A Physician’s Fork in the Road: Student Loan Repayment, Forgiveness, and Refinancing
Recently published in the New England Journal of Medicine Resident 360 under “Managing Medical School Debt”.
I work at Indiana University School of Medicine – the largest medical school in the U.S. – where more than 315 medical students graduate each year and more than 80% owe at least $200,000 in a combination of student loan principal and accrued interest. In my 28 years as Director of Student Financial Assistance, medical school tuition has increased 650%, leading to a dramatic increase in medical student loan indebtedness. Our medical school is by no means one with the highest student debt. Rather, we represent an average example of medical student loan indebtedness. Of course, a few medical school outliers have substantial resources that help medical students minimize — but not completely eliminate — student loan debt. And yes, 15%–20% of medical students graduate each year without any debt, as a result of family resources, service-connected scholarships (e.g., Military, National Health Service Corp), or a combination of savings and scholarships.
In an era when medical student debt is steadily rising and health care payment reform makes expected monetary returns in any specialty more nebulous, one big question is: Should medical students consider medical school debt a burden or an investment? I espouse that it should be the latter—an investment. Some calculations estimate that the return on investment (educational debt) of a medical education can be greater than 35% annually. No other profession offers the respect, satisfaction, and return on investment. Unfortunately, the profession comes at the expense of time. With at least 4 years of medical school, an additional 3–7 years of residency training, and 2–3 years of fellowship training, it’s a long road.
Financial outcomes for medical students, residents, and practicing physicians vary widely and depend on many variables, including the wide spectrum of wealth-generating power across all medical specialties. Therefore, it’s important to understand how the variables affect your financial future and outcome.
For example, in one scenario, the physician is regarded as a wealth-building machine. This is a physician who graduates from a state-supported school without undergraduate student-loan debt, lives frugally while in medical school, consolidates medical student loans at a low interest rate, works in a high-paying specialty, chooses to live in a location with a reasonable cost of living, maxes out all of his or her investment options, lives below his or her means until all debt is paid off, and is able to save heavily to amass a strong investment portfolio.
In contrast, physicians can easily go broke and question why they chose medicine in the first place. In this scenario, the physician enters medical school with substantial undergraduate student-loan debt, goes to a pricey private medical school in an expensive city, takes out large educational loans, lives above his or her means (hey, what’s a few more dollars of debt?), decides to practice in one of the lower paying specialties, doesn’t learn about financial skills or vehicles to optimize his or her position, has high-interest loans, moves to one of the coasts with a high cost of living (because that’s where the fun is!), immediately starts spending “like a doctor” (because they’ve waited so long to finally drive that Audi), ignores financial education (because they are too busy), and then pays too much for bad financial advice that only benefits the financial advisor.
As you can see, MANY decisions are involved in these scenarios. Medical students must understand how all these variables contribute to their overall financial picture. Specialty choice is one of the more heavily weighted choices that needs to be carefully measured against the other variables, some of which are fixed (e.g., undergraduate and medical school educational debt). So the saying, “just do what you love,” ends up feeling a bit shallow if all the other variables are not carefully managed. Math can be very unforgiving.
What are graduating medical students doing about medical school debt? Today, medical school graduates have two distinct pathways for managing medical student loans.
Forbearance or Deferment: Mandatory Internship/Residency Forbearance allows graduates to forego making payments on federal student loans during the residency program as interest accrues on the entire principal balance. Similarly, the Graduate Fellowship Deferment (GFD) is available during fellowship training, although it differs from forbearance in that interest accrues on the unsubsidized and Grad PLUS Loan balances only. All interest on subsidized loans is subsidized by the federal government. Although both methods of delaying repayment are now seldom used, they remain a viable way to manage federal student loans for some people.
Income-Driven Repayment (IDR) plans: IDRs make repayment more manageable and feasible when income is low during residency training. In the Income-Based Repayment (IBR) plan, calculation of payment starts with adjusted gross income (AGI) and subtracts 150% of the federal poverty guidelines for the graduate’s household size. The resulting amount is referred to as discretionary income and is multiplied by 15% to determine the annual repayment amount (divided by 12 months for the monthly repayment amount). A simple formula for the calculations is (AGI-150%) X 15%)/12. The program has income requirements and requires proof of financial hardship (i.e., total federal loan debt is higher than income). IBR has a forgiveness clause stating that any balance can be forgiven after 25 years and the forgiven balance is taxable.
In 2012, another IDR – Pay as You Earn (PAYE) – was implemented as a result of a presidential order. This repayment plan uses 10% of discretionary income to calculate the monthly payment with the formula (AGI-150%) X 10%)/12. The program is not available to anyone who borrowed for the first time before October 2007.Those borrowers have to use the IBR. PAYE has a forgiveness clause after 20 years and the forgiven balance is taxable.
Both IBR and PAYE calculate a standard cap payment based on paying off the total debt in 10 years at the time the repayment plan is set up. This standard cap payment is the default payment when the IBR or PAYE calculation exceeds the standard cap payment. Therefore, when residents transition from resident earnings to physician income, it is generally wise to stay in the IDR plan unless their income is high enough to sustain a higher payment and pay the debt off more aggressively.
Both IBR and PAYE also make it possible for borrowers to use a Married Filing Separately federal income tax return in the formulas. However, the loss of marital tax benefits means higher taxes. Therefore, this option should only be used if the tax loss is recovered by the savings in monthly payments during the repayment year.
In 2015, in an effort to expand PAYE to another 5 million borrowers, President Obama proposed that the Department of Education change some rules to target lower-income borrowers and discourage high-debt/high-income borrowers (e.g., doctors and lawyers) from taking advantage of the PAYE generous repayment terms. In December 2015, revised PAYE (REPAYE) became available using the same repayment formula as PAYE but allowing all Direct Loan borrowers to qualify regardless of when they took out their first loan. Now, older loans can be consolidated and qualify for REPAYE. Unlike IBR and PAYE, REPAYE does not have an income requirement or require proof of financial hardship. REPAYE has a forgiveness clause after 25 years for graduate students (20 years for undergraduates) and the forgiven balance is taxed. REPAYE does not have a standard cap payment and does not allow use of the Married Filing Separately IRS tax return. REPAYE does provide a major incentive: It limits interest charged to borrowers. The borrower is only charged 50% of the accrued interest on all of their loans. In essence, it is like getting a 50% reduction in student loan interest rates. A video that explains and compares PAYE and REPAYE can be viewed here. Another video that explains the benefits of REPAYE for medical school graduates can be viewed here.
Needless to say, repayment has become complicated and some companies are capitalizing on this confusion (e.g., Doctors without Quarters) to help graduates sort through the maze. Medical school financial aid offices are also becoming more adept and involved with the loan process by ensuring that graduates are aware of the differences among the repayment plans as they strategize which one to use.
IDRs become even more important in loan-forgiveness programs because they can maximize opportunities for forgiveness. According to the Public Service Loan Forgiveness (PSLF) implemented in July 2009, a borrower must make 120 income-driven repayments while working in a not-for-profit organization to reach loan forgiveness. Only Direct Loans (DL) qualify for loan forgiveness. If a borrower with Federal Family Education Loans (FFEL) wants to qualify the FFEL loans for PSLF, they must consolidate their loans under the DL Consolidation Loan Program. The consolidation process is available at www.studentloans.gov.
With more than 78% of U.S. hospitals and 98% of current residency programs claiming not-for-profit status, it is no wonder why medical school graduates want to set up income-driven repayments as soon as possible after graduating from medical school. The potential for PSLF to discharge a portion of medical school loans tax-free is significant. Unfortunately, not all medical careers are amenable to not-for-profit employment.
Nonetheless, IDRs could be a great way to manage debt while maintaining the possibility of benefiting from the PSLF.
In the last few years, as student loan interest rates continues to creep up and burden borrowers and the federal government continues to drag its feet about allowing borrowers to refinance federal student loans, a proliferation of private-sector companies (e.g., DRB, SoFi, and Earnest) offer graduates the opportunity to consolidate educational loans with attractive interest-rate reductions, specifically targeting graduate student borrowers in lucrative careers. Refinancing federal student loans with private student loans is risky, but borrowers making good money increasingly believe it’s worth the risk, given how much money they are paying in interest to the federal government.
One of the reasons the federal government justifies high interest rates on graduate student loans is because, theoretically, graduate students can earn enough money to pay everything back. These higher returns are then supposed to subsidize lower-interest undergraduate loans. Unfortunately, the federal government is losing the stable and lucrative graduate borrower to private refinancing companies. Why wouldn’t borrowers consider switching to a lender with a more attractive interest rate at the risk of leaving the federal student loan program and missing out on PSLF? As long as private companies continue to syphon the most successful borrowers from the federal government loan programs, the federal student loan system will continue to destabilize and be less able to absorb costs and risks. If graduate student loans are supposed to finance (at least in part) undergraduate student loans, where does that leave the system?
What Congress will do next is unknown. White House budget proposals are already trying to change PSLF, albeit the proposals have been ignored by Congress. Nevertheless, the question of what will happen to PSLF remains. On a more comforting note, changes in financial aid programs generally include grandfather clauses for borrowers in existing programs.