[My April column in ACEP Now was entitled “Tips for Managing Medical School Student Loans.” It discusses IBR, ICR-A/PAYE, PSLF, refinancing and includes a nice little priority list previously available only to purchasers of my book. I hope you like it. This issue is becoming more and more timely. I have run into a half dozen residency graduates in the last couple of weeks who owe more than $450K just in student loans.]
Debt-consolidation, loan forgiveness programs can help physicians deal with student loan debt
Question: I have heard that there are debt-consolidation and loan-forgiveness programs that might be useful to me. How should I manage my student loans?
Answer: Many established attending emergency physicians are unaware of the incredible size of the student loan burden faced by more recent graduates. According to the Association of American Medical Colleges, in 2012, the average student loan debt among indebted medical school graduates was about $167,000 for MD students. Debt levels are even higher for DO students. These numbers, of course, are mere averages. Twenty-five percent of 2012 graduates owe more than $200,000, and 5 percent owe more than $300,000. I’m confident these sums have not gone down since 2012. Student loan interest rates for those in residency now are no lower than 6.8 percent and sometimes as high as 11 to 15 percent for private loans. At an average interest rate of 8 percent, a student with $300,000 of debt at medical school graduation may owe as much as $378,000 upon completion of residency. Required payments on this debt may be more than $3,600 per month, much more than the typical American, and many a physician, spends on a mortgage. Many of these young physicians also have substantial consumer debt from automobile loans or credit cards. Emergency physicians, however, should count their blessings. Some attending physicians practicing in lower-paying specialties after attending expensive medical schools are now being turned down for student loan refinancing due to their income-to-debt ratio being too high! No wonder young doctors are looking for some relief from this financial pressure.
The Income-Based Repayment (IBR) Plan
Without IBR, most residents would be either bankrupt or forced into forbearance or hardship deferrals. IBR bases student loan payments on income rather than total debt or interest rate. As a result, residents making IBR payments on unsubsidized loans are often paying much less than even the interest on their loans. The IBR plan was recently changed; it is technically a modification of an older loan program called Income-Contingent Repayment, or ICR-A, and is also called “Pay as You Earn.” It caps student loan payments at 10 percent of “discretionary income” instead of the previous 15 percent under IBR. Discretionary income is defined as the difference between adjusted gross income (line 38 on IRS Form 1040) and 150 percent of the federal poverty level, about $18,000 for a single physician and about $36,000 for a family of four. So if you’re a resident making $50,000, your payments are capped at $267 per month if you are single and $117 per month if you are married with two kids. Since the interest alone on a $300,000 8 percent loan is $2,000 per month, you can see that the IBR/ICR-A payments are just a drop in the bucket, and the debt will continue to grow while in the program. When a resident graduates and begins earning a higher income, IBR/ICR-A payments will revert to a higher amount, calculated using the original debt on a 10-year repayment basis. If payments are made every month for 20 years, the remainder of the debt will then be forgiven. However, the typical emergency physician making even the minimum payments will have the debt paid off by then, so IBR forgiveness is really not a factor for most doctors.
Even emergency physicians, with their relatively short residency, can gain substantial benefits from Public Service Loan Forgiveness.
The Public Service Loan Forgiveness (PSLF) Program
PSLF is a type of loan forgiveness that can be beneficial for doctors. If a doctor works for a qualifying 501(c)3 employer, such as the military, Department of Veterans Affairs, a university hospital, or a non-profit hospital, the remainder of the loan forgiveness can be received after 10 years of qualifying payments instead of 20. This is a particularly beneficial program for specialists with long training programs, such as medical, pediatric, and surgical subspecialists. However, even emergency physicians, with their relatively short residency, can gain substantial benefits from PSLF. Basically, you are forgiven the amount by which you underpaid your loans in residency, plus the interest that accumulated because of those underpayments.
Consider again the physician with $300,000 of debt at 8 percent. On a straightforward 10-year repayment plan, the payments would be $3,616 per month. Since three of those seven years were spent on an IBR plan paying $117 per month, then the underpayment is ($3,616 – $117) x 36, or nearly $126,000. However, due to accumulated interest, the amount forgiven after 10 years will be even more, about $252,000. The physician who owed $300,000 upon medical school graduation will end up paying about $308,000 and receiving another $252,000 in loan forgiveness. The more years spent in training and the higher the interest rate, the higher the debt burden and the more that stands to be forgiven. Forgiveness obtained through PSLF, unlike IBR forgiveness, is tax-free.
A few caveats: First, notice how the emergency physician in the example still ended up paying more than the original debt. It does not make any sense to run up extra debt thinking it will all be forgiven. You will end up paying a large portion of it, especially after a short residency. Second, many emergency physicians who work in 501(c)3 hospitals are not actually employed by the hospital. They may be an employee or a partner of a small democratic group or a large contract-management group that contracts with the hospital. These doctors are not eligible for PSLF. Third, I would not be surprised to see the benefits of this program disappear or become means-tested once the press finds out that “rich doctors are having hundreds of thousands of dollars forgiven at the taxpayers’ expense.”
Nearly every resident will need to make IBR/ICR-A payments in residency. They simply cannot afford the regular payments. However, at residency graduation, physicians need to make a decision. If they will be working for a 501(c)3, they should probably go for PSLF, continuing to make minimum payments for another seven years. If they will be working for a private employer, then it is time to get busy paying off those loans just as fast as they can. Continuing a lifestyle similar to the one they had as a resident is the key to freeing themselves from this substantial financial burden within two to five years.
Many established attending emergency physicians are unaware of the incredible size of the student loan burden faced by more recent graduates.
Loan Consolidation Versus Loan Refinancing
The federal government has offered loan-consolidation programs for years. However, they were nearly useless because they simply turned all a borrower’s loans into a single loan at the average interest rate of the consolidated loans. While convenient, this did not actually save the physician borrower any money. A better option for doctors not going for PSLF is loan refinancing with a private bank or other lender, although they do have to qualify based on their income-to-debt ratio and credit score. Refinancing can currently be done at rates as low as 5 percent fixed and 3 percent variable, but there are very few lenders currently offering these refinancing loans. Refinanced loans are not eligible for PSLF, may be assessed against the estate should the borrower die before paying them off, and, like other student loans, are generally not forgivable in bankruptcy. Doctors with some home equity have an even better option: converting student loans into mortgage loans by using a home-equity loan or other refinancing technique. Student loans are inferior to mortgage loans in many ways. They are generally nondeductible, usually nonforgivable, and are often high interest, at least for loans taken out in the last eight to 10 years. A physician with fully deductible mortgage interest might be able to turn an 8 percent student loan into an after-tax 2 percent loan.
Student Loans Versus Investing
Another dilemma attending physicians face is deciding when to use extra money to invest, particularly in tax-advantaged retirement accounts, and when to use that money to pay down student loan debt. The following guidelines published in chapter six of The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing may be helpful:
- Get the match. Employer-provided retirement plan matching funds are really part of your salary. Don’t leave the match on the table by not contributing.
- Pay off any high-interest debt (greater than 8 percent), such as credit cards, car loans, expensive private student loans, etc. This is a fantastic guaranteed investment return.
- Maximize your tax-deferred retirement plan contributions, including 401(k)s, profit-sharing plans, 403(b)s, 457s, and defined benefit/cash balance plans.
- Fund a Health Savings Account (HSA) if eligible (see my January 2014 ACEP Now column for details). The following four items can be reordered, according to your financial priorities.
- Fund a personal and spousal Backdoor Roth IRA (see http://whitecoatinvestor.com/backdoor-roth-ira-tutorial/ for more on this technique to be covered in a future column).
- Fund a college savings plan (529) for each child up to the amount that your state subsidizes with tax breaks.
- Pay off moderate-interest debt (4 to 8 percent), such as student loans (unless you anticipate forgiveness).
- Save for a house down payment (if not using a physician loan). The next four items can be reordered, according to your financial priorities and comfort level with debt.
- If you used a physician mortgage, pay it down to enable refinancing into a lower-rate conventional mortgage.
- Add additional funding if desired to college savings (529) accounts.
- Invest in a taxable account in risky investments (stock index funds, real estate, etc.).
- Pay off low-interest (1 to 3 percent) student loan debt (unless you anticipate forgiveness). The final three items can also be reordered according to your priorities.
- Make extra payments on your mortgage.
- Invest in a taxable account in low-risk investments (municipal bond funds, etc.).
- Spend your money on what makes you happy.
Managing your student loans wisely will set you up for financial success during your career and retirement.