Think Twice Before Loan Forbearance During Residency

by | Jun 5, 2018

https://youtu.be/8ONha2ZqKXk

SEE FULL VIDEO TRANSCRIPT BELOW:

– What’s up everybody? Justin Harvey here. I wanted to shoot a quick video to discuss a very common financial planning mistake that physicians are making, using forbearance too quickly. I’ve seen it a handful of times in the last couple weeks alone. It’s very, very costly and very simple to avoid. It has to do with student loan payback strategies and elections made for student loan payback.

Specifically what I’m talking about is when young physicians will elect forbearance for their loans during training, during residency and fellowship instead of making payments on an income-driven repayment strategy, such as Pay As You Earn, REPAYE, IBR, etc. They’re electing to forbear, meaning they’re making no payments for a period of a couple years until they’re done with training. The rationale is that whenever I’m an attending I’m making more money, I’ll be able to easily afford whatever that future liability is. However, this is a very, very costly mistake. It results in tens of thousands of dollars unnecessarily accruing during that time. And there’s a number of ways to avoid this and I want to address one of them with this video. It has to do with Revised Pay As You Earn. This is one of the income-driven repayment strategies that is available to physicians that before you forbear you oughta consider Revised Pay As You Earn because it could result in significant savings.

Specifically, this strategy is valuable because it has attached to it a 50% interest subsidy. What this means is whenever you make a monthly payment on your income-driven repayment plan, somewhere in the $3-$400 a month range, if you’re earning $55k as an intern, when you pay that $400 a month you don’t even cover the interest due on your several hundred thousand dollars of debt. So what happens is if you owe $1,000 of interest, you pay $400, that’s 600 of interest that’s left over. So the government will split that 600 in half and say we’re gonna pay 300 and we’ll accumulate 300 onto your total. Rather than that full 600 going back onto to the pile and you’re gonna have to pay later, the government is covering half of that. They’ll do that every month. So if you elect REPAY through your whole training you’re making a smaller payment. The government is picking up half of the interest, half of the interest, half of the interest, every single month. And over time this has a very powerful effect.

In order to illustrate this concept I want to do a quick case study. First we have doctor number one, who is an anesthesia resident. They’re an intern, they’re making 55k a year. They have $300,000 of debt outstanding at 6.63%. This is a direct federal loan from their medical school. They’re gonna elect to forbear. They think well, when I’m an attending I’ll be making a lot of money in private practice. I can pay it off at that time. However, this is a very expensive mistake, because by the end of CA-3, after four years of training, their loan balance grows from 300 to 379,500. This is all the interest that accumulates over these four years. It’s almost $80,000. Now, the reason that that’s a significant mistake, I’m gonna get to that, comes back to this idea of REPAYE, back to the idea of the interest subsidy that could be available.

So that same physician, who is an intern, who’s making the same amount of money, accept this physician is willing to allocate a couple hundred dollars a month to be able to pay their student loans back. Same income, same debt, 300k. They elect Revised Pay As You Earn. Based on their income-driven repayment calculation, they’re gonna pay between $3-$400 a month, which it’s not an insignificant number, but if you’re making 60k you should be able to budget to allow for that payment hopefully. In so doing, over four years they’re going to receive an average monthly interest subsidy of $700 a month. $700! That’s $700 every month that is not getting accumulated on their total debt that is being paid by the government that they’re never gonna have to deal with again. Multiply that times 48 months of training that they’re gonna have through the end of CA-3, and look at this ending loan balance. $321,300. So this is almost $60,000 less than doctor number one, who elected to forbear, forbear, forbear, and all that interest just keeps piling up. So the way that this works out practically after four years of making these payments the physician, there’s some variables here that I’ve made some assumptions about the repayment plan, but the physician is gonna pay between $12-$15,000 over these four years. Look at how much the government is paying. $33,600 in interest subsidy.

That’s gonna result in a return on investment of 273%. Now, if you came to me on the street and said, Justin, I’m looking for an investment that gonna return a guaranteed 273%. What do you recommend? There’s nothing like that out there. And if you found somebody who was trying to sell it to you, I’d say run for the hills. That doesn’t exist. However, if you do Revised Pay As You Earn, look at these numbers. This is really incredible. So this an option potentially for anyone who’s considering forbearance. You can have an income-driven repayment option available to you that will enable you to capture this interest subsidy every month and that by the time you get to the end of training whether you’re gonna do PSLF, or whether you’re gonna do private practice and conserve refinance, no matter what you do, you’re way better off capturing this interest subsidy.

So again, there’s no one size fits all approach for student loan planning, but this is an option that way more physicians should consider because when your forbear that interest is gonna pile and pile and pile. And then whenever you refinance at the end of the line, at the end of training, it’s gonna be a very expensive event. So that’s all I’ve got for today. If you’ve got any specific questions about this, I would love to help. Chime in in the comments below. Thanks for taking the time to watch this video. Hope this is helpful. I hope you have a great day.

 

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Herein contains my one-take thoughts on financial concepts, behavioral investing, money management strategies, financial media, and letting you “behind the curtain” on my efforts to help move my physician clients toward financial independence.  Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Website Disclaimer page for a full disclaimer.

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