PAYE vs REPAYE: interest capitalization cap better than interest subsidy?

The PAYE interest cap is essentially never better than the REPAYE interest subsidy. There are reasons PAYE can be a better choice for many borrowers, but the interest capitalization cap isn’t really one of them.

But let’s take a step back: If you’re reading this post, you may already know the relevant facets of income-driven repayment plans that I’m referring to: Within the PAYE plan, any accrued interest that capitalizes is limited to 10% of the original principal amount when you enter repayment. What this means is that no matter how much interest accrues, the maximum principal amount after capitalization in the long-term is the original amount + 10%. Which means that over the long term, the rate of interest accrual is capped (but not the amount, of course). When does interest capitalize within the PAYE program? When you lose your partial financial hardship, which will likely happen at some point during attendinghood depending on how much you owe vs. how much you make. An example would be if you had a $200k loan with $50k in accrued interested; after capitalization in PAYE, the loan would be $220k with $30k in accrued interest instead of $250k, which means at 6.8% $14,960 accrues per year instead of $17,000.

In contrast, REPAYE has a subsidy that pays half of the unpaid accrued interest on a monthly basis. The reason the above question is basically never is because REPAYE interest never capitalizes unless you leave the plan. Because there is no hardship requirement, your interest will continue to accrue at the same rate it always has. Only if you try to change back to a different repayment plan (say, to lower payments as a high-earning attending) would your interest capitalize. That $200k loan in REPAYE will always accrue the same amount of interest every year (until you begin to pay down the principal, of course).

Continue reading

How/Why to Consolidate Federal Student Loans When You Graduate Medical School

When you get federal student loans from the government for medical school, you don’t just get one loan: you get at least one per year. Back in the day when graduate students still received subsidized loans, many borrowers would receive three: one subsidized, one unsubsidized, and often a small “low-interest” (5%) Perkins loan. Now, in practice, holding on to multiple loans doesn’t really affect your daily life much. Your federal loan servicer (the company that takes your payments) will apply your payments automatically across all of your DIRECT loans for you (your Perkins loans, if you have any, will be due separately from the rest).

Consolidating your federal loans into a DIRECT Consolidation from the federal government (as opposed to private refinancing, discussed here) does make things look nice and tidy in that you’ll now have a single loan with a weighted-average interest rate based on the rates of the individual loans it replaced, but this paperwork trick isn’t particularly meaningful in and of itself. Unlike private refinance options, you’re guaranteed to not save a single dime on the interest rate. In fact, a slight rounding change could give you a trivially higher rate (it’s rounded up to the nearest one-eighth of 1%).

But there are definitely a few reasons to consider consolidating your loans, particularly as early as you can, in large part due to government’s newest income-driven repayment plan: REPAYE. (Sidebar: please read this for more info about REPAYE and why it’s generally a good idea of residents if you’re not already familiar with the program). And there’s a double reason if you’re considering PSLF.

In short, starting a consolidation when you finish medical school will do three things to save you money:

  1. Reduce the amount of capitalized interest on your loan, which reduces the rate at which it will grow for a long time
  2. Temporarily increase the amount of your REPAYE unpaid-interest subsidy
  3. Help you achieve loan forgiveness a few months faster

We’ll discuss each of these in detail followed by brief step by step instructions. Stay with me.

Continue reading

Yes, you can switch back from REPAYE to IBR or PAYE

There has been a lot of confusion from borrowers whether or not REPAYE, with its partial interest subsidy, is a good choice for people with high future income (e.g. residents). The main concern is what happens after training when salaries increase and the possibility of breaking past the monthly payment cap, which could make you lose money (in the context of trying to minimize payments in anticipation of PSLF). Note: If you’re just trying to pay off your loans in an efficient way, breaking past the cap should be mostly irrelevant–you should be trying to pay down your loans as fast as possible anyway.1

If you call your federal loan servicer but don’t ask the right questions, your servicer may lead you astray in how they answer questions about the terms of the REPAYE program. It’s misleading but technically true: if you are making so much money that you break past the REPAYE cap, you absolutely cannot switch back to PAYE or IBR.

That’s NOT because you aren’t allowed to switch out of REPAYE in general (you are), but because at that point you would no longer have a “partial financial hardship” and thus no longer qualify for those plans to begin with. Your servicer is able to provide information and advice, but don’t for a second think that they don’t have a vested interest (see what I did there?) in your payments. A simple rule of thumb is that if you owe more on your loans than you make in a year, you definitely still quality for your income driven repayment plan.

What is actually used for payment calculations is not your gross income but your discretionary income: your gross income minus 150% of the federal poverty line for your family size (e.g. family size of 1, 2, and 3 is &17,655, $23,895, and $30,135 in 2015, respectively). The official rule is that if your calculated monthly PAYE/IBR payment (whichever you qualify for) using 10/15% of your discretionary income is less than the standard 10-year repayment, then you still qualify.

So there is a simple solution for forward-thinking borrowers who want to take advantage of the REPAYE benefits but don’t want to tie themselves to higher future payments: Switch back before you make money.

You can switch from REPAYE to PAYE as long as you still qualify for PAYE. Or you can switch back to IBR instead if you had older loans and didn’t qualify for PAYE to begin with.2 Do this at the end of your training and the problem is solved. (Technically, many people could do it even once out in practice; it all depends on how much you borrowed versus how much you/your family makes per year. You can use the calculator to see what household income you’ll need to break past the threshold.)

Also note that since most people generally use tax-returns and not pay stubs to verify income, there is generally a delay between when your income rises and when your taxes reflect that increase. This isn’t the way servicers would like it, but it’s the reality on the ground. You could be an attending as of July 2016, but when you resubmit income verification in the fall of 2016 for REPAYE, you’ll be submitting your 2015 taxes, which is a combination of your last two PGY years of training.

The bottom line is that you absolutely can switch out of REPAYE—you just have to be a little bit thoughtful on when you want to switch out to not miss the window. REPAYE makes the most sense for many if not most residents. For people who aren’t going for PSLF (especially if they’ve borrowed smaller amounts and won’t enjoy a big interest subsidy), no-cost private refinancing may be a better choice.

This plan-switch information comes from this document and FAQ, and I’ve confirmed this interpretation with Nelnet (one of the federal loan servicers). If you talk to your servicer and they say otherwise, ask them to explain exactly why and we’ll get to the bottom of it. Because they should be wrong.

 


  1. I.e. it would mostly likely only matter if lifestyle has inflated to the point where the money you should be using to pay down your loans has been earmarked for other purposes, like car loans.

  2. IBR payments are higher than PAYE payments (15% vs 10% of AGI), so PAYE is preferable in the context of minimizing payments for PSLF.

Book Review: Physician Finance

Next up through the Kindle Unlimited tour of “free” books written for physicians is Physician Finance: A Personal Finance Guide for Doctors by KM Awad.

This book’s style is very casual. Normally that’s fine, but I wonder if perhaps among the jokes and looseness if the message is maybe diluted (some may appreciate it more than me; I found it tiresome but it certainly keeps things light). This book covers the basics. In fact, every book covers the basics. And in practice, the basics can always be summarized in a few bullet points.

  • Spend less than you earn. If you can, spend a lot less.
  • Housing and transportation are people’s two biggest expenses. If you can, definitely spend less on these.
  • Pay off your debts as fast as you can: the higher the interest rate, the faster you need to pay it off.
  • Invest for retirement (in tax-advantaged accounts like 401(k)s, 403(b)s, 457(b)s, and Roth IRAs). The earlier you start and the more you save, the better.
  • Seriously, stop spending so much money.

But here, some of the “details” are wrong. And if not wrong, some are definitely fringe viewpoints expressed like facts.

Incorrect view of credit cards and credit card perks

Credit cards aren’t the work of the devil; they’re a (potentially dangerous) tool of convenience. No one likes the idea of being in debt (or actually being in debt), but Awad writes with an almost irrational fear of it (to the point that otherwise reasonable arguments begin to lose steam). There’s been a recent push among some authors to encourage people to use cash over plastic, as it’s been shown in some studies that people spend more per purchase with credit cards than cash. This may be true, but using cash is super inconvenient (and try booking a hotel without a credit card). Credit card perks are in fact real (and there are whole sites dedicated to this), and while it’d be silly to think that the card companies are doing this for charity, if you pay on time, it’s the merchants you buy from who are paying the fees, not you. The only people who should really be staying away from cards are the ones carrying around high-interest credit card debt month to month.

Poor understanding of car leases

Don’t get me wrong, no one is being “frugal” when they they get a car lease (or buy a new car at all), but Awad is wrong on some basic lease facts. Anyone who simply writes that leases are always worse than buying is equally wrong as someone who says renting is always worse than owning. A simple common misconception. Don’t get me wrong, ideally everyone should buy a three year old Honda in cash. But given that not every reader is going to do that, this treatment comes across as ridiculous. If you are going to go get a brand new vehicle, then you should know that whether you lease or buy, the vast majority of all that money goes to depreciation. Even if you buy, there’s minimal equity after a typical three year lease term. So whether leasing is worse than buying depends entirely on the terms of your lease versus the terms of your purchase as well as how long you plan on holding on to the car. It’s not that leasing is always worse than buying, it’s that getting a new car every few years is a costly luxury.

Poor understanding of mortgages

Treatment of mortgages is also overly simplistic and somewhat misleading. Awad is particularity wrong regarding adjustable rate mortgages, particularly with regards to loans like 5-year ARMs, where the rate is fixed for a set amount of time and then adjustable afterwards. Again, you can get in a lot of trouble if you use a nice low rate on an ARM to buy a house you can’t afford, but depending on your plans, an ARM may make perfect sense.1

He also argues for a 15 year over a 30 year mortgage without any consideration of their tax consequences, for example. No one would argue that a 15 year costs less (it does) or will have a better interest rate (it will), but that doesn’t mean that depending on the interest rate difference that a 30 year isn’t a better choice, say for someone getting a super low fixed rate and who has plenty of tax-deferred retirement space left to invest the excess.

Useless discussion of student loans

The biggest, most complicated, most-“physiciany” issue facing young docs is their large student loan burden.This book does a terrible job discussing student loan debt, being both too succinct and simplistic, out of date, and also inaccurate. Awad spends time discussing subsidized loans, which you can’t get anymore for medical school. He recommends deferment, which you also can’t get anymore (forbearance is different and with worse terms). No meaningful discussion on any of the actual payment options, IBR, PAYE, REPAYE, consolidation, or private refinancing. Nothing about PSLF. This topic is one of the things that actually deserves some detail in a finance book from docs and is conspicuously absent.

Overall

One downside to Awad’s viewpoint of extreme debt fear is the potential quality of life hit. The purpose of money is to make you happy (i.e. many of us “work to live”). Sometimes trying to save a buck here and there results in a big happiness hit, especially during the medical school time period. It’s not always worth it, and it’s silly to pretend it is. It’s at least as alienating as it is inspiring.2

The core message of the book is fine. The core message of the book is also the core message of every personal finance book, which could also be a blog post (which is true of every self-help book). The details though, from credit cards to loans to retirement, are just too patchy to recommend.3

Verdict: While this book is free for KU subscribers, anyone paying should just read The White Coat Investor, which while definitely not perfect (and particularly lacking for student loans), is a substantially better book overall.


  1. For example, if you were to decide to buy a reasonably priced starter home in a strong area for a 5-year surgical residency knowing you will want/need to buy a family home later, then buying a 7-year ARM may make good sense and save you money without any meaningful risk.

  2. Ironically the author promotes his super stingy living expenses during medical school as a way to save money on top of his private school tuition (as opposed to mentioning the massive and likely bigger savings from going to a public medical school)

  3. Another random example, he discusses the Sep IRA for the self-employed without mention of the solo 401k, which is an overall better vehicle for most people and enables you to also contribute to the “backdoor Roth IRA.”

Book Review: Pay Yourself First & Changing Outcomes

I recently started a 30-day Kindle Unlimited free trial, which gave me a chance to pick up a bunch of Kindle titles (to read on my phone).1 I used the opportunity to take a look at a large fraction of the (mostly self-published) books on medical school advice and physician finance.

My first review is a combo of two sibling books written by financial planners of “TGS Financial Advisors.” These folks specialize in “servicing” physicians; they’re CFPs and not MDs.

The first, Pay Yourself First, is geared toward doctors just out residency/fellowship (potential clients for their $5000/year fee-based advisor service). The second, Changing Outcomes, is directed toward mid-career physicians (who presumably could fork over even more money). This is amusingly reflected in the price, as Changing Outcomes costs a bit more.

Both books are short and share large portions verbatim. Pay Yourself First focuses on convincing you to save more and not spend too much of your new-found income. Changing Outcomes begs you to save more and stop spending so much. The actual financial advice is physician-directed though almost entirely not physician-specific.

The covers are nice, and they paid Kirkus a few hundred bucks for a blurb, so they’re taking the “book as native advertising” concept seriously. There are a few typos and whatnot, perhaps less than average for self-published. I think most recent medical school grads with their massive student loan burdens are more in tune/fearful of their financial future than older docs of the more lucrative medical past, but the discussion of why a high savings rate is the foundation of building wealth and retirement security is nicely written.

A few of my favorite passages.

Here at the beginning of your career your assets are probably smaller than those owned by the average public school teacher. Asset poor and cash flow rich; in your first years of practice, everyone will want a piece of that cash flow.

This is a hidden cost of medical training that most non-physicians simply cannot understand. Not only have you studied longer than any other professional, incurred hundreds of thousands of dollars in education loans, and deferred a serious payday until your mid-30s, you have also lost precious years of potential compounding on your savings.

When you finally start making money, you’re already way behind. You have tons of debt and haven’t saved nearly enough, and those valuable years of compounding interest are gone forever.

Unfortunately, the relationship of wealth to happiness is asymmetric. Moving up is often only temporarily rewarding. But losing ground—suffering even a limited reduction in socio-economic status—is durably painful.

Lifestyle inflation is much easier to avoid than reverse.

Spending on possessions has the most transient effect on happiness, while spending on relationships and experiences has more durable emotional benefits. Unlike status based on earning or spending, research suggests that attaining $1 million of net worth is associated with a permanent increase in confidence and self-esteem.

Having enough money to tell the hospital admin to do something profane to themselves: Priceless.

Outside of these general themes, there is almost zero detail. This is not a DIY book, so other than the inspiration, the books are pretty much useless. Hint: They think you should get a financial advisor.

Overall, the you-need-an-advisor sell isn’t particularly egregious, but it is a bit amusing as it comes after discussion of how low-cost low-fee index fund investing is the right choice (something you definitely don’t need an advisor to set up). Fee-based financial advisors are essentially life coaches who focus on your money. You really only need one if you can’t be trusted to not sabotage yourself.

Verdict: If you need convincing to save more and spend less, either one is a pretty well-written plea and is a fine free read if you have KU. Otherwise, save your money and look elsewhere, like WCI or Bogleheads’.

 


  1. I’ve actually always ignored the “Kindle Unlimited: Free” offers that I’ve been seeing on Amazon for a long time. But a lot of folks have been reading my book as part the program recently, so I thought I’d finally check it out.