THE LOWEST PAYMENT OPTION (RIGHT NOW) MAY NOT BE IN YOUR BEST INTEREST (IN THE FUTURE).
The lowest payment option you come up with now may not be the best payment option for you in 2-3 years.
For most new grads, the online calculator will push you in the direction of an income-drive repayment (IDR) plans. It’s important to understand the mechanics of IDR plans. For IDR plans the minimum monthly payment is set as a percentage of your discretionary income. For example, Income-Based Repayment (IBR) sets your monthly payment at 10-15% of your discretionary income, depending on the origination date of your loans. The calculation is taking into account your current income and current debt load.
Two things can change this calculation:
- Increased income: What happens when your income increases substantially in years 2 and 3? Are you still eligible for an IDR?
- Increased debt: What happens if your loan balance increases? No, we’re not talking about going back to school. We’re talking about negative amortization! When you have big loans, IDR options can put you into negative amortization. In short – you’ll be paying less than the interest on your loans. All that unpaid interest is added to the total of your loan.
Over time, that adds up. For someone who’s expecting to have a consistent, average income for the life of the loan – this isn’t a bad deal. The payments stay low, eventually, the loan is forgiven, and that’s that. But if you have a high income, it’s a different story. You’ll end up feeling as though you’re paying off your loan, but you’ll actually be digging yourself into a deeper hole.
When you have high-income potential, you end up putting yourself in negative amortization for the beginning portion of your student loans. Soon you’ll stop qualifying for IDR plans as your career advances and income grows. Then, you’re stuck with (still) super-hefty loans and you’ve added extra interest to the loan’s total on top of it all.
DIFFERENT LOAN REPAYMENT PLANS ARE CREATED BECAUSE THEY WORK FOR DIFFERENT PEOPLE.
The various repayment plans exist for a reason – for some people they work incredibly well. Whether they’re the best plan for you is what’s important. Let’s break down some common repayment plans and who they usually “work” for.
Pay-As-You-Earn: This type of loan generally doesn’t apply to new grads based on date requirements.
Income-Based Repayment: Most people who qualify for Public Service Loan Forgiveness (PSLF) or other Loan Forgiveness Programs fall into this loan repayment category. Also, for graduates with high debt-to-income loads where loans will be forgiven after 20 or 25 years of repayment, it’s a convenient way to make low payments until your loan is forgiven.
Standard Repayment: Graduates with lower debt loads tend to go this route.
Extended Repayment: This is what I typically use for people who don’t qualify for PSLF or Loan Forgiveness.
This is a very high-level view of different repayment options. Like I’ve mentioned before, everyone has a unique debt situation and the type of loan repayment plan you select shouldn’t just be the option that gets you the lowest payments right now. To help you determine what plan works for you, you should consider a wide variety of factors. Here are a handful of questions to ask yourself when you’re looking to demolish your debt with the right repayment plan:
Will your loans be forgiven through a Loan Forgiveness plan (outside of PSLF)?
If your loans will be forgiven through Loan Forgiveness, how do you plan to prepare for the tax bill after they’ve been forgiven? This is important to think about. Nobody wants to be caught off guard with a hefty tax bill and no way to pay it.
If you go the IDR route (Income Based or Pay-As-You-Earn), how do we control your repayment?
There are several ways to control your Adjusted Gross Income (AGI) to keep yourself within the income requirements for these repayment plans.
- Are you planning to decrease your AGI somehow?
- Do you have access to 401(k) or another workplace plan (like an HSA)?
- Are you eligible to fund a tax-deductible Traditional IRA?
- Are you considering filing as Married Filing Separately on your taxes?
- Do you or your spouse claim the kids on your taxes?
Anything you can do to decrease your AGI will impact the minimum payment calculations you do when you select one of these repayment plans.
What’s your approach to debt?
Your attitude towards debt will impact the kind of repayment plan you choose. If you’re debt adverse, you probably won’t want to choose a plan where you’re going into negative amortization and must pay more money back over time. If you want to pay off your debt ASAP, you’ll want to pick a plan with some flexibility to make extra payments.
Are you planning to make extra payments in the future?
Whether you’re planning to make extra payments towards your student loan debt right out of the gate or 2+ years down the line, you want a repayment plan that’s going to empower you to make that call. If you’re leaning toward the extended plan because of this, make sure that you can make the monthly payments now as well as down the road.
Is loan consolidation something to think about?
This may seem like a whole other can of worms – and you’re right, loan consolidation can be complicated. First, federal loans are typically forgiven in the case of disability or death. On the other hand, private loans will usually “work with you” on loan repayment in the case of disability or death (aka they may pass the loan repayment on to your estate). Disability or death may not seem a factor in your decision making, but it should be. If you choose to consolidate, you’ll need to know that your family will be taken care of in case the unthinkable happens. The key here is ensuring that you have the appropriate life or disability insurance you need to cover you in the worst-case scenario.
In general, payments on traditional federal loan repayment plans work out to be more than the payments required by a consolidated, low interest loan and life and/or disability insurance premiums in the long run. You should ask yourself as an individual if you have enough cash flow right now to make all this work. In the case of medical professionals, they’ll typically have a consistent cash flow that would free them up to take on life and disability insurance premiums as well as a private loan payment each month within 2-3 years of entering the workforce.
As a medical professional, loan repayment can feel overwhelming. Just thinking about the debt you carry might make you dizzy. It’s important to take a step away from the emotional aspect of it to make effective financial decisions. In situations like these, it pays to speak with a financial planner to help you evaluate your financial life and set yourself up for success – both by selecting the right repayment plan and by helping you get in the right mindset of prioritizing your debt demolition.
The best part, you don’t have to do this on your own. We specialize in helping people find the best repayment plan for them and their family. Not only for right now, but also for the future. Contact me today for a free consultation.