The most complicated time period for physician student loan management is during residency. While there can still be some complicated issues as an attending, it generally boils down to a simple “Go for PSLF vs refinance and pay off quickly” decision that is primarily based on whether or not you are working full-time for a 501(c)(3). However, in residency there are all kinds of student-loan related decisions to make like:
- Should you refinance or not?
- Which IDR should you enroll in?
- How should you file your taxes?
- What retirement accounts should you contribute to?
If you struggle with any of these decisions, we recommend you contact Andrew Paulson at StudentLoanAdvice.com for a one-time, flat-fee student loan consultation. Spending an hour and a few hundred bucks now could mean tens of thousands of dollars in savings over the course of your loans.
Today we’re going to talk about the first of those questions, and specifically whether an intern or junior resident should enroll in REPAYE and take advantage of its subsidy, or whether that intern should refinance the loans.
If you have private loans, the decision is easy for them. You can’t enroll those into an IDR, and they won’t be eligible for forgiveness. So you can safely refinance them any time you can get a lower rate. If you go through the WCI Links on this page and elsewhere on the site, you will get all of these benefits:
- A lower interest rate
- Fewer loans to keep track of
- Better customer service
- Easier to understand terms (government programs can be complicated)
- $300-1500 Cash back (if you refinance through the WCI Student Loan Refinancing Links)
- Free enrollment in our Fire Your Financial Advisor online course (a $799 value) if you refinance $100K+ through our links
So refinance those private loans early and often. The lower your rate and the more cash you get, the faster you can get them paid off.
Naturally, the decision to enroll in REPAYE versus refinance is more complicated when it comes to federal loans. Before we get into any calculations, we should first point out the obvious. Also, note that we’re talking about REPAYE today because that is the usual default for graduating medical students these days due to the interest rate subsidy provided by REPAYE. There are some situations (primarily IDR forgiveness) where enrolling in PAYE can be the right move. If you think this might apply to you, we REALLY suggest that consultation with StudentLoanAdvice.com.
Going for PSLF?
If you are planning to be a full-time employee of a 501(c)(3) or a governmental employer, then you DEFINITELY DO NOT want to refinance your federal student loans. If you do so, those loans are no longer eligible for Public Service Loan Forgiveness (PSLF). Even if you’re just not sure if you might go for PSLF, you should not refinance until you are positive you will not qualify for that benefit.
Going for IDR Forgiveness?
Some doctors, usually those with high debt to income ratios (usually > 2.5X but perhaps with a ratio as low as 1.5X), choose to go for Income-Driven Repayment (IDR) forgiveness through a program such as Income-Based Repayment (IBR), Pay As You Earn (PAYE), or Revised Pay As You Earn (REPAYE). Now IDR forgiveness is much less attractive than PSLF, not only because, unlike PSLF, IDR forgiveness comes with a tax bomb (the amount forgiven is taxable as ordinary income in the year of forgiveness), but also because you have to make payments for 20 (PAYE) to 25 (IBR, REPAYE) years!
However, if you are one of those considering this strategy, you definitely don’t want to refinance those federal student loans. You might want to be in PAYE instead of REPAYE too. Again, seek advice if you’re not sure how to run the numbers yourself.
REPAYE vs Refinance
Now, there are still a whole bunch of you out there who have federal loans and are not planning to have them forgiven. You know you will be paying them off yourself, so the only real question left is what you do with them during residency. The usual choices for you are REPAYE or refinance. There are two considerations. The first is effective interest rate and the second is cash flow.
#1 Interest Rate
It is important to understand how the REPAYE subsidy works. It forgives/waives half of the unpaid interest each month. So long as your payment is less than the accumulating interest, there is some interest rate subsidy going on. Let me give you four examples to demonstrate how to calculate your effective interest rate. In each of these examples, we’ll assume you have a $200,000, 6% student loan. That’s a conveniently chosen number because it generates precisely a nice, round $1,000 a month in interest. Let’s also assume you have applied to each of the four lenders in the chart below who refinances student loans for residents without an attending contract in hand and the best interest rate you could find was 4.5%. The question to answer is whether you get a lower effective interest rate by remaining in REPAYE or refinancing to 4.5%.
Payments of $0
Imagine you’re a brand new intern who filed taxes in the Spring of your intern year showing an income of $0 for the prior year. Your REPAYE payments are $0. So there is $1,000 of interest on the loan. 1/2 of that, $500, is waived because you are in REPAYE and the other $500 is added to the loan. Thus, your effective interest rate is 6% * $500/1000 = 3%. Since 3% < 4.5%, you should not refinance yet.
Payments of $200
Now, let’s say your income is a little higher and you now have REPAYE payments of $200. $1,000 in interest – $200 = $800 in interest. REPAYE waives 1/2 of that interest, or $400, and $400 is added to the loan. In this case, your effective interest rate is 6% * $600/$1,000 = 3.6%. Since 3.6% < 4.5%, you should not refinance yet.
Payments of $800
Maybe your spouse is working too and your REPAYE payments are $800. $1,000 in interest – $800 = $200 in unpaid interest. REPAYE waives 1/2 of that interest, or $100, and $100 is added to the loan. In this case, your effective interest rate is 6% * $900/$1,000 = 5.4%. Since 5.4% > 4.5%, you should refinance.
Payments of $1,500
Let’s say you’re married to an attending and now your REPAYE payments are $1,500. ALL of your interest and some principal is covered by that payment, so there is no unpaid interest for REPAYE to waive. Your effective interest rate is simply 6%, and since 6% > 4.5%, you should refinance
What about the student loan interest deduction?
One other consideration is that student loan interest deduction. For tax year 2020, if your Modified Adjusted Gross Income (MAGI) is less than $70,000 ($140,000 Married Filing Jointly) you can deduct up to $2,500 of student loan interest paid during the year from your income. That benefit phases out up to an income of $85,000 ($170,000 MFJ) above which there is no deduction. If you, like most residents, qualify for that deduction, you also need to adjust your effective tax rate for that. Luckily, this is a pretty minor effect. Consider the third example above where the doc has $12,000 in interest but only pays $400 * 12 = $4,800 of that interest. The doc can take the full $2,500 deduction for it. They’re probably in the 22% bracket for federal and maybe 5% state, so $2,500 * 27% = a savings of $675. If you split that up by 12 months, it’s $56 a month. So in reality, the effective tax rate is not truly 5.4%, it’s 6% * $844/$1,000 = 5.1%. 4.5% is still better, of course.
However, don’t forget that the refinanced loan is also eligible for that deduction; it isn’t limited to federal student loans. If the doc refinances and pays $100 a month toward the loan, that would all go to interest, providing a $1,200 deduction worth $324. So the effective rate there isn’t just 4.5%, it’s really (4.5% * 200,000 – $324)/$200,000 = 4.3%. Still, 4.34% is better than 5.1%, so refinancing is still in order.
Note that the borrower COULD pay more of that interest if he or she wanted. By paying extra on the loan, the effective interest rate could be reduced from (4.5% to 4.5% * $200,000 – $675)/$200,000 = 4.16%
This effect is generally relatively minor compared to the effect of the REPAYE subsidy on the effective interest rate.
#2 Cash Flow
The second consideration in the REPAYE vs Refinance conundrum is cash flow. Most residents NEED to be enrolled in an IDR program simply because they cannot afford to make full payments on their student loans. They can afford $100 or even $400 a month, but they can’t afford the full 10-year payment on a $200,000, 6% loan ($2,264 a month). So they would not refinance to get a lower interest rate just due to cash flow issues.
However, the student loan refinancing companies have (finally, after many years of me urging them to do it) recognized this reality and structured their loans such that the resident can make payments of just $100 a month! For many residents, their required payments are actually LOWER after refinancing than when they are in an IDR. Whether lower or not, a resident certainly cannot complain about a $100 a month payment. In fact, there may even be some residents out there who would refinance into a private loan with a slightly higher effective interest rate than what they would have in REPAYE just to improve their cash flow.
Refinancing During Residency
If you think this situation applies to you, I would encourage you to take the first step in making the comparison. Apply with the four companies below that will refinance resident student loans and see how low of an interest rate you can get. Then compare it to your effective tax rate under REPAYE. If you are not going for forgiveness, you can get a lower effective interest, and you can improve your cash flow, what are you waiting for? Refinance today!
† Bonus includes cash rebates and value of free course. Borrowers who refinance more than $100,000 in student loans using the WCI links will be enrolled in The White Coat Investor’s flagship course, Fire Your Financial Advisor for free ($799 value). Borrowers will still receive the amazing cash rebates that WCI has negotiated with each lender. Offer valid for loan applications submitted from May 1, 2021 through October 31, 2021. Free course must be claimed within 90 days of loan disbursement. To claim free course enrollment, visit https://www.whitecoatinvestor.com/RefiBonus.
What do you think? Are you a resident planning to pay off your loans yourself? Are you in REPAYE or did you refinance and why? Comment below!
Originally posted at https://www.whitecoatinvestor.com/repaye-vs-refinancing-student-loans-as-a-resident/