Effective Rates of Negatively Amortized Federal Student Loans

Excellent post from my internet friend Dr. Sotirios Keros over at Doctored Money (a great non-profit non-conflicted site on physician finance and student loans), “Your Federal Student Loan Interest Rate May Be Lower Than You Think”:

Federal students loans are unlike other types of debt in that the interest is not capitalized except in certain circumstances. This means that your unpaid interest is not costing you anything. You still owe it, of course, but it represents “interest-free” debt. For example, consider an initial balance of $200,000 at 5%, which now has accumulated unpaid interest of $30,000. Although you owe a total of $230,000, interest only accumulates at $10,000/year. That’s an effective rate of 4.3% (e.g. $10,000/$230,000).

Seriously, check out the post.

Misunderstanding how federal student loan interest works is something I see wrong all the time, especially on the rare occasions I log into any of the physician finance-type Facebook groups. Accrued interest doesn’t hurt you in the short term unless it capitalizes. For example, rushing to make a token interest-only payment does nothing to change the natural history of your loans. That money can be leveraged–for example even just earning trivial interest in an online savings account–before being deployed more effectively.

The common advice from sites that make lots of money from student loan refinancing is that all graduating residents not doing PSLF should refinance. This seems logical because the private company sticker rates are nearly always less than the federal rates. But that’s not necessarily functionally true, because a resident whose loans spent years negatively amortizing likely has a big chunk of uncapitalized interest that’s doing nothing while in the federal program but will capitalize and earn its own interest after refinancing.

It may still be the right choice, but except in certain situations, you can’t just compare rates apples to apples and know you’re saving money.

You have to compare the effective rates!

Review: The Physician Philosopher’s Guide to Personal Finance

Back in May, I had the chance to sit down with The Physician Philosopher’s Guide to Personal Finance: The 20% of Personal Finance Doctors Need to Know to Get 80% of the Results.

The Pareto approach is a good conceit and is most of what people need. Real personal finance for most people is two things: simple and behavioral. Save a significant amount of your income by living on less than you earn and then do something really boring with it. Then, stay the course no matter what.

Add in bits about how important it is to buy own-occupation disability insurance and term (not whole) life insurance, and that’s the meat of the book.

My main beef, unsurprisingly, is the chapters dedicated to student loans. One, there are some factual inaccuracies (e.g. about eligibility criteria for the PAYE program, the fraction of physician jobs that qualify for PSLF, the common misconception that losing a partial financial hardship in IBR or PAYE boots you out of IDR and into the standard plan [it doesn’t, the payments just cap at that amount]), and the notion that all doctors should leave REPAYE after training and switch to PAYE in order to minimize payments [it depends!].

Two, the Pareto principle applies well to most people’s retirement finances but less well to nitty-gritty loan details, especially once you get into PSLF-territory. For the former, there is no evidence that a complicated portfolio outperforms a simple one when it comes to your investment accounts. As author Rick Ferri recently advised on the White Coat Investor podcast:

Regarding your portfolio: make it simple, make it automated, and just let it do its thing. Don’t touch it. That’s the best financial advice I can give. Simplicity, automation, hibernation.

But, there can be a big difference with small details when it comes to loans, which can easily change result in swings of tens to hundreds of thousands of dollars. I see what should be simple mistakes cost thousands constantly. Technicalities are the lifeblood of the system, but I do agree with TPP’s overall thrust though. Luckily, there’s a free book that knocks that particular topic out of the park.

Overall Jimmy is a solid writer and the book is readable and reasonably concise. The first editions of my books had small errors too (okay, I’m sure they all still do–I’m a very fallible human). The beauty of self-publishing is that Jimmy has probably already fixed the errata I found.

It’s a great book for students, residents, and early career physicians.

Updated Student Loan books

Nice, productive holiday weekend. I also got around to making some minor revisions and 2019 updates to Medical Student Loans and Dealing with Student Loans, both of which you can always download for free right here. Yes, these beloved best-in-class books are completely free, because student loan debt is crippling generations of Americans, and that outweighs every other consideration.

If you already have a copy, you can still drop your email on the download page and get this most recent edition in your inbox. (And of course you’re always welcome unsubscribe immediately.)

While I would recommend reading one of the two books to literally anybody with a student loan from current college students to seasoned physicians, I strongly recommend any graduating students to take a few hours this month and get your financial house in order.

This is literally the perfect time.

Doctor jobs at “nonprofit” 501(c)(3) hospitals don’t all qualify for PSLF

Depending on where your searches take you or which books and articles you read, you may come across some questionable insight when it comes to PSLF eligibility for doctors. In short, people often argue that because approximately 70% of all hospitals in the United States are nonprofit hospitals, that a similar fraction of jobs at those hospitals qualifies for loan forgiveness. This is very logical, but it is unfortunately not true.

Now to be clear, this is often used as an argument for why residents should remain in a federal repayment plan like REPAYE instead of private refinancing, for which I wholeheartedly agree. In most cases, residents will get as good if not a better rate staying in REPAYE than they could get with a private company, all while enjoying the benefits, protections, and flexibility of the government plans while giving you the chance to achieve tax-free loan forgiveness via PSLF–depending on what job you take after finishing training. You really never know until you know. Most of you reading probably didn’t even apply for the same residency you’d have guessed when you applied to medical school, so why pretend you know exactly where you’ll be working years in the future?

That post-residency job bit is key though because the magic of tax-free loan forgiveness via PSLF requires a few things: qualifying loans paid for using a qualifying repayment plan while working at a qualifying institution.

The counterintuitive issue here is that it does not actually matter what you do for your job or even where you do it, it only matters who pays you. Outside of academia, county hospitals, and the government (including the VA and active duty military hospitals), relatively few “nonprofit hospitals” directly employ their docs. In some states like Texas and California, none at all.

It’s common knowledge that many specialties like radiology, pathology, and emergency medicine are nearly always a contracted private practice group that provides services. Specialists are a relatively uncommon direct hire at most non-profits. But even many hospitalists are actually employed by a separate physician group. So the question in many cases isn’t “is the hospital a non-profit?” It’s: is the physician group also a non-profit?

To give you an example: the very famous healthcare organization Kaiser Permanente runs a lot of 501(c)(3) hospitals. Many people who work at these places would definitely qualify for PSLF. However, the physicians who work for Kaiser are not employed by Kaiser Permanente itself or any of its network nonprofit hospitals. They are employed by various for-profit Permanente Medical Groups. It doesn’t matter if they work at a nonprofit; it matters who pays the bills. Whoever appears at the top of your W2 is who counts.

Sad but true. While the law was intended to encourage people to pursue careers in public service, the nature of how it was written dictates that it is only the details that matter, not the substance.

This is not to say that there are no qualifying nonprofit hospital jobs out there outside of the usual academic/safety net/government axis (of course there are) but rather that working at a nonprofit hospital doesn’t necessarily mean you are working for that hospital. It’s not the same kind of guarantee that working at an academic/university institution typically is, and even some academic hospitals are “privademics” that still silo off most of their doctors.

If you are relying on or planning for PSLF, then eligibility will be an important consideration when choosing your first job or two as an attending. In this case, you had better make sure you know exactly who your real employer would be, not just where you’d be working.

To repeat: if your hospitalist gig means you’re actually employed by a hospital-associated provider group, it’s the group that needs to be a 501(c)(3).

It doesn’t matter what hospital you work at if the hospital doesn’t employ you. It matters that your direct employer is a 501(c)(3) organization that treats you as a full-time employee.