Medical school 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? Maybe you tell yourself you’re going to start off with forbearance just to get “caught up”. 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 ability (not the desire) to make payments.
Let’s take a closer look at the costs of forbearance. If you eventually go for PSLF, forbearance typically costs several thousand dollars PER MONTH. This quickly adds up to 10’s or even 100’s of thousands of dollars over the course of several years.
And don’t think you’re out of the woods if you’re NOT going for PSLF. The negative aspects of forbearance are expensive and add up quickly. But typically the biggest is the cost of forfeiting RePAYE’s interest subsidy. This can eaisly cost you several hundred per month! And for those with very large balances, the costs can exceed one thousand per month.
Wrong Repayment Plan
With so many options on the table, this is bound to happen. You have PAYE, RePAYE, IBR, new IBR, ICR, 10 year standard, graduated, extended graduated.
When income is low, student loan balances are high and PSLF is off the table, RePAYE’s interest subsidy becomes extremely appealing. Many residents fall into this situation, but for whatever reason select the PAYE repayment plan and miss out on the RePAYE interest subsidy.
However when PSLF is in play, interest in most cases is irrelevant. Value is maximized by making qualified payments that are as low as possible. Each payment has the same net effect no matter the amount. All that matters is reaching your 120th payment. Therefore, it’s absolutely critical to make sure your repayment plan is “qualified” and offers the lowest possible payments for your circumstances.
Many young physicians going for PSLF are using IBR because it was originally the only option. However, in some cases, RePAYE provides a lower payment (up to 33% lower). Many are missing this opportunity.
Failure to Consider Tax Implications
Taxes used to be independent of student loans. Today, that’s not the case.
Student loan decisions 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 affect student loans. Lower PSLF qualifying payments provide 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 periods of forbearance around the time people file for income-driven recertification. Often the borrower has no clue that the forbearance period exists. 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 these intermittent forbearance periods sprinkled into repayment. These forbearance periods cost the average physician borrower thousands per month.
To avoid 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 $100,000’s of forgiveness benefits.
Instead, we encourage physicians to verify employment annually. This proactive approach has been reinforced as we see people regularly find errors from the past year. Sometimes it was their error and sometimes it was someone else’s error. Nonetheless, it’s an error. And when you have hundreds of thousands on the line, errors are critical to address quickly. This is why we believe PSLF is a ticking time bomb.
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/subsidy program (including RePAYE) 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 tens of thousands 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 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.
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.
Let’s say you’re finishing medical school, have several direct federal student loans and plan to go for PSLF. When you go through loan exit counseling, you’re confused by all the options. And it seems like you’re not really required to do much until grace period ends. So that’s what you do. Consolidating your loans now never crosses your mind. Yet, it’s often a very smart move. By consolidating your loans, you’re able to side-step grace period and effectively start PSLF payments sooner. Also, you’re able to submit IDR paperwork before residency starts, when income is lower. Remember, lower income equals lower payments. Lower payments equal higher PSLF benefits.
Reactive Income-driven Verification
Most people don’t think about income-drive repayment plans unless they have to. As a result, they tend to look at it one time per year around the time when annual IDR is required. 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.
It may be a good deal for you to refinance, but if your spouse is going for PSLF, refinance can end up costing them tens of thousands in the missed PSLF benefit. Before refinancing, consider your spouse’s PSLF impact. In some 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. Revisit the numbers annually to see if it’s still valuable. If there comes a point when it’s not anymore or when loans are forgiven, the non-PSLF spouse refinances (assuming rates are still favorable) and/or pays a lump sum using the side account.
Not Fighting Servicer Errors
Loan servicers will inevitably make errors that negatively affect borrowers. As student loans become even more complex, errors will likely increase. It’s a mistake to assume the loan servicer will always look out for you.
You should always keep good records and track your progress toward PSLF. 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 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 student loan “advisors” 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, when PSLF is in play, it’s often an absolute waste of resources. 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.