[Editor's Note: We've had a big focus this last month on student loan management for the New Year and The Physician Philosopher wanted to get in on the action with a post about “laddering” your loans to get the best rates and cashback on refinancing your student loans while you are busy paying them off. ]
There is an elephant in the room when people finish their medical training. It is called student loan debt. Some choose to pursue student loan forgiveness options, while others choose to refinance their student loans. Then, they start making their monthly payments. This is where the thought process usually stops. For those that choose to refinance their student loans, you need to know about one other technique: using a student loan refinance ladder.
Let’s discuss what this is, why it might be beneficial, and work our way through an example of how you might apply this along the way to destroying your student loan debt.
Student Loan Refinance Ladder
I’ve advised multiple residents to consider refinancing their student loans multiple times as they finish up training.
I even discuss refinancing more than once in The Physician Philosopher’s Guide to Personal Finance.
Then, I recently heard a podcast featuring Travis Hornsby over at The Student Loan Planner. Leave it to him to come up with a good name for this multiple refinance process: the Student Loan Refinancing Ladder.
Student Loan Refinancing Basics
Not everyone should refinance their loans. Let’s discuss some of the basics behind student loan refinancing. Then, we will be better prepared to discuss who should consider using the student loan refinance ladder.
Note: The most important thing to say upfront is that refinancing student loans is NOT like refinancing a house. There is no cost to refinancing student loans (unlike refinancing a house, which costs a good chunk of change). This is why the student loan refinance ladder discussed below works.
First, if you are planning to pursue student loan forgiveness, you should not refinance your federal student loans.
However, private loans cannot be forgiven through federal programs. So, feel free to refinance private loans even if you have federal loans (you can deal with them separately).
Next, it is good to know that student loan interest rates are based on the LIBOR (London Inter-bank Offered Rate), which changes monthly. This means, that – as interest rates rise – there is a chance that your rate could also increase if you refinance. So, if you still have a boatload of student loans, refinancing may not be the best option in this situation.
Fortunately, you can get quotes before you actually refinance (the quotes are a “soft check” that do not count against your credit). So, you’ll know if the LIBOR rate has changed and whether your rate stands to improve or not.
For example, you could refinance to a 20 year fixed rate to lower your monthly payment (for those private practice doctors who need to increase cash flow so that a bank will let you buy into a business).
Then, after you are approved, you could refinance again to lower your interest rate by getting a shorter term with a variable rate (e.g. refinancing with a 7-year variable rate).
Student Loan Refinance Ladder Case Study
Let’s take the graduate from medical school with $200,000 in student loans earning 7% interest (~$14,000 annually).
In this example, let’s say she is single and intends to go into private practice after her five-year general surgery residency. She wants to minimize the total amount she pays back on her student loans, and plans to have them paid off in two years after finishing residency.
Even though private refinancing options exist for residents, REPAYE is the clear winner in this doctor’s situation. Through REPAYE, she knows that she will have half of her unpaid interest (as much as $7,000 but usually less) paid each year by the U.S. Department of Education.
Given the interest that is paid on her behalf, this effectively lowers her interest rate through REPAYE to as low as 3.5% (although usually a little higher). This is better than what she is likely to get through private refinancing options while making a resident salary.
So, she wisely chooses REPAYE for the first four years of her residency training.
Using the Student Loan Refinance Ladder
In July of her last year in training, she lands her dream job in private practice. She has signed on the dotted line for a $250,000 salary. She will make more when she becomes a partner. This places her Debt to Income Ratio (DIR) at < 1, which is a situation where I encourage doctors to refinance their loans.
She refinances with the first company, earning her a cashback bonus, through the Student Loan Refinance page. Some companies require a zero dollar payment if you refinance with a contract in hand as a resident, though she plans to continue making the same payment she had been previously under REPAYE.
Her interest rate drops below her “effective interest rate reduction” she was receiving through REPAYE for this year. She can also throw any additional money (say, from moonlighting income) she has at these loans without getting hit by a fee.
Interest rates continue to decline. So, she chooses to refinance with a different refinancing company to lower her rate even further when she becomes an attending physician. She knows that she will be buying into a practice, and so she chooses a 15-year term to increase cash flow so that the bank will lend her the money.
Six months later, she refinances one last time with a third company to a 7-year variable rate. The shorter term-length lowers her interest rate, and she plans on paying the loans off in 3 to 5 years anyway.
What’s the Outcome
In the example given above, this financially savvy doctor has accomplished a lot.
She minimized her debt in training utilizing REPAYE. Then, she used a student loan refinance ladder to earn ~$1000 in cash back during the process. She could have earned more, if she refinanced with some other companies, too. Remember, there is no limit.
In addition, the lower rate that she received through refinancing is sure to save her thousands of dollars during the time she pays back her student loans.
[Editor's Note: Even if rates don't drop, as you shorten your term, change to variable rates, improve your debt to income ratio, and increase your credit score, you may often still qualify for a lower rate. Refinance early and often.]
Knowledge is power. By realizing that you won’t incur any costs when you refinance your student loans, and that there is no limit to it… real benefits can be found in using a student loan refinance ladder.
I’d love to hear from those of you who have refinanced multiple times. If you are considering doing this, but haven’t – what’s holding you up? Leave a comment below.