Further Facets of Income-Driven Repayment

Undergraduate or old grad school loans during medical school

While you can’t enter repayment for the loans you’ve borrowed for your current schooling due to their “in-school” status, you can decline the normal in-school deferment on your old loans. You can even do a federal consolidation early so you can pick your servicer (especially helpful if you have more than one) and streamline your loan statements. After graduating, you can simply file for a consolidation add-on to add your med school loans to the consolidation.

Most medical students without significantly employed spouses would qualify for $0 payments under IDR plans. If you have unsubsidized loans from undergrad that would be accruing interest during school, it makes sense to decline the in-school deferment and put those loans into the REPAYE program. Due to the unpaid interest subsidy, you’d cut the effective interest rate in half and save a bunch of money.

A relevant bit from the official PSLF Q&A:

If I return to school and qualify for an in-school deferment on my Direct Loans that are in repayment, can I decline the deferment and make qualifying PSLF payments while I’m in school?

Yes. You may decline an in-school deferment on your loans that are in repayment status and make qualifying payments on those loans while you are in school. Remember, in order for your payments to qualify for PSLF, you must be employed full-time by a public service organization while you attend school. Note: If you receive new Direct Subsidized Loans or Direct Unsubsidized Loans when you return to school, you will not be able to make qualifying PSLF payments on those loans while you are in school. Any new Direct Subsidized Loans or Direct Unsubsidized Loans you receive will not enter repayment until the end of the six-month grace period. Although you could voluntarily make payments on your new Direct Subsidized Loans and Direct Unsubsidized Loans while you are in school or during your grace period, those payments would not count toward PSLF.

So those $0 payments won’t work for achieving PSLF (unless you were somehow also working full-time for a qualifying non-profit), but they would count toward the baked-in IDR forgiveness that you should probably be ignoring. Most important would be the interest subsidy, but this makes sense only for unsubsidized loans. Subsidized loans don’t accrue interest while in school, so if all of you have from your prior education are subsidized loans, there isn’t much to be gained as there isn’t any accruing interest to be unpaid and subsequently subsidized.

 

Switching from REPAYE

There has been a lot of confusion from borrowers concerning 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).

Brief aside: 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.

So, 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 in your payments (see what I did there?). A simple rule of thumb is that if you owe more on your loans than you make in a year, you definitely still qualify for your income-driven repayment plan.

Remember that 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. 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. Put differently, if you put your income into the federal calculator and it spits out an IDR payment lower than the standard, then your income qualifies for you that IDR plan.

As we discussed break-even points earlier, once you hit your break-even salary you have no unpaid interest and thus no REPAYE interest subsidy. For a $200,000 loan at 6%, that’s a salary of about $138,000. At this point, REPAYE isn’t offering you anything over PAYE.

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 good money.

You can switch from REPAYE to PAYE as long as you still qualify for PAYE. If you didn’t qualify for PAYE due to older loans, then you can switch back to IBR instead. 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.) An endocrinologist who borrowed $200k but makes $150k annually would qualify forever.

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 2017, but when you resubmit income verification in the fall of 2017 for REPAYE, you’ll be submitting your 2016 tax return, which was a combination of your last two PGY years of training. The annual certification does indeed ask you if your current income has changed from your taxes. In order to answer this question truthfully and avoid the possibility of getting stumped by a paystub request, one would just certify your income early before starting your new job. Because most MD jobs start in July, it’s generally a good thing to have your annual certification take place in June before your income increases for the year, something we will discuss in the chapter on Direct Consolidation.

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.

The briefest verbiage for this plan-switch information comes from the plan breakdown table in the official IDR Plans Q&A (emphasis mine):

Leaving the Plan (REPAYE)

If you choose to leave this plan, you may change to any other repayment plan for which you are eligible

If you talk to your servicer and they say otherwise, ask them to explain exactly why and get to the bottom of it. Because they are wrong.

 

Switching out of IBR

Switching out of PAYE or REPAYE is straightforward. You may be placed on a 1-month administrative forbearance while the servicer makes the change (especially if you submit your annual certification toward the deadline), but otherwise the process should be smooth and automatic.

However, to switch out of IBR, this annoying thing happens:

If you leave this plan, you will be placed on the Standard Repayment Plan. If you want to change to a different repayment plan, you must first make at least one payment under the Standard Repayment Plan, or one payment under a reduced payment forbearance (you may request a reduced-payment forbearance if you can’t afford the Standard Repayment Plan payment).

This was presumably done to stop people from immediately jumping ship from IBR to PAYE. In practice, the “reduced-payment” requirement is $5. So, you don’t need to shell over a few thousand to cover a month’s standard repayment. On the other hand, a reduced-payment month won’t count towards PSLF.

Additionally, switching plans will cause all of your accrued interest to capitalize. If you’ve been out for a few years making the typical negative amortizing IBR payments during residency, you may have a sizable chunk of accumulated interest sitting around.

An illustrative example:

  • $200k loan @ 6.8% accrues $13.6k per year
  • Assuming a $50k salary and $400/month IBR payment, the annual unpaid interest is $8,800
  • After 2 years of residency, that’s $17.6k accrued interest. After 3 years, it’s $26.4k.
  • Switching from IBR to PAYE after two or three years results in a new loan balance of $217.6k and $226.4k respectively. From that point on, the annual interest then would increase to $14.7k and $15.4k.

In this example, your monthly payment is reduced from $400 in IBR to around $266 under PAYE or REPAYE, which is great from a cash flow perspective and for PSLF. But now your loans may be growing faster than ever (both from the capitalized interest on top of the fact that you are simply paying less of it).

By cutting those payments down from 15% to 10%, you’ll be taking an even bigger hit in terms of your loan growth, unless you switch to REPAYE and are getting a nice subsidy. Keep in mind however that the interest that accrued while you were in school capitalized when you graduated, so you don’t have a ton to worry about if you’re fresh out of school or relatively close.

Switching to REPAYE for the interest subsidy is one thing, but outside of desperate cash flow needs, the main reason to switch from IBR to PAYE is really only to double down for PSLF. In order to maximize the gains of public service loan forgiveness, you want to spend the least amount possible during your 120 qualifying payments. The spiraling balance is then irrelevant because it’s going to be forgiven. When deciding if switching makes sense, don’t forget you’ll need to make one more big attending or “standard” payment if you switch while in training and lose a smaller residency-sized payment (losing up to $2,300 on the above example and basically washing 17 months of that reduced monthly payment away). You may decide that the lower payments now are worth it regardless, which they basically will be unless you’re within your final two years of training.

 

PAYE vs REPAYE

If you’ve gotten this far, you know that PAYE and REPAYE have a lot in common. But there are differences that can make one or the other the better choice.

Interest capitalization cap vs interest subsidy

To start, what about that PAYE interest capitalization cap? How does that compare to the REPAYE interest subsidy?

Poorly! There are reasons PAYE can be a better choice for many borrowers, but the interest capitalization cap isn’t really one of them.

As you may recall, 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 at any point 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 often happens 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 interest; 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. This may or may not be a big deal.

In contrast, REPAYE has a subsidy that pays half of the unpaid accrued interest on a monthly basis. But the real reason the cap itself is never better than the subsidy 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 using the married-filing-separately loophole) 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).

So, when does PAYE beat REPAYE then?

For single people or married people filing jointly, PAYE and REPAYE payments will always be the same (10% of AGI) until income rises high enough such that 10% of your income is greater than the 10-year standard payment calculated based on your original loan amount when you enter repayment. At this point, PAYE caps at that amount while REPAYE continues to grow with growing income. Big money means bigger payments. This is actually good from the perspective of minimizing the amount of interest that accrues while paying your loan off and thus saving money overall but bad from the perspective of minimizing payments for possible loan forgiveness or to fund your high-rolling lifestyle.

The other big difference is when you rely on filing taxes separately from your spouse in order to get low payments with PAYE, a trick/loophole closed by REPAYE.

So, PAYE will frequently “beat” REPAYE in three scenarios:

  1. A spouse earns a significant income without holding significant federal student loans.
  2. When your adjusted gross income rises beyond the standard “cap.” For a $200k loan at 6.8% for example, that amount is around $295,000 a year for a single filer.
  3. If your income to loan ratio means you’re not getting an interest subsidy. In this case, your payments are capped at standard and you’re free to use the loopholes you need.

You can run these scenarios easily in one of the calculators listed at the end of the book (just put different salaries and look at the first monthly payment). When either of these situations is about to happen while in REPAYE, it’s permissible to switch to PAYE (if eligible) or IBR (if that still works out in your favor). Note that switching to PAYE/IBR to avoid the spousal income issue requires that you file taxes separately and then submit your IDR income certification paperwork, so you can’t simply do this right before you start a new job without some planning. You typically file your taxes by April, but most people certify in the summer or fall.

Bottom line: the likelihood of PAYE being better than REPAYE in the future isn’t necessarily a reason to avoid REPAYE in the present if it otherwise makes sense.

What about over the super long term, like 20 vs 25-year forgiveness?

Ah, yes, the super long-term baked-in forgiveness that sounds perfect for someone with $500k in student loans who wants to work part-time making $150k forever. See the chapter on Long-Term IDR Loan Forgiveness.

 

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