Student Debt – A Primer Pt. 1

It’s the elephant in the room. According to the AVMA, the average veterinary student graduated in 2016 with $143,757 in student loans and if you exclude those with no debt the number goes up to $167,534. More than 20% of new grads had over $200,000 in debt by the time they finished veterinary school and the numbers are climbing. To make matters worse, research suggests that the average starting salary is only about $66,000! If the gap between salaries and loans continues to grow, it’s not clear how the profession will be viable in the future.

Federal loan repayment plans

There are no fewer than 8 federal loan repayment plans! Essentially options fall into one of two groups. The “income driven plans” (which most veterinarians will likely select) and “standard plans.” There is a ton of information about all the 8 plans here.  We are going to focus our current discussion on just 3: The standard repayment plan; pay as you earn repayment plan (PAYE); Revised pay as you earn repayment plan (REPAYE).

The standard repayment plan is the simplest. Direct subsidized and unsubsidized loans, subsidized and unsubsidized federal Stafford Loans, all PLUS loans and Consolidation Loans (Direct or FFEL) all qualify. The payments are structured so that equal monthly payments are paid over 10 years (up to 30 years for Direct Consolidation loans) regardless of income or marital status. This is the plan that someone with a relatively small loan or high income would select. Monthly payments would be relatively high, but the total amount paid (including interest) would be low. In addition, your loans are guaranteed to be paid off in 10 years.

Why the standard repayment plan isn’t for everyone

Lets look at 2 different borrowers: Prudence and Sandra.

• Prudence had lots of family assistance, paid in-state tuition, lived frugally and finished vet school with $45,000 in unsubsidized debt. Her interest rate is 6.2%. She has recently accepted a job making $70,000.

• Sandra had little family assistance and had to pay “out-of-state” tuition. She graduated with $200,000 in unsubsidized debt and her average interest is 6.2%. She also recently accepted a job making $70,000.

If both selected the standard repayment plan, Prudence would pay $504 a month for 10 years. She will have paid a total of $60,495 including interest. This would be very manageable. Sandra would pay $2,241 a month, which after taxes leaves her precious little. After 10 years, she will have paid a total of $268,866 including interest. While this might be a good plan for Prudence, Sandra would find it hard to pay for food, never mind rent!

Income-driven loan repayment

With an “income-driven plan”, your monthly payments are capped at 10% to 20% of discretionary income (plan dependent), and the term is increased from 10 years to 20 or 25 years. By definition, discretionary income is everything you earn above 150% of the poverty level. In 2018 poverty level for a single person living in the contiguous United States is defined as $12,140 a year. (Alaska = $15,180; Hawaii = $13,960). The definition of poverty is dependent on number of people in a family and you can find family sized based poverty tables here. For Sandra, her discretionary income would be $51,790 ($70,000 –(1.50* $12,140)). Income-driven plans are unique in that any remaining loan balance at the end of the 20-25 years is forgiven. That’s right – you don’t have to pay it – but you will have to pay tax on it as if it was income – and that can be substantial. Some folks even call it a “tax bomb.” Lets look at two of these plans: REPAYE and PAYE.

REPAYE

Key Points:

• Eligible loans: Direct subsidized loans, direct unsubsidized loans, direct GradPLUS loans, direct consolidation loans that don’t include a Parent Plus Loan.
• Monthly payments are 10% of discretionary income and is recalculated each year
• Borrower must re-file every year
• If married, spouse’s income and loan debt must be used for determining repayment
• Outstanding balance is forgiven after 25 years
• Monthly payment CAN be more than 10-year standard repayment plan
• Plan is interest subsidized for the entire 25 years

Interest subsidy: If your monthly payment doesn’t cover the interest that accrues on your loan, the government will cover: 100% of the unpaid interest on subsidized loans for the first three years and 50% of the accruing interest for the rest of the loan. They also pay 50% of the interest due on all unsubsidized loans for the life of the loan. This limits the growth of the loan resulting from capitalization (loan balance increasing when unpaid interest is added)

For Sandra, her monthly payment would initially be $432 and increase to $1,614 as her income increased over time (5% per year).  She will have paid $272,799 over the life of the loan and will be forgiven for $203,324 at the end. So at the end of 25 years, Sandra will have to pay tax on $203,324! Using today’s federal tax brackets she will owe one lump payment of around $71,000 in federal taxes. How will she come up with the $71,000? Simple –  we saw earlier that this is a just a time value of money calculation: she will have the $71,000 all ready by saving $102 a month and earning 6% or if Sandra thinks she can earn only 5% then $120 a month should cover it. So we see that the real cost per month would initially be about $552 ($432 loan + $120 savings) which is still much more manageable than $2,241 per month!

• Note: a real drawback of this plan is that a spouse’s income MUST be included in the income calculation. Lets say for a moment that Sandra marries her significant other – an investment banker earning $150,000 a year. Her monthly payments would skyrocket to $1,626 for the first month and eventually increase to an estimated  $2,869! It’s important to remember that spousal income counts and there is no maximum payment – you can pay more than the standard repayment plan!  This is certainly something to ponder when planning your life.

PAYE

Key Points:

• Eligible loans: Direct subsidized loans, direct unsubsidized loans, direct GradPLUS loans, direct consolidation loans that don’t include a Parent Plus Loan.
• You must be a new borrower (on or after Oct. 1, 2007), and must have received a disbursement on or after Oct. 1, 2011.
• Monthly payments are 10% of discretionary income and is recalculated each year
• Borrower must re-file every year
• If married, spouse’s income and debt only considered if you file a joint tax return
• Outstanding balance is forgiven after 20 years
• Payment plan will NEVER be more than 10-year standard plan
• Subsidized loans are interest subsidized only for first 3 years.
• No interest subsidy on non-subsidized loans.

For Sandra, her monthly payment would initially be $432 and increase to $1,236 over 20 years as her income increased over time (5% per year).  She will have paid $185,491 over the life of the loan and will be forgiven for $262,509 of unpaid debt. The reason that the unpaid debt is higher is partly due to the less generous interest subsidy. This will pose a slightly bigger tax issue for Sandra who will have to pay around $97,000 in 20 years. If she earns 5% on her money, she will need to save about $210 a month. So her monthly outlay will be ~$642 with the PAYE vs $552 with REPAY.  One important thing to note is that even if Sandra marries her beau – her payments will not be affected by his income if they do not file a joint return. So depending on her life circumstances, this may or may not be the best plan. 

By simply entering a few pieces of data here you can see all of the repayment options for Sandra (or yourself). No math needed!

Specifics for any particular loan repayment option can be seen by clicking the “+”

Import things to consider about student debt repayment:

• No one plan is best for everyone. You need to use the repayment calculator and consider your life circumstances see what works best for you!
• For any income-driven plan there will be a future tax consequence that’s manageable if we plan – save every month!
• A spouse’s income can affect REPAY. Also, there is no max limit on REPAY monthly payments.

Lastly, no discussion about student debt would be complete with out talking about Public Service Loan Forgiveness (PSLF) Program. We will talk bout this and more in the next post!