going for student loan forgiveness—and why it’s both good and bad if you still have big student debt from medical school (or grad school) but aren’t going for forgiveness.
First, let’s review how we got here:
In March 2020, President Donald Trump, by way of the CARES Act, froze interest and payments for borrowers with direct federal student loans. This also provided relief for borrowers in default. The first extension was set to expire in September 2020. With the pandemic continuing to wreak havoc on the world, it was postponed until January 2021. President Joe Biden has continued in lockstep with additional loan extensions.
As is generally the case for either party that holds the White House when midterm elections roll around, Democrats face a steep climb to retain seats and their control in Congress. I expect another extension just before the mid-terms in November to bring younger voters to the polls and even up the race in Congress. If student loans are pushed back again, assume that payments will resume on January 1, 2023.
2 Common Paths for Paying Down Student Loans
Two of the most common paths for paying down your loans are:
- Income Driven Repayment (IDR) to Public Service Loan Forgiveness (PSLF)
- Private Refinancing
There are a select few of you pursuing 20-25 year taxable loan forgiveness. But most high-earners who read this blog would never need to consider it an option unless they're in a specific situation.
Let's discuss these two common paths and a way to think about them while the student loan holiday still exists.
Why It’s a Bad Idea to Pay Now If You ARE Going for Student Loan Forgiveness
If you are going for student loan forgiveness, your objective is to minimize your monthly payments as much as possible. While payments and interest are on hold, each of these months will count as credit toward your forgiveness track even if you're not actually paying any money (remember, to reach PSLF, you need to make 120 on-time payments). For those pursuing PSLF, all you need is qualifying employment—full-time employment at a non-profit or 501(c)(3)—for these months to count as credit.
At this point, you’re not required to make a monthly payment on direct federal student loans. This means you shouldn't put money toward your federal loans unless you are trying to pay them off before you reach forgiveness. Each dollar you don't pay to your loans is a dollar you can repurpose any way you’d like, whether that’s saving for retirement, saving for college, buying a rental property, or purchasing that dream home.
Making payments to your servicer now when you’re going for forgiveness is like throwing your dollars into a black hole. Just remember, you want to MAXIMIZE your forgiveness at this point and not pay a penny more.
These months with $0 required monthly payments count toward those 120 payments just as much as those high monthly payments you were making pre-pandemic— or those payments you’re anticipated to make when your income jumps after training and when the student loan holiday ends.
Why It’s a Good Idea to Pay Now If You’re NOT Going for Student Loan Forgiveness
If you’re not going for student loan forgiveness, there’s a good chance you should be paying down your student loans now if you have a long-term horizon of 15-20 years. The reason is that most people not pursuing loan forgiveness will privately refinance their student loans, because they can typically cut their interest rate in half. This process can save the borrower thousands of dollars in the long run.
Many planning to refinance their federal student loans have stayed on the sidelines during the federal loan holiday, stacking those Benjamins in a high-yield saving account, an index fund, or their favorite crypto. There was no reason at the time to privately refinance, because they would be excluded from the 0% interest, would have to begin repayment earlier when the rates were still low, and would lose the chance that all or a portion of their loans were covered through widespread loan forgiveness.
However, with inflation spiking to the highest its been since the 1980s, the Federal Reserve has begun raising rates to help offset inflation. The first rate hike was in March 2022, and the Fed has indicated there will be more during the year.
Those who are planning to refinance over a long term could end up worse off if they don’t refinance their loans now with interest rates rising. Here are two examples that help explain it:
1) A dentist owes $350,000 in student loans at a 7% interest rate. Their loans are growing at $24,500 per year ($350,000 * 7.00%). The borrower, who continues to pay nothing during the loan holiday, then refinances to a 20-year loan at 4.5% at the end of the federal loan holiday.
2) A doctor owes $350,000 in student loans at a 7% interest rate and decides to opt out of the federal loan hold and refinance now to a 20-year loan at 3.5% before the interest rates continue to rise.
- Monthly payment = $2,214
- Interest paid $181,425
- Total paid = $531,425
- Monthly payment = $2,030
- Interest paid = $137,166
- Total paid = $487,166
The difference? The doctor is out of debt four months earlier and pays ($531,425-$487,166) $44,259 less than the dentist does. The reason why the doc pays less is because of the lower interest rate, even though they started paying their loans earlier and didn't take advantage of 0% interest.
Please note: I'm not suggesting rates will go up 1% by the end of the year, but they certainly could.
What if you’re planning to live like a resident or pay your loans down in less than 10 years? Let’s discuss this in the next section.
Why It’s a Bad Idea to Pay Now If You’re NOT Going for Student Loan Forgiveness
It could be a bad idea to pay down your loans now even if you aren’t going for student loan forgiveness. As mentioned above, most who are not planning on loan forgiveness will privately refinance their student loans.
Many of those are considering the risk of waiting to refinance their private loans with interest rates rising. Those who are planning to refinance over a short term (5-7 years) could end up better off if they don’t refinance their loans now. Let me explain with these two examples:
1) A dentist owes $350,000 in student loans at a 7% interest rate. Their loans are growing at $24,500 per year ($350,000 * 7.00%). The borrower then refinances to a five-year loan at 3.5% at the end of the federal loan holiday.
2) A doctor owes $350,000 in student loans at a 7% interest rate and decides to opt out of the federal loan hold and refinance now to a five-year loan at 2.5%.
- Monthly payment = $6,367
- Interest paid = $32,027
- Total paid = $382,027
- Monthly payment = $6,212
- Interest paid = $22,695
- Total paid = $372,695
The difference? The dentist and the doctor will now pay a much similar amount to pay down their student loans. But the doctor still pays a little less because of the lower interest rate.
Again, I can’t provide you with certainty that rates will go up 1% by the end of the year, but they certainly could. This is definitely a situation that merits your consideration when running the numbers.
I understand your situation might not exactly fit the example. Whatever you are considering—PSLF, private refinancing, or maybe a mix of the two if you and your partner both have loans—don’t wait to execute on the optimal plan. The only thing I can provide you with certainty is that student loan rules and laws will not stop changing.
Quit wondering about how you’ll tackle your student loans and let an expert guide you through your options today!
Are you thinking about making payments during the student loan holiday? Why or why not? Comment below!