debt repayment, student loans

SHOULD I CHOOSE AN INCOME BASED REPAYMENT PLAN OR PAY OFF MY STUDENT LOANS QUICKLY?

income based repayment; what student loan repayment plan is right for me,

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.

income based repayment; what student loan debt repayment plan is right for me

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?:

  1. 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.

 

CLICK HERE TO DOWNLOAD THE STUDENT LOAN PLANNER CALCULATOR

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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12 Comments on “SHOULD I CHOOSE AN INCOME BASED REPAYMENT PLAN OR PAY OFF MY STUDENT LOANS QUICKLY?

  1. I love everything you’ve said and my husband and I have thought looooong and hard about what we want to do. He’s a PA and will be working in the public sector for at least the next 8 years (we’ve been on PSLF for 2 years). We are paying everything we can to get our loans down, just in case the government lets us down. We figure it will take us about 12-13 years to pay it off on our own, so after the 10 years, it would just be an amazing gift (did you know with PSLF you don’t have to pay the taxes on it? PSLF rocks). Also, I have a friend whose husband is a doc and their student loans will be done with PSLF in 2019 and she anticipates them to have over 500k forgiven. Yikes. Yeah that new headline could cause some major problems.

  2. I am working on PSLF, but I also meet every point you raised for people who should use IBR, so I guess I’m okay 🙂

    I did consider all of the same factors, but opted to go the other direction. I did really heavily consider the idea that the program could be canceled at any time. Ultimately I decided that if it was canceled, it would likely be in a way that grandfathered current enrollees. Without a grandfather provision, it would hurt specific people without actually helping specific people, which is a recipe for turning public opinion against you quickly. Plus, I think lawyers who opt for jobs in the public sector making under 50% of what they could make in the private sector are somewhat sympathetic.

    I also wanted to note (as Natalie did above) that the loan forgiveness under PSLF is not taxed. I would guess that it won’t be taxed for the regular forgiveness either once it gets there. People who still have student loan debt after 25-years getting hit with a huge tax bill are another recipe for bad PR.

    1. Plsf is definitely the program I’d feel safest on for two reasons 1- it’s shorter (10 years instead of 20-25, as you well know) and 2- you are working for the public! That has to count for something and likely for the reasons you described. Oh and that no tax hit! Really hard to pass up especially if it also otherwise makes sense. Here’s to hoping you are grandfathered in! I feel like PLSF borrowers are the most likely candidates

      1. I’d actually feel more certain of getting close to the terms I signed up for on the private sector loan forgiveness after 20-25 years. Since the current rules make the debt forgiven taxable income, I don’t think the govt would make it more onerous. I def think there’s more upside to PSLF for sure and there’s a high percentage chance folks working towards it now will get it. I agree that REPAYE and PAYE are maybe doubtful but considering they’re talking about the Trump plan which in many ways is more generous, I think that I feel comfortable with folks using long term income based repayment options. However, personal preferences have to weigh heavily in this.

        Thanks for the shoutout and sharing my spreadsheet R2G! Hope people get good use out of it.

        1. Thats a good point about getting the same terms under the private sector– usually the terms you sign in those agreements falls under contract law and you’ll both be held to the original terms of the agreement.

          Even if the Trump plan is more generous, whose to say that the next person in office won’t come in and undo everything he’s doing– just like he’s doing to Obama. That is the part that makes me uncomfortable.

          In the end, all many of us can do is cross are fingers and see what the next 5-25 years bring, ha. Thanks for making such a great spreadsheet!

  3. I have such a problem with this loan forgiveness! This is one of the reasons that student loans could not be dismissed in bankruptcy. Professionals were racking up student loan debt and declaring it in bankruptcy. When these first loans are forgiven, I think we can expect to hear some outcry. It’s theft to me. You borrow, you pay it back.

  4. I agree that income-based repayment is complicated, but the way we are approaching it is to use it as a way to minimize interest while we do everything we can to knock out our loans. My husband works for the state and has for the past 3 years. He qualifies for public service loan forgiveness and we have another friend who is using this program and essentially not paying their debt. I don’t necessarily have an issue with that – when you work in public service, the pay is often a lot lower than free market and I see it as equivalent to a GI bill or a 100% scholarship that the military offers to doctors who serve the military after graduating.

    That said, we felt like it was more straightforward to just pay our debt and do as much as we could afford. If an emergency comes up, then we might consider PSLF if we couldn’t truly afford to pay, but even on our meager little government income (starting at 50K, now 60K) we have knocked out almost 30K in 3 years, and hopefully we will finish off the rest in the next 3 years (we still have a little over 60K to go). My husband put it this way, “I would feel really bad if we had extra money and decided to use it on something else that was unnecessary when we still had debt.”

    I know you have a lot of debt to deal with, but from what I gather your income should be higher too. I really do think that if you keep at it, while it will feel painfully slow at first, you will pick up speed and start to see true progress. Hang in there!

  5. My wife and I are in a similar position as you. A few years ago we were just over $500k in student loan debt after getting out of grad/dental school. For us the decision was easy. We traded in our 6.8 and 8.5% loans for the best deal we could find. We cut our interest accumulation by over $1,000 per month just by that action alone. It also meant we were committed to paying the loans off. My wife is a dentist, so we can relate to the ebb and flow of the pay that comes with the job. We rolled with it and have found a way to make it work. By maximizing the gap between what we spend (including payments) and what we earn, the good months can more than make up for the bad.

    In the end we decided it was right for us to focus on traditional refinance and repayment. We could afford the repayment, so we paid little mind to any other option.

    Best of luck to you both.

    1. Thank you so much for sharing this! We have a lot of readers who have six figures of debt, but not a lot of people who have over $500k of debt who are actually paying it off. We love to hear about people who are suffering with us 😉 Good luck to you two as well! I’m sure with your combined income you’ll be able to knock it out faster than you think.

  6. I just can’t get behind the 20 or 25 year student loan forgiveness programs. I can’t. When people signed up to go to school they knew exactly what debt they were signing on for, and they signed on the dotted line. When it comes to the 25th year and the remaining balance is forgiven, yes they may be stuck with a hefty tax bill but the rest that is “forgiven”, is it truly forgiven? It shows up in regular increases in tuition or gets handed over to the taxpayers, it doesn’t just magically disappear. I am not completely against PSLF programs for under served areas because I know of some areas that are in dire need of providers of all professions but can’t seem to recruit anyone and a monetary forgiveness is about the only thing that will help draw people, but I also know providers who are making six figures who are not in under served areas who are choosing to not pay anything but the bare minimum and are taking Hawaiian cruises and buying brand new cars and just banking on having their loans forgiven because “it’s not fair their college charged so much and I’m not going to go my whole like without having any fun”. Maybe they should have picked a different college or profession then.

    My husband is a chiropractor. Between buying our office and his student loans we had $260,000 in debt. Not near what you guys have but still enough to crush the soul. Three months after we purchased our office we decided that we were going to be grown ups and pay it back as fast as we could, and that’s exactly what we did. We started out at about $150,000 annually and by the time we made our last payment we were at $200,000/yr income. It took us almost 2 years to the day and we cash flowed every single penny, didn’t sell a thing. We sacrificed and budgeted every penny but guys, it was only 2 years, that is not a lot of time. Yes, it felt like eternity at the time but now having come out the other end, it was a blip on the timeline map. 2 years and we broke the bonds and we’re free. We don’t ever lose any sleep over worrying if we are going to be able to make this month’s payment. I understand most people don’t have an income like we do but we decided we were going to continue to live like poor college students still and throw everything towards debt. And we did and now we get to go on the Hawaiian vacations and save up for a house and save for an early retirement. We knew that we signed up to take out these loans and we knew that morally we wouldn’t feel right if we didn’t pay them back. Our moral compass isn’t everyone else’s and that’s ok, it’s what worked for us. Just wanted to share my 2 cents and part of our story.

    1. Thanks for sharing your story Michelle! I think it helps a TON (not only for us- for others as well) to hear people with six figures of debt who have been able to pay it off on their own. It really is encouraging.

  7. Always great to hear you telling your story Amber. I’m generally in the camp that it’s better to take control and pay off the loans yourself. Travis’s spreadsheet is extremely helpful in letting you see the big picture to better understand your choices.

    Regarding #2 above though – can you dive a little deeper on getting kicked out of student loan forgiveness? I didn’t think that was possible. There’s a provision in the Master Promissory Note that’s pretty clear you stay in IBR even if your income rises. You just switch to the 10 Year Standard Repayment. As you said, if it’s the way you describe it, it would be pretty counterintuitive to be encouraged to earn less money.

    See my point on IBR in this article where I cut/paste the Master Promissory Note:
    http://www.biglawinvestor.com/5-facts-about-repaye-ibr-and-pslf/

    Josh

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