Student loans have quickly become the most complex financial issue facing young physicians. The average physician in training owes well over six figures. And these aren’t your normal run of the mill loans. Student loans today come with high interest rates and 100’s of options to analyze – all of which end up intertwining into personal and professional planning. The additional complexity paired with massive balances dramatically increases the potential for costly errors.
As financial planners for young physicians, student loan planning has become a big part of our business. I can tell you first hand that we see an alarming volume of errors occurring. Even those people I would consider “on the ball” are missing opportunity to the tune of tens to hundreds of thousands of dollars.
I’ll share 13 of the most costly errors we see young physicians making with student loans. My hope is that you can learn from the mistakes of others instead of making these mistakes yourself.
Student loan forbearance is tempting during residency and fellowship. What’s the harm in delaying payments when finances are tight? It’ll be easy to make up on the back end when the big bucks start to come in. After all, student loans are “good debts”. Many young physicians use logic like this to justify entering into forbearance during training. But they’re failing to figure up the true cost of this decision!
Forbearance sets off a number of negative triggers with opaque costs. Collectively these negative side effects make forbearance a terrible idea for anyone with the means to make payments.
Not Going For PSLF
Let’s look at how this might affect someone with $300,000 of unsubsidized federal student loans at 6% coming out of medical school that’s not going for PSLF. To simplify, we’ll assume Income-Driven payments are $0/mo. (which is reasonable for the person legitimately considering forbearance because they lack discretionary income). Forbearance payments are also $0/mo. Check out how the balance grows over time.
Total balance at the end of 4 years of residency:
Forbearance – $378,743.09
IBR/PAYE – $372,000 ($6,743.09 savings)
RePAYE – $336,000 ($42,743.09 savings)
Total balance at the end of 8 years of residency and fellowship:
Forbearance – $478,154.42
IBR/PAYE – $444,000 ($34,154.42 savings)
RePAYE – $372,000 ($106,154.42 savings)
When PSLF isn’t in play, total balance owed is critical because 100% must be paid back. If you come out of training owing $100,000+ more because of poor decisions, you must own it.
Going For PSLF
Forbearance is also terrible for the PSLF crowd but for totally different reasons. PSLF makes total balance much less important. Instead, it’s all about making qualified monthly payments that are as small as possible (lower payments = greater forgiveness). Let’s use the same loan scenario and consider PSLF.
Say Dr. Davis originally plans to go into private practice and chooses to forbear on loans during residency. Then midway through, she realizes the hospital she’ll likely work for is a PSLF eligible not-for-profit. At this point, she starts the PSLF clock by signing us for RePAYE. But what’s the cost of missing two years? Let’s assume her payments would have been $0/mo. for the first two years of residency. When she is in practice, payments max out at $3,000/mo.
With PSLF, you clock in 120 qualified payments and then you’re done with the loans. As far as PSLF is concerned, $0/mo payments are equal to $3,000/mo payments. She misses the opportunity for 24 “free” PSLF payments and is forced to make them up in practice at a cost of $3,000/mo. In just two years, this mistake costs her $72,000 ($3,000 times 24 months) in future wealth.
In these examples we looked at extended periods of forbearance during training. It’s also common to see intermittent forbearance periods (many of which are a surprise to borrowers). We’ll cover these more in mistake #4.
The only way forbearance makes sense is when you truly have a major financial hardship – obviously it’s more important to feed your family than to make payments on student loans (when you could otherwise forbear). I get that. But if you’re fortunate and have enough to cover life’s necessities, don’t forbear. Get rid of your cable TV or your decked-out cell phone plan so you can make the minimum student loan payments.
Wrong Repayment Plan
With so many options on the table, this is bound to happen. You have PAYE, RePAYE, IBR, new IBR, 10 year standard, graduated, extended graduated… and several others.
When PSLF is off the table, student loans act more like traditional debts. In general, it’s wise to minimize interest and maximize payments. Ideally, you pay off debt with the highest interest rate first.
With PSLF, the goal is to make qualified payments at the lowest amount possible. One of the requirements of a “qualified payment” is being on a certain type of repayment plan. If your repayment plan is not qualified, those payments don’t count toward the 120-payment clock. If you are using a qualified repayment plan, the key is to pay the least amount possible. Each payment has the same net effect no matter the amount. Therefore, it’s absolutely critical to make sure your repayment plan offers the lowest possible payments for your circumstances.
For example, many young physicians can qualify for PSLF under RePAYE or IBR but aren’t eligible for PAYE based on the dates their loans were taken out. Most of these physicians are using IBR because it was the original option. However, in many cases, RePAYE provides a payment that’s 30% lower. This easily results in $10,000’s in additional forgiveness. Many are missing this opportunity.
Failure to Consider Tax Implications
Taxes used to be independent of student loans. Today, though, that’s not the case with “income-driven” repayment, PSLF and income-driven forgiveness.
Student loan decisions can affect taxes. If you’re going for income-driven forgiveness (20 or 25 year), you better be prepared to pay income taxes on the ultimate forgiveness amount.
Tax decisions also can affect student loans. Lower PSLF qualifying payments = greater forgiveness. One simple way to lower your PSLF qualifying payments is to make decisions that lower your Adjusted Gross Income – “AGI”. If you save in pre-tax retirement plans like the 401k, your AGI will be lower and, therefore, income-driven payments will be lower. This can ultimately increase the amount forgiven under PSLF and income-driven forgiveness.
Another example… if you’re married and elect to file taxes separately, IBR and PAYE payments only consider one borrower’s income. If the tax cost of filing separately is less than the increased projected forgiveness caused by lowering payments, this strategy can add value.
Income-driven Application Procrastination
We regularly see NSLDS student loan reports showing periods of forbearance around the time people file for income-driven recertification. Often the borrower has no clue that the forbearance periods exist. They submitted the forms before the deadline and never missed a payment. Often, that’s not enough.
Loan servicers need time (apparently a lot of time) to process the application. If you submit the income-driven application a couple weeks before the deadline, it’s likely they will not finish “processing” until after the deadline. The average student loan report we see has intermittent forbearance periods sprinkled into repayment that the borrower was totally unaware of.
Let’s look at an example – Dr. Smith is going for PSLF and his student loans have a 10 year standard payment of $2,500/mo which he expects to begin paying after a few years in practice. During his 5 year training, he has the opportunity to rack up 60 PSLF qualifying payments that average $200/mo. Although he successfully makes all 60 payments, to his surprise, he only gets credit for 50. The 10 non-PSLF payments were actually periods of forbearance he wasn’t aware of. At a net cost of $2,300 per payment, we’re talking $23,000 of total additional costs.
To counter this, submit the application as soon as you receive the annual letter. Fax in the paper version and follow up weekly until you receive confirmation that it’s complete. This may sound like a hassle, but for the average physician with six figure loans going for PSLF, it’s worth thousands to get right.
Failing to Verify Employment
According to the US Government Accountability Office Student Loan Research Report from August ’15, about 147,000 borrowers had employment and loans certified in anticipation of PSLF, and 4 million current direct loan borrowers may be employed in public service. Essentially, less than 4% of those likely eligible for PSLF are proactively positioning themselves for approval. The problem is that people have a choice: Verify now – or – verify later.
“Employment verification” is not required until you apply for PSLF (after 120 payments). You can either verify when you apply or as you progress through time. It seems most people are opting to verify later. They choose to work for 10 years “unverified” and then go back and verify all 10 years at once. This is all happening while they’re waiting to see if they qualify for $10,000’s and sometimes $100,000’s of forgiveness benefits.
Based on my experience helping people apply (over time) for employment verification, I expect this to be a huge mess for some borrowers opting for the procrastination method. I see the challenges and surprises that pop up going through this process year by year. Mistakes are made, people get confused, the process gets dragged out. I can only imagine what that might look like when you try and verify 10 years all at once.
Paying too much Interest
This is mainly for the non-PSLF folks out there. When you’re not going for PSLF, student loans are more like a typical debt. The higher your interest rate, the more you end up paying back. What’s interesting with student loan interest rates is that they vary considerably. There are loans out there with interest rates in the 2% range and others with rates over 10%.
As a general rule of thumb, if you’re not going for PSLF or any other forgiveness program and your rate is above 5%, you should be considering refinance. The higher your rate, the more emphasis I would put on this. Failure to refinance into a lower rate can easily cost $10,000’s in extra interest payments.
Be extremely cautious when refinancing – especially if you or your spouse (see #10) have any chance of going for PSLF or income-driven forgiveness.
Poor Refinancing Decisions
If you or your spouse are eligible for PSLF, refinance is almost always a really bad idea (see #10). You must maintain qualified federal loans in order to maintain eligibility for PSLF. Some borrowers unknowingly refinance when they are qualified for PSLF. Others aren’t confident in PSLF panning out and refinance. Either way, it’s going to cost you.
And for those who aren’t eligible for PSLF, you have to watch out for bad refinancing deals. Many lenders offer student loan refinancing deals that are not in your best interest. Do your homework and make sure you understand the options. Here is more info on several of the lenders offering student loan refinancing.
Bad Consolidation Decisions
Some borrowers fail to consolidate loans they should have consolidated, and others consolidate loans they should have never touched. Still others wait to consolidate and miss out on valuable cost savings. Either way, consolidation mistakes are very common.
Dr. Turner is finishing up medical school, has lots of Direct federal loans and plans to go for PSLF. When she goes through loan exit counseling, she’s confused by all the options. Ultimately, she decides to go for PAYE and will fill out income-driven paperwork before her grace period is up to get the PSLF clock started. Consolidating her loans never crosses her mind – why consolidate two loans? What she doesn’t realize is consolidating into a Direct Consolidation loan immediately after graduation allows income-driven payments to begin much sooner by side-stepping the grace period. If she were able to get payments started six months earlier, it would have increased her projected forgiveness amount by $12,000. For most recent medical school grads, these early payments are very low or even $0.
Dr. Baker is also going for PSLF. He has some Direct Loans and some older FFEL (or non-direct) loans. FFEL loans were very common federal loans before 2010 and aren’t PSLF qualified unless you consolidate them into a Direct Consolidation loan. Dr. Baker chooses to leave the FFEL loans as is because he doesn’t want to mess up his PSLF progress. When you consolidate, this starts your PSLF 120-payment clock. A big misconception is that when you consolidate, you must wrap all loans into the new consolidation loan. Naturally this would discourage someone like Dr. Baker with Direct loans well on their way to PSLF from consolidating an old FFEL loan. Fortunately, it’s not true. You can leave the current Direct loans as is and consolidate the FFEL loans into a separate Direct Consolidation loan. This allows the otherwise non-PSLF loans to joint the party.
Dr. Jones has a similar loan profile to Dr. Baker – mostly Direct loans with some older FFEL loans – except he’s not as far along with PSLF. He hears somewhere that it’s smart to consolidate FFEL loans so they become PSLF qualified. Like Dr. Baker, he believes consolidation is an all or none deal. After running the numbers, he decides it’s best to reset the PSLF clock on all his loans to allow the FFEL loans to be included on PSLF. So he does the full consolidation. This comes with a major cost – all those PSLF payments made on the already qualified loans are lost when he “resets the clock”. Instead, just like Dr. Baker, he should have consolidated the FFEL loans only.
Either one of the above consolidation mistakes eaisly cost tens of thousands of dollars. Be extremely cautious with consolidating your loans. Make sure you have a good reason for each loan you choose to consolidate. And always keep PSLF qualification in mind before making decisions.
Reactive Income-driven Verification
Young physicians, like many people, tend to make reactive decisions. Income-driven verification is no different. They receive the annual notification that it’s time to re-certify and they knock it out. And that’s about the only time they think about it each year. What people don’t realize is they always have the option to volunteer income verification outside the normal annual timeline.
This can prove extremely valuable when income verification results in lower PSLF qualifying payments. This might occur if your income decreased as a result of changing your filing status, going back into training, or reducing moonlighting. Or maybe you’re expecting a pay increase or bonus before your next recertification date. Why not recertify now at the lower income level. If your income decreases or is about to increase, don’t wait until your next verification. Apply now.
Not Considering Spousal Student Loans
For many physicians in private practice, refinance may seem incredibly obvious. Why hang onto your 7% interest rate student loans when lenders are offering 4%? Especially if PSLF is off the table. But what if your spouse is going for PSLF? Many physicians fail to consider the impact a refinance has on their spouse’s federal loans.
Your spouse’s income-driven payment calculation uses income to set payments. The resulting payment then gets prorated between ALL household FEDERAL student loans. In many cases where loan balances are high, the total payment will not be affected when the total federal loan balance decreases as a result of private refinance. Therefore, the income-driven payment due for the family stays the same after refinance. Effectively, the PSLF spouse’s payment increases substantially to compensate. This comes with massive PSLF costs to the total household that typically dwarf interest saved from a refinance.
It may be a good deal for you, but if your spouse is going for PSLF, refinance can end up costing them 10’s of thousands in the missed PSLF benefit. Before refinancing, consider your spouse’s PSLF impact. In many cases, it’s better to keep both spouse’s student loans with the federal government, and save the additional desired payments into a side account. Then as soon as the PSLF spouse qualifies for forgiveness, the non-PSLF spouse refinances (assuming rates are still favorable) and pays a lump sum using the side account.
Not Fighting Servicer Errors
Loan servicers will inevitably make errors that negatively affect unfortunate borrowers. As student loans become even more complex, this will likely increase. It’s a mistake to assume the loan servicer will always look out for you.
You should be keeping an eye on your progress and make sure your records match the loan servicer and NSLDS records. When you spot errors, they should be addressed immediately.
As you submit paperwork and have interactions with loan servicers, it’s important to document everything. Save copies of all paperwork and correspondence (like annual income driven applications and confirmation letters). Write down notes from all calls you make that include the name of the people you talk with and the date of the call.
Taking Bad Advice
As a result of growth in student loan balances and complexity, companies are popping up everywhere claiming to be student loan experts. Be extremely cautious taking advice from a student loan advisor. Figure out if they Fee-only (100% of revenue comes directly from clients) or not. Many of the student loan companies aren’t fee-only and get compensated from student loan refinance companies to send business. That’s a major conflict of interest that can cloud their advice.
Student loan planning today is very different from traditional debt planning. It’s much more complex and traditional rules of thumb don’t apply. As a result, many financial advisors, accountants and other advisors are unknowingly providing the wrong advice.
Improperly Negotiating Student Loan Stipends
Every year, not-for-profit 501(c)(3) hospitals all over the country hire thousands of young physicians. Many offer student loan stipends and repayment packages for new hires. These hospitals agree to pay annual lump-sum student loan payments for new physician hires. Normally these payments are made directly to the student loan servicers.
On the surface, this seems like a fantastic benefit. However, it’s often an absolute waste of resources when PSLF is in play. With PSLF, the goal is to pay the minimum payment. Lump-sum extra payments end up providing no economic benefit as they end up reducing total forgiveness dollar for dollar. On top of that, it’s typically a taxable benefit. So you pay tax on money you effectively give right back to the government. We have seen cases where people are better off not receiving anything at all. It’s a mistake to let this happen without intervening.
A better route would be to negotiate a salary increase instead of student loan payments. Or have the payments paid directly to you. Most hospitals are happy to make the adjustment once they realize it helps you and doesn’t affect them. However, some hospitals won’t allow this even though it’s an absolute waste of money.
Bringing It All Together
As you can see, student loans have become pretty intense. To help you simplify this concept and wrap your head around the best path to take, we created this student loan flow chart you can see below.
Also, if you’re interested in our student loan advising services, check out this page for more info.