Student Loan Planning for Doctors: Managing Consolidation, PSLF, and Getting a Mortgage

Michael Lux Blog, Student Loan Plan, Student Loans 0 Comments

Student loan planning can be a tricky subject.  In addition to figuring out repayment plans that work and trying to consolidate to get lower interest rates, this planning necessarily impacts your taxes, retirement and ability to buy a home.  Understanding how these concepts come together is critical to smart planning.  Today we will look at Melissa’s situation: she just got her doctorate, has well over 100k in debt, is thinking about PSLF, and would like to buy a house.  If you want tips for dealing with your student loans, contact us.

Melissa writes:

Hi,

I’m hoping you can give me some advice.  Here’s my situation:

1. I have undergraduate loans consolidated by AES.  All of my undergrad federal loans are paid off and I have about $28k left in private loans.  My monthly payments are $234.

2. I recently finished my doctorate and started working as a psychologist for the federal government with an income of $60k a few months ago.  It will go up to $72k within the next year once I get licensed.

3. I have student loan debt from grad school including about $100k in (8) federal loans and $18k in (2) private loans.  None of this is consolidated and they just went into repayment.  My federal loans are asking for more than $1000 per month and private loans are asking for about $221 per month.

Clearly, I cannot afford to be paying this much.  I thought I signed up for income-based repayment when I took out the loans, but this can’t be right.  I’m in the process of checking on this.  In terms of making my payments more manageable, as well as being eligible for the PSLF through my public service job, what can I do?  After doing some research, my initial thought is to apply for a federal consolidation loan for my $100k in federal loans and pay on an IBR schedule to qualify for the PSLF.  For my private loans, I’m wondering if it makes sense to do a separate consolidation (i.e., separate from my federal loans) of  my undergraduate and graduate loans, if this is even a possibility. 

What would you suggest I do in this situation?  I’m also in the process of buying a house with my husband so that increases the financial stressors, and we’re hoping to start a family in the next year.

Thanks so much for your help!

Melissa

Monthly Payments

Regardless of your financial circumstances, one of the best things you can do in student loan planning is to research the minimum payment on all of your student loans.  Even if you can afford your current payment, getting a lower minimum payment has a distinct advantage.  It allows you to direct more student loan repayment money towards higher interest loans.  The faster you attack your high interest debt, the faster it will be paid off.  It sounds like Melissa is already in this process.

As far as what she is being told about her federal payments, the $1000 per month sure sounds like a payment calculated on the standard repayment plan, rather than an income driven plan.  Unfortunately, loan servicers are often guilty of getting the details wrong on this critical piece of information.  One of the best tools that a borrower has available is the Department of Education Repayment Estimator.  Spending some time on this page should give any borrower a good idea of what their federal loan repayment will look like.  It also helps verify the information being provided by loan servicers.

Consolidation Options

There are two types of student loan consolidation.

Federal direct consolidation can only be done with federal loans and it does not lower your interest rate.  The advantage of federal direct consolidation is that if you have older federal loans that are not eligible for programs like Public Service Loan Forgiveness, they can be included in a federal direct consolidation loan and become eligible.  However, there are risks associated with federal direct consolidation as well.  If you include a loan that isn’t eligible for certain programs, then the entire new consolidation loan could lose its eligibility.  Making things even more difficult is the fact that there is no way to undo any loan consolidation.  As a result, it is critical to understand the consequences before going that route.

Private loan consolidation can be done with federal loans or private loans.  The advantage to this process is that borrowers can get significantly lower interest rates and save thousands over the life of the loan.  The downside is that if you include federal loans in a private loan, those loans lose their federal perks, such as Income Based Repayment and Public Service Loan Forgiveness.  It is for this reason that Melissa is very smart to want to consolidate just her private loans while leaving her federal loans untouched.  The lower rate saves money on interest, and depending upon the repayment plan selected, it could lower monthly payments which will help with the home shopping.  As far as the feasibility of consolidating some loans with private lenders, you do not have to go “all-in” on your student loan consolidation.  In fact, it is often the smart move to pick and choose the loans included.  The key to a successful refinance or consolidation is to shop around to find the lender that offers you the best rates.  This is because the advertised rates and offered rates can often be different and all lenders evaluate applications differently.  Our page on consolidation provides a list of lenders, reviews of the companies, current lender promotions, and some tips to avoid mistakes.

Taxes

One of the issues that Melissa and many other student loan borrowers will face is a tax related question.  Income driven repayment plans, such as IBR, will look at your taxes to determine your yearly income and what you can afford.  If you file your taxes jointly with your spouse, that income is also included.  (If Melissa’s husband has a large income, this might also explain her high IBR payments).  However, if you file your taxes as married filing separately, spousal income is not included.  The problem with this route is that it results in a higher tax bill each April.  We recently discussed the considerations that go into making this decision.

Public Service Loan Forgiveness

Public Service Loan Forgiveness or PSLF, is an uneasy topic for those that are counting on it.  The program was created in 2007, so we are on the brink of the first applicants to have their remaining student debt wiped away.  As the debt forgiven increases, this already criticized program will be attacked.  Even President Obama proposed a budget that would cap the amount forgiven under the program.  However, the fears about the continued existence of the program are merely fears and not reality.  While it may be changed, odds are good that existing borrowers may be grandfathered in under the current rules.  Ultimately, unless you have a time machine, there is no way to know for sure, so it is important to be ready for anything that could happen.

Public Service Loan Forgiveness has a lot of fine print in the rules, but for borrowers who are able to take advantage of the program, it is a huge benefit.  Whether or not the program makes sense for Melissa will depend upon how successful she is getting her payments lowered.  If she is going to be paying $1000 per month at minimum, there may not be much debt left to forgive after 10 years.  In that circumstance, it makes more sense to aggressively pay off the debt.  However, if she can get a lower payment and is looking at a small fortune being forgiven, it makes sense to jump through all the hoops to get her debt wiped off the books.

If you are on the fence about aggressively paying off your loan or going after PSLF, we suggest that you try to find the best of both worlds.  With your loan servicer, get on an income driven repayment plan and pay the minimum in an attempt to maximize your forgiveness.  Meanwhile, aggressively save money that would otherwise be used towards your payments to attack the debt.  These additional funds can be invested in stocks, bonds, or a high interest savings account so that you don’t take too much of a beating on the interest.  If PSLF ends up working out, you have a nice nest egg to put towards retirement.  If it doesn’t work out, you have funds in place to attack your federal loans.

Buying a House

When people think about buying a house, the top concern usually revolves around getting their credit score up as high as possible.  However, for most student loan borrowers, the big issue is debt-to-income ratio.

Melissa has a lot of debt and that will be compared to her income at the time she applies for the house.  Mortgage companies and banks will be looking at her monthly student loan bills and comparing them to her monthly paycheck.  When she addresses her student loans, she needs to be mindful of how the moves she makes will affect her debt-to-income ratio.  This could have a big impact on the amount of money she is able to borrow.

Another consideration is the timeline.  When you apply for a mortgage, you want a credit report that is not in flux.  Income Based Repayment applications that are still being processed can be a huge headache when you are applying for the mortgage.  Additionally, we think the mortgage industry does a lousy job in evaluating federal student loan debt for those on income driven plans.  If you are about to apply for a mortgage and on IBR, PAYE, or REPAYE, be sure you understand what the lenders will be looking at and how they will be doing the math.

Bottom Line

In dealing with these situations, repayment strategy depends upon a number of different factors.  Your financial goals and aversion to risk might result in you making one decision while someone in exactly the same position goes another route.

The critical part of this planning is to understand how topics ranging from taxes to politics to bank lending procedures come together to impact your finances.  Once you have an understanding of the moving parts, making the smart decisions becomes much easier.