Federal “Direct” Consolidation

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 subsidized “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). After setting up auto-debit for your loans, the monthly payments are withdrawn and applied appropriately automatically. You’ll even get a small rate discount. It’s a set-it and forget-it situation.

Consolidating your federal loans into a federal Direct Consolidation from the federal government (as opposed to private refinancing/consolidation, discussed in detail later) 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: the new loan’s rate is rounded up to the nearest one-eighth of 1%. The subsidized loans within a consolidation maintain their subsidized status, though any Perkins loans do not.

But there are definitely a few reasons why you should consolidate your loans, particularly as early as you can after graduation, in large part due to the REPAYE program. And there’s a double reason if you’re considering PSLF.

In short, starting your federal 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
  4. Max out the student loan interest deduction for the year of graduation

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


Consolidating to Make Your Loans IDR & PSLF Eligible

The first benefit of Direct consolidation is that it can make more of your debt eligible for income-driven repayment (IDR) and public service loan forgiveness (PSLF). Not all loans you can get for financial aid are eligible for PSLF, only Direct loans are: Direct loans are those provided “directly” by the federal government: Direct Stafford (for older borrowers), Direct Subsidized (for undergrads only), Direct Unsubsidized (the most common med school loan), Direct PLUS (higher interest rate for big borrowers), and Direct Consolidation.

If you want to have your Perkins loans forgiven, then consolidation is the only way. Perkins loans are normally automatically put on their own separate 10-year repayment, so consolidation is also the only way to have Perkins loans included within an income-driven repayment plan, which would reduce the amount you pay monthly if you’re worried about cash flow problems (note: you can’t forbear a Perkins loan). Most medical students don’t get a ton in Perkins a year, so we’re not talking about huge amounts of money (and now that the Perkins program was canceled in September 2017, no one will be getting any new Perkins loans at all). That being said, having my $4,500 in Perkins forgiven would be another $4,500+ that I didn’t have to pay and $50/month less in payments.

Important caveat:

If you’ve already been repaying your loans and are wondering if you should consolidate in order to add your Perkins: Achieving loan forgiveness through the PSLF program is based on making 120 qualifying monthly payments on a given loan. When you consolidate, the feds pay off your old loans and create a new consolidation loan in their place. Because the consolidation is a new loan, the monthly payment count resets to zero. Any payments you’ve made towards your loans prior to this do not count toward the PSLF required 120.


Consolidating at the End of School Saves You Money

The key facet to saving money with federal consolidation is that consolidation loans have no grace period. Normally, you have a mandatory 6-month grace period starting at the end of graduation before you begin paying back any money. If you graduate at the beginning of May, you normally won’t be paying anything until November. During this grace period, interest continues to accrue and is then capitalized (added to the principal) at the end when you enter repayment. And, of course, you also won’t start making any payments toward PSLF until 6 months after graduation either.

The only way to waive the grace period is to consolidate:

If you want to immediately begin making qualifying payments on your federal student loans as soon as you leave school, you may consolidate your loans into a Direct Consolidation Loan during your grace period and enter repayment right away.

For the following example, let’s assume you file for consolidation at the end of school in May, which is then processed in June. You’ll probably lose one or two months out of the 6-month grace period to the consolidation process.  Another 4 weeks later to set up repayment, and your first payment might start in July, which coincidentally is when you start working. The example numbers here are based on a $200,000 loan at 6% with an intern salary of $50k and a household size of 1 (some reasonable numbers for purely illustrative purposes; as always, do your own math).

  1. Less capitalized interest. The interest accrued during school will capitalize when you consolidate instead of after an additional six months of accrued interest. With $200k @ 6%, that’s $6,000 of interest that won’t be part of the principal accruing its own interest. That change in capitalization would result in around $360/year less interest accruing at the above rate. Note: If your loans are eventually forgiven as part of PSLF, this part would be irrelevant.
  2. The REPAYE interest subsidy kicks in earlier. This assumes, of course, that you don’t already have low-debt/high-income mismatch and will be receiving one in the first place. In our above example with a solo $50k intern salary, the projected monthly payment is about $270/month. $1,000 of interest accrues per month on the $200,000 loan. $730 of that is unpaid, and thus $365 is forgiven. Every month. An extra four months in REPAYE could save you $1,460 (again, I’m assuming you’ll lose a couple of months in the consolidation/repayment process). This part also won’t matter if you eventually achieve PSLF.

But it’s actually better than that example: you typically certify your application for income-driven repayment plans using last year’s tax filings. The tax year prior was half of your MS3 and MS4 years, when you probably had little to no taxable income, which would result in a $0 monthly payment: $500 would be forgiven each month ($2,000 over 4 months) while making $3,240 ($270 x 12) less in payments during your intern year. Now that is real savings even if you do PSLF.

A few years ago, some of the servicers wised up to the $0/month trick that people were commonly using when they filed for IDR at the end of grace period, and they sometimes asked for pay stubs from your intern year (the application also started asking if your income had “changed significantly” since your prior tax return), which meant that people who wanted a $0 qualifying IDR payment had to start fibbing and hope theirs was one of the servicers that didn’t always ask for proof.

We’re in a better place now because the application has changed again to specifically ask about any income decreases (not changes), but by consolidating early and applying for your repayment plan before you start your intern year, you actually don’t have any new income to report regardless, your circumstances haven’t changed since last year, and a $0 reported income is kosher again. By the federal government’s own rules (see IDR FAQ #46), you don’t have to update the servicers with new income numbers if your income changes before the annual income recertification, so once you have $0/month payments for the year, you’re safe until the following year.

Yes, this means that—unless you have spousal income to account for—every intern can qualify for a REPAYE interest subsidy: $0 payments mean you’ll always have unpaid interest. Even those planning on private refinancing will likely want to wait until they’ve enjoyed the fruits of the subsidy for a year or two.

Having $0 payments is essentially forbearing your intern year without any of the downsides and all of the upsides of making regularly scheduled income-based payments (no interest capitalization, qualified towards PSLF and long-term loan forgiveness, interest subsidy in REPAYE, etc.).

  1. Earlier qualifying PSLF payments. Waiving the six-month grace period means a few more months of making payments as a low-income resident and a few months less as a high-earning attending. As an example, the standard 10-year repayment on that $200k loan is $,2302/month. If you were able to start repayment in July instead of November, those 4 months at $0 instead of $2,302 could save you $9,208 when it comes time to file for PSLF.
  2. If you have low or $0 payments, you’d think that you would pay little to no interest and thus get no deduction on your taxes. However, long story short, the consolidation loan “pays” off all of the interest on your loans that accrued while you were in school, to the tune of likely far more than the $2,500 maximum deduction.

Note: The government specifically states that $0/month payments count toward PSLF when that is the calculated payment under a qualifying repayment plan (see PSLF FAQ #24). If you consolidate in a timely fashion after graduation, such a payment will be the result of a calculation based on the honest truth and completely in keeping with everything official out there.


How to Consolidate

Step 1:

File taxes on time in April of your fourth/final year of medical school (or at least before you graduate). You can do this for free in multiple ways online. File even if you didn’t make money; it’ll make things easier, as it will document your (lack of) income and will only take a few minutes. You won’t have pay stubs yet, so your tax return is all you have.

Step 2:

Your loans must be out of “in-school” status (e.g. graduated or grace period) to file for consolidation. So, once you graduate, immediately file for a federal loan consolidation by visiting studentloans.gov. Note: do not fill in the box with your “grace period end date” as this will delay the consolidation from taking place until the end of your grace period (i.e. item 17 on the paper application found at https://studentaid.gov/app-static/images/ApplicationAndPromissoryNote.pdf), which is exactly what we’re trying to avoid. A list of the loans types that are federal consolidation-eligible is available at https://studentaid.gov/app-static/images/Instructions.pdf in case you have some rare ones not in the Loan Eligibility table in the Federal Repayment Options chapter. Note that you can see all of your loans listed, their total amounts (principal and interest), and your “enrollment status” (to confirm that the feds know you’ve graduated) using NSLDS (https://www.nslds.ed.gov).

You get to pick your servicer as part of your application. If you’re considering PSLF at all, you may as well pick FedLoan, as you’ll be transferred to them whenever you submit your first PSLF employment certification form anyway. If not, it would be hard to know which to pick from the four consolidation choices: Nelnet, FedLoan, Great Lakes, and Navient. The feds actually periodically release student loan data, including an overall borrower satisfaction survey, with recent values ranging from around 60 to 70%. Great Lakes was consistently the “best” from this small spread. Navient is the most hated. If you’re sure you don’t want PSLF, I’d pick Great Lakes.

At the same time as your consolidation, you’ll also be applying for the IDR plan you want to use to pay off your new consolidation loan, which will likely be REPAYE.

Step 3:

Ideally, after two months or so you’ll be the proud owner of a lot of debt in one place and a payment plan to start taking care of it. Once your servicer lets you know that you’ve entered repayment, make sure to sign up for their auto-debit program to make payments automatically through your checking account if available: auto-debit gets you an additional 0.25% interest rate reduction. If your payments are $0, they probably won’t give you the option or won’t apply the discount, but if you can, definitely do it. If you have non-zero payments, you’ll get the reduction. In our example above, the auto-pay reduction saves you an extra $500.

Things may go wrong, so follow up if things don’t start moving after 6 weeks. If you have multiple loans from multiple schools with multiple servicers, you may run into more problems. Note that it’s also possible that your school and servicers may temporarily forget to update your loan status from “in-school” (not consolidation eligible) to “graduated” or “grace period” (consolidation eligible), so check on NSLDS and call your school and servicers if things don’t progress after graduation.


Undergraduate loans

If you have undergrad loans, you could consolidate those at any point during med school and then file a “Direct Consolidation Loan Request to Add Loans” for the med school loans after graduation. I’m honestly not sure how much if any time that will save you, but it could potentially help prevent some of the difficulties associated with your servicer finding and paying off a bunch of different loans in a timely manner.

As we discussed in the “Further Facets of Income-Driven Repayment” chapter, you might save some money on interest by consolidating old undergraduate unsubsidized loans, waiving the in-school deferment, and entering REPAYE for those loans to get the interest subsidy. But outside of that situation, I’d personally just go with the one-step method after graduation.


$0 Payments

It’s important to realize that zero-dollar payments will temporarily result in more disposable income than you may otherwise have in the future. The typical annual increase in your residency salary will make up some of the difference when you actually start making payments, but if you are living paycheck to paycheck as an intern with $0 payments, you need to consider how you will handle your loan payments in the subsequent years when your payments increase to reflect your actual income.


Parting Thoughts on Consolidation

Most of this isn’t deal-breaking stuff for recent graduates. If you’re already in repayment and haven’t done this, don’t kick yourself. You’ll note that getting PSLF negates some of the extra plusses while not doing PSLF nullifies others. Early consolidation is a fantastic return on a small investment of time, but the fact that you’re thinking about your debt and seriously want to take care of it is more important than the money you’ll save.

So, in the end, the take-home points:

  • Most of the loans that can be forgiven are automatically PSLF eligible.
  • Perkins loans are the exception, which if you have them are typically a small fraction of your total debt. Adding them to a Direct Consolidation will make them eligible.
  • Consolidating your loans immediately after graduating medical school can allow you to enter repayment immediately at the start of residency by foregoing/erasing the traditional mandatory six-month grace period, which can save you money by reducing interest capitalization, increasing your REPAYE subsidy, allowing for $0/month payments, and helping you reach loan forgiveness (if applicable) with fewer attending-sized payments.
  • If you owe so little that the REPAYE subsidy is nominal and your effective interest rate is still high, you may consider private refinance to reduce your interest rate when appropriate.


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