[Editor's Note: This guest post is from student loan consultant Travis Hornsby who helped his physician wife navigate her “ridiculously complex student loan repayment options”. Figuring out what to do with your student loans can be a complicated process and if you make a mistake by refinancing under the wrong circumstances it can cost you tens of thousands of dollars. Some situations can be extremely complex. If your situation is complicated you may benefit from consulting with an expert. This post contains some controversial information, which I'll mention in an editor's note at the end. At the time of publication, Travis and I have no financial relationship, although we've discussed some advertising in the past. ]

More Private Sector Physicians Should Avoid Refinancing than You Think

One commonly held assumption by many smart people is that student loans are not complicated as a physician unless you need to take advantage of the Public Service Loan Forgiveness (PSLF) program. If you’re in private practice, then it’s very straightforward, just refinance your loans with a private lender for a lower rate and pay them back quickly.

I used to believe this too until I had hundreds of case studies to look at from real life physicians, many with loan balances that reflect the out of control cost of medical education. In fact, many private sector physicians would benefit from not refinancing their loans. In fact, it’s not even all that rare for refinancing to look inferior mathematically to a longer term 20-25-year forgiveness strategy.

According to the Association of American Medical Colleges, 14% of 2017 grads left med school with over $300,000 in student debt. 48% left with more than $200,000.

That doesn’t tell the full story of how bad physician student loan balances are though. During training, many savvy doctors use Pay As You Earn (PAYE) or Revised Pay As You Earn (REPAYE) to keep their payments low as residents and fellows. These low payments, usually in the $300 to $500 a month range, allow most of the interest to accrue onto the balance. I know this firsthand from my wife’s med school loan balance during her fellowship in urogynecology.

Assume a resident pays for 4 years on PAYE with a $200,000 balance at 7% interest. By the time she becomes an attending, she now owes almost $250,000. Add in a couple forbearances and deferment periods, and it’s easy to see this balance ending up at $275,000 or more.

What’s scary is that I just used the typical debt from a typical med school grad with a normal length of training. The top quarter of indebted physicians likely owe well over $300,000 once they finish training. If you graduated 10 years ago or more, you dodged a bullet if you are the kind of person that would want to always pay back their loans.

Real World Example 1: The A/I Specialist with $400,000

Not every physician lives in exurban Texas with no job market saturation. Let’s assume we have an allergist in Northern California who just signed on to a $200,000 a year job with a private practice. He expects his salary will increase gradually to $250,000 within five years, with 3% inflation level increases after that. He already has five years of credit on the PAYE program when he starts as an attending. Look at these numbers compared to using PAYE for 15 more years vs refinancing to a 3.5% fixed 5-year loan.

Many physicians are well versed in the nuances surrounding Public Service Loan Forgiveness, where forgiveness is tax-free. In contrast, forgiveness while employed at a private sector employer, not only takes longer (20-25 years), the forgiveness is considered taxable income.

In this example, the physician, let’s call him Brad, pays $322,352 in total payments over 15 years (time left to forgiveness on PAYE with a 20-year total clock). At that time, he still owes almost $500,000. He would then have to pay tax on a $500,000 bonus all at once. That would cost him about $200,000 assuming a 40% effective rate. Add up the payments plus the taxes, and the total cost would be about $521,000.

travis hornsby

Travis Hornsby

Would you rather pay $521,000 over 15 years, or would you rather pay $443,000 over 5 years? The answer depends on how you value money. If your target rate of return for your portfolio is 5% though, the answer is clear: you would much rather use PAYE and not refinance in this case.

What’s the breakeven point? About 2%. If you were planning on leaving all your savings in a checking account, yes you would be better off paying the loans down.

However, assuming non-cataclysmic long term returns on equity and bond markets, you’d be making an expensive decision mostly based on what makes you “feel good.”

Real World Example 2: Private Practice Interventional Cardiologist Married to PSLF-Eligible Internal Medicine Doc, Joint Debt $600,000

What about high-income private practice physicians in specialties like cardiology? Surely, they should all refinance, right?

The answer is once again, it depends. There are a bunch of physicians out there who marry other physicians. Let’s look at this example of Sarah, who’s an interventional cardiologist at a private practice. She earns $350,000 a year and has $300,000 of student loans. She met her husband Tom in med school. Tom is an internal medicine doc at the local academic hospital and earns $140,000. He also has $300,000 in student loans. Tom has 4 years of certified PSLF credit.

The trap here is that Sarah thinks “I’m a private practice physician with a debt to income ratio less than 2 to 1, I have to refinance!”

If she does that, suddenly Sarah and Tom go from being a couple with $490,000 of income and $600,000 in debt to a couple with $490,000 in income and $300,000 in debt as far as the federal government is concerned.

If Tom was using the IBR or PAYE plans, his payments would hit the Standard 10 Year Cap of approximately $3,400 a month quickly. However, if his wife Sarah left her loans on the federal system, their combined monthly payment would be about $4,000 a month. This gets split proportionately based on their loan size. Hence, Tom’s payment if Sarah stayed on the federal system would be about $2,000 a month.

Since Tom is eligible for PSLF, the savings from Sarah choosing to stay on the federal system would be about $16,800 a year since PSLF offers tax-free loan forgiveness. If they refinanced Sarah’s loans but filed separately for taxes to only count Tom’s income for his PAYE payments, they would likely incur a tax penalty in the $10,000 to $30,000 range. My guess is that it could easily be about $20,000 a year.

In contrast, if Sarah refinanced to a 3.5% 5-year fixed rate, her interest savings would be about $10,000 a year. If you think about your finances jointly as a couple, it doesn’t make sense to lose over $16,000 to gain $10,000, yet a lot of married physician couples are doing exactly that by having the higher earning private practice spouse refinance.

You can make an argument that PSLF isn’t a sure thing and therefore you shouldn’t count on it, but most people haven’t thought through the problem to this extent. I’ve encountered many couples who’ve jumped at the chance to refinance one spouse’s debt only to obliterate the other’s chance at Public Service Loan Forgiveness.

Real World Example 3: Pediatrician with Large Family and $225,000 of Debt

Let’s look at this example of Amy the pediatrician. She’s married to a teacher, and she earns $120,000 a year at a private practice pediatrics group in a saturated market. She has $225,000 in student loans at a 7% with four years of credit towards loan forgiveness.

Amy prefers having a good lifestyle at work over maximizing income or gaining equity in the practice. She could work longer hours or take on a partnership role, but she prefers to just focus on medicine. The academic hospital in her city has branch offices all over the metro area, which would require significant travel. She has four children, and Amy’s husband Blake earns about $40,000 a year and has no student debt.

We’ll assume that Amy never takes time away from the workforce and continues at her current income level adjusted upwards for 3% inflation over time. Amy’s childcare expenses run about $3,000 a month, thus she can’t afford a 5-year payment schedule without making major sacrifices.

She can afford the 10-year monthly repayment comfortably though. She gets a quote for 4.5% fixed in 10 years and feels pretty good about it. She won’t have much left over for maxing her and her husband’s retirement accounts, but at least the loans will be taken care of, she thinks. Here are some sample numbers below:

I included a couple extra columns compared with earlier. We can see that Amy can pay $224,000 over 16 more years, with a final balance of $252,000. She then owes about $101,000 in taxes. To prepare for this, she would need to save $380 a month in a brokerage account earning 5% a year on average.

The total cost would be $325,000. Compare this to $285,000 over 10 years. If you look at the value in today’s dollars, the PAYE option is cheaper by about $30,000. Additionally, the required cash flow is for a fully implemented PAYE strategy is about $1,000 less a month than refinancing. That money probably comes in handier now than when Amy’s older and her kids are grown.

Here’s where I might really blow your mind. What if Amy plans to max her and her husband’s retirement plans? Let’s assume she puts $18,500 each into both 401k type plans over the course of the year. This increases the attractiveness of PAYE to where it’s not just cheaper on a relative basis, it’s cheaper on an absolute basis by $5,000 AND she gets to pay that sum over 6 more years.

Amy’s $225,000 of debt is not at all unusual for an early career attending physician. Her husband’s $40,000 income will count against her for income-driven repayment too. If she had been a single mom, then going for forgiveness would’ve been even more attractive.

Who is Refinancing Great For?

White Coat Investor has helped hundreds of physicians refinance, and certainly, it’s great for many individuals. Refinancing and paying down your med school debt in less than 10 years (and preferably less than 5) can be a wonderful way to race to financial freedom.

Private practice physicians who refinance often have a combination of these factors:

  • Household debt to income ratios below 1.5
  • Spouse that could not benefit from PSLF
  • Smaller family size
  • Desire to reach financial independence from medicine as fast as possible
  • Spouse that earns a lot of money but who also has a minimal amount of debt

Who is Refinancing Potentially Hazardous For?

Once you’ve refinanced, you can’t go back. The refinancing decision warrants an abundance of caution if you have a combination of these characteristics below:

  • Potential that you might now or ever go for PSLF (obvious)
  • Large family size
  • Household debt to income ratio above 1.5 to 1, with no expectation that you’ll hit this level within 5 years (ie you earn $200,000 but have more than $300,000 of debt)
  • Physicians who would like to go part-time or work less for family reasons
  • Private sector physicians with loans married to PSLF eligible physicians with loans
  • Spouse with low or no income
  • More than $300,000 of debt

In Summary

In my experience, private sector physicians who do not need to refinance are far from rare, they’re actually common.

There are far more private practice pediatricians in high population areas like California and New York making $150,000 than there are private practice gastroenterologists in rural areas making over $500,000. Many physicians in both groups, however, have $300,000+ loan balances.

The larger your student loans, the more time you should spend thinking about them before taking an irreversible action like refinancing. The math is more complex than even highly financially literate people realize.

[Editor's Note: First my conflict of interest- Like you, I get paid if you refinance through my links. I do not get paid if you stay in an IDR program, get PAYE forgiveness, or get PSLF. Next, I wanted to make a few points to consider in conjunction with this post.

The first and most important is that I do not think it is wise for a physician to carry her student loans for 20 (PAYE) to 25 (IBR, REPAYE) years unless she is in a desperate financial situation. I know many do, but I think becoming “comfortable with” and “managing” that debt are dangerous for your financial health. If you want to hold on to the debt for 3-7 years after finishing your training because you're expecting tax-free PSLF of it, I can live with that as it isn't that different from paying them off in <5 years. For everyone else, I think you should first consider what it would take to be out of debt within five years of residency. That usually means living like a resident and really focusing on pounding that debt into submission. I mean, you could have had the military pay for school and been out of debt in four years. You really want to have it for 20? Even if you spent 7 years in training making payments the whole time, it's still 13 years out of training (and possibly as many as 17) before your student loans are gone (and that's after paying a massive tax bill on the forgiven amount.) Physician on FIRE and I were both not only out of debt, but financially independent less than 13 years out of training. I like to see you paying off the mortgage on your dream house at that point in your financial life, not just barely getting the student loans out of your life. I just cannot in good conscience recommend you drag your loans out that long even if you can spreadsheet your way to it seeming financially advantageous to do so.

Second, remember that there is generally a tax penalty associated with doing the MFS/PAYE thing. You are weighing lower payments (and thus more forgiveness) against a higher tax bill. That significantly lowers the benefit associated with getting PAYE forgiveness. This penalty will be different for everyone, but be sure to include this in your calculations. 

Third, people worry about the legislative risk associated with PSLF. That could come as little as 3 years away after completion of fellowship. If you're worried that Congress could do something in the ten years between med school graduation and PSLF, you should be REALLY worried that they will do something in the two decades between med school graduation and PAYE forgiveness. Not only is that a lot of legislative risk to run (for example the Obama administration proposal to limit PSLF to $57K) but the longer you run it, the bigger the penalty of not refinancing (i.e. the difference between your federal interest rates and what you could have refinanced to) even if you're smart and keep a “side investment fund” to decrease the legislative risk (i.e. money that you use to pay down/off the loans if you aren't grandfathered in to a change.)

Fourth, keep in mind what happens with the side investment fund in the event that you actually receive PAYE forgiveness- a big chunk of it goes to the tax man instead of your nest egg.

Finally, don't forget a couple of truisms with student loan management- you can always safely refinance private loans since they will never be eligible for IDR programs or PSLF and you must work full-time to get PSLF (but not PAYE).

Bottom line: Be very careful signing on to a scheme that involves you spending most of your career paying for your medical school tuition and making assumptions about future returns, future tax laws, and future changes in student loan programs. In some ways, you're not done with medical school until you're done paying for it. If you are in a complicated student loan situation (such as those Travis illustrated so well above), spend a few hundred bucks on professional advice from StudentLoanAdvice.com.] 

What do you think? Are you in a complicated student loan situation like those discussed in this post? What did you decide to do? How is it working out for you? What would you say to someone a few years behind you? Comment below!