[Update March 2018: This post was updated a bit. When originally written, there was no PAYE or REPAYE. Be aware that the Obama Administration, the Trump Administration and our current Congress have considered changes to the PSLF program. There is significant legislative risk to relying on this program. I think the best way to deal with that risk if you are going for PSLF is to save up a side fund with the money you could have used to pay off the loans in 2-5 years after residency. If the program goes away, use the side fund to pay off the loans. If it doesn’t and your loans are forgiven, add the side fund money to your retirement nest egg.]
There was a recent, excellent discussion, over at the Bogleheads. A new poster showed up who happened to be an emergency physician with a large student loan burden at a high-interest rate. He wanted to know if he should pay down the loans or contribute to his retirement accounts. The problem was that he had not yet made a decision about Public Service Loan Forgiveness (PSLF), which he could be eligible for. The second decision is dependent on the results of the first decision. If you’re going for PSLF, you only want to pay the minimum on your loans. However, it quickly became evident in the conversation that not only did we not have the information needed to do a proper analysis, but we didn’t know how to do the analysis either. This post is my attempt to do an analysis on the PSLF vs Refinance and Pay Off decision.
Let’s take a physician with an income of $250K, who owed $300K in student loans at 7% upon medical school graduation. He just finished a 3-year residency at a 501c3 institution during which he made 36 Income-Driven Repayment (IDR) (IDR includes IBR, PAYE, and REPAYE) payments of $300 a piece. He has started his first job at a 501(c)3 institution, and so if he makes his next 84 IDR payments, the remainder of his debt will be forgiven. He also has the option to refinance his student loans at 3%, and thinks that by living like a resident, he could pay them off in 3 years while making his retirement plan contributions. Should he go for the PSLF or Refinance and Pay Off?
The PSLF Option
Now, he only had to pay $300 a month ($3600 per year) as a resident, and since this loan accrued $21K in interest per year, he now owes approximately $352K. The IDR payments, however, are calculated on a ten year schedule starting at medical school graduation. That payment is $3,483 per month. If he makes 84 of those payments on this 7% $352K loan, after 84 months he will have paid a total of $292,572, but only $154,388 of that will have gone toward the principal, so he will still owe ~$192K, which will be forgiven if the program is still in place and remains non-means-tested.
Refinance And Pay Off
The other alternative is to refinance the loans upon residency graduation at 3%. Since he will only have the loan for 3 years, and he has a high income, the risk of a variable rate loan is one he can take. In order to have a 3%, $352K loan paid off in 36 months, he would need to make payments of $10,237 per month. After 36 months, he would have paid a total of $369K.
So Which Is Better?
He will pay less money, especially when you consider the time value of money (money paid toward a loan 6 years from now is less valuable than money paid toward a loan this year), by going for the Public Service Loan Forgiveness program. Essentially, he’ll save himself around $76K despite paying at double the interest rate for over twice as long. In the end, nearly 2/3 of his original loan will be forgiven. He will have to run the risk that the PSLF program goes away, or that it is modified significantly such that it becomes means-tested, in which case he might not be eligible for forgiveness or might receive much less than planned. He will also be locked into a 501(c)3 job for at least 7 years, potentially giving up income, freedom, and opportunity. If he leaves that job, or the program is significantly modified, he will come out way behind.
The cash-flow issue is also not insignificant. Payments of both $3,483 for 7 years and $10,237 for 3 years are not insignificant. It would be tough to max out retirement plans, live a reasonable life, AND pay $123K per year toward student loans for 3 years on a $250K income. It is doable, but you would have to live like a resident for 3 years. The other option isn’t great either. Although your cash flow would be much better for the first 3 years, it would be much worse for post-residency years 4-7, when most docs really find it difficult to continue living like a resident. I’m not sure which is worse from a cash flow issue.
In the end, someone who is eligible for PSLF is almost surely better off paying the minimum IBR payments and getting the PSLF. Longer training periods and larger debt burdens make this option even more advantageous.
What do you think? Are you PSLF eligible? Will you be going for that, or paying off your loans as soon as possible? Comment below!
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Fixed 3.75% - 7.03%
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Fixed starts 3.35%
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Fixed 3.20% - 6.25%