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Is income based repayment right for me? Is a standard payment plan right for me? What is my best option for paying off student loan debt? These are some of the questions I was stumped by when we graduated from dental school and law school. Our student loan situation presents some unique challenges. For example, never in the history of dental school (or law school, or any college degree for that matter) have people graduated with half a million (or more) dollars in debt. At the same time, never has the federal government offered to help with student loan repayment as it does now, through income based repayment plans (also known as student loan forgiveness). It is a weird time to be a new graduate. Advice and information surrounding student loan forgiveness is ever changing.
Since Danny graduated dental school we have been working towards paying off our debt on our own. We decided to forgo income based repayment after discussing our student loans with financial advisers, the financial aid offices at our respective graduate schools, similarly situated friends, and friends we have that are just frankly good with money and investments. It seemed like the better option for us; we’d rather just pay off our debt and move on. It has required us to hustle hard, looking for any opportunity we can to save and earn extra money. However, since we graduated and have started working the past few months, we have found it more difficult than anticipated to stick with our plan. People are constantly questioning our repayment plan. That in turn, has lead us to question ourselves. The point is often raised that instead of hurrying to pay off student loan debt by refinancing our student loans, new graduates can save for their tax hit (the year that student loans are forgiven, the balance that was forgiven is tacked onto your income, so you pay a big tax bill that year) and invest any other extra income. The argument is that you could potentially earn more in investments than you would be paying in student loan debt interest. It’s a plan that is presented to us quite often and if I’m being frank, I find it tempting. It has really made us think about the question — should we seek student loan forgiveness or should we pay off our student loans on our own?
At first glance, it seems like a easy decision. It’s like asking, would you rather pay for something yourself or have someone else pay it for you? But, as we quickly found out when we were researching this very subject last year, it is more complicated than it seems.
What makes the decision about signing up for a student loan forgiveness plan so complicated?:
- Student loan forgiveness plans are changeable.
First, these forgiveness plans are changeable, meaning you might not get what you signed up for. All federal income based repayment is set forth by federal statute (See 20 U.S. Code § 1098E). That means that student loan forgiveness is somewhat easy to change. It does not take an act of Congress to change income based repayment plans. Thus, each time there is a change in administration, these programs can change. It is difficult to foresee just exactly where student loan forgiveness will be in 20-25 years when student loans would be forgiven. In fact, the Republican led House of Representatives has pushed for the complete elimination of student loan forgiveness, such as PLSF, in the past. Not that I don’t trust politicians in Washington to keep their word (wink), but, it is a little unnerving that hypothetically, a new graduate could sign up for income based repayment with the assumption that the remaining balance of their loans would be forgiven, and later, the terms of income based repayment could change on them. This is especially worrisome for professional and graduate students since there are already public voices suggesting that the amount of student loan debt forgiven should be capped off at a specified amount. And that makes sense. Just imagine several years from now, when the first doctors who graduated with $300,000 in student loan debt have their debts forgiven. I can see it in the headlines. “Rich doctors with $300,000 in debt have it all forgiven by the federal government!” It will likely be disfavored by the public, to put it mildly. Which means it will likely change. Which means people (most likely doctors and lawyers) shouldn’t get too cozy on any income based repayment plan.
However, there is also a fair chance that borrowers will be grandfathered in under the terms to which they agreed when the signed up for income based repayment. For example, the Public Service Loan Forgiveness (“PLSF”) program is included in the Federal Direct student loan promissory notes. Student Loan Hero said it best, that “promissory notes put forth the terms and conditions of the loans, similar to a contract.” Thus, “if the government changes the terms on borrowers, it could be viewed as a contractual violation.” But the bottom line is, it is unclear how everything related to student loan forgiveness is going to shake out twenty years from now. Twenty years is a long time, and student loan forgiveness is uncharted territory in this country.
2. You can get kicked off of a student loan forgiveness program if you earn too much money.
That means that if your income increases past a certain threshold, you will no longer be eligible for student loan forgiveness and will be responsible for the balance of your loans. Each year, you have to reapply for many of the income based repayment plans to determine if you are still eligible. If your discretionary income as exceeded the threshold, you will be removed from the plan. At that point, the balance on your loans will likely have increased substantially since you were only paying 10-15% of your income under any of the loan forgiveness plans. That means that in the end, you will have spent substantially more money on your student loans that you would have if you had just hustled to pay them off in the first place. Said differently, in a way, student loan forgiveness actually encourages you to earn less money because if you earn too much money, you are no longer eligible. I don’t know about you, but I don’t like the feeling of being discouraged to earn more money.
3. No one has actually had their student loans forgiven yet.
While student loan forgiveness might sound good in theory, no borrowers have actually had their student loans forgiven yet. The first folks to sign up for forgiveness signed up for PLSF when it was established in 2007, and are on track to have their loans forgiven this year. It is impossible to view how student loan forgiveness will play out for you when you have nowhere to look to see how it actually has played out for someone else.
4. It can be hard to accurately calculate how much money you will earn to determine what repayment plan is right for you.
There seem to be three camps of borrowers– people who are refinancing with private lenders and paying their loans off quickly, people sticking with their standard repayment plans through their private lenders or through the federal government, and people on income based repayment. It is quite difficult to ascertain which camp you should join when you don’t have an accurate picture of what your income will be in the initial and progressing years of your career. One rule of thumb is that if you owe more than twice your yearly income, you should consider income based repayment. Travis from Student Loan Planner explains that this is because “private lenders won’t give you great offers with interest rates significantly below what you’re paying the government. On top of that, when you owe more than double your salary in student loans, you qualify for extensive interest rate subsidies on the Revised Pay as You Earn Program (“REPAYE”). For all those reasons, private refinancing really makes no sense at all if your joint debt to income ratio is above 2. And realistically, you won’t see compelling offers from private lenders in most cases until that debt to income ratio is below 1.5.”
The problem with this, is that in many professions, it is hard to accurately predict how much money you are going to earn to determine what your debt to income ratio will be in the coming years. Some career paths have set salary figures that borrowers can accurately rely on, but many jobs are much less reliable. Let’s use ours for example. Danny, as a dentist, gets paid a percentage from the procedures he performs. So, if his patients show up and happen to need a lot of dental work, he gets paid well. If no patients show up or decline procedures they need, he doesn’t. On top of that, some months are busier than others, and some are slower. Since he has only been working for a few months, it is difficult to ascertain what his income will be for his first full year of work. That makes it difficult to determine what our debt to income ratio is or will be, which makes it difficult to know what repayment plan is right for us. Thus, it is a good idea for borrowers who are really unsure what their income will be for the first 5-10 years of their careers, to consider signing up for a income based repayment plan, saving most of their earnings and holding on to them to see if, in a year or two, it makes sense to hurry and pay their loans off (or stick around on income based repayment).
What is to be gleaned from a discussion on the complications surrounding student loans? Well, fortunately, there are a few cold facts that can help us determine which repayment option is right for us. Let’s categorize them as who should and should not use income based repayment.
WHO SHOULD PAY OFF THEIR STUDENT LOANS ON THEIR OWN:
- People who can afford the minimum standard monthly payments under a standard 10 year plan. Afford is an ambiguous term. What I mean is, if you can scrape around to make those payments, even if you have to sacrifice having cable or going out to eat every night, I would suggest going for it. You’ll have to live frugally, probably more frugally than you want, but then when those loans are gone, you will be sitting comfortably.
- People with debt to income ratios under 2:1. In other words, if you owe less than twice your income, paying off student loan debt on your own is likely the best option.
- People who don’t trust the federal government. (Just kidding just kidding. Kind of.) More fairly stated, people who are uncomfortable with the idea that their plan could change on them later on down the road.
WHO SHOULD USE INCOME BASED REPAYMENT
- People whose debt to income ratio is more than 2:1. (if you owe more than twice your income)
- People who are driven to save money on their own. One argument for signing up for income based repayment is that you will have extra money to put in savings, especially for retirement. In reality, some people tend to be spenders and have a hard time saving that money away. Instead, they spend it. Twenty years down the road they still have student loan debt AND no savings AND will have to pay a big tax bill that year, that will require saving up for. Thus, you must carefully assess what kind of money person you are. If you don’t think saving will be realistic for you, then paying off your loans quickly (living frugally for a while) might be a better option.
- People who have a clear picture of what their salary will be for the next 10-20 years, and find that their salary will keep them eligible for student loan forgiveness. For example, if you are a lawyer with $140,000 of debt, and know that you are going to work in the public sector (think prosecutor or public defender) earning $40,000 a year, with small raises each year, you are a good candidate for student loan forgiveness (and should sign up for PLSF while you can).
Finally, I have been saving this jewel for the end. Here is an excel sheet from Student Loan Planner to help you determine what repayment option is right for you. You can plug in your own information, and play around with the numbers, to help you see what option will save you the most money in the long run, or seems most doable for you. Running your own numbers here is likely the most helpful thing you can do to make the decision for yourself.
In your opinion, what makes student loan debt repayment complicated? Are we crazy for wanting to pay off our loans ourselves?
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