Engagements are such a joyous time! The romance, the ring, the excitement of telling friends and family and Facebook! Far be it from me to cast a shadow on the whole joyous event, but someone here needs to be the realist. One of the first things you need to consider before saying “Will you…” or “Yes” is the potential catastrophic effect on your student loan payments. Unless you were fortunate enough to have had substantial scholarships or family assistance many newly minted veterinarians will find themselves in one of the “income-driven plans” and if you are like most DVMs, you might just be in REPAYE. Depending on who you marry, this could be a very, very big problem.
Student loan repayment for Veterinarians
We covered student loan repayments before (here and here) so we won’t rehash the whole topic. In short, with REPAYE, your monthly payments are capped at 10% your discretionary income; however there is not maximum payment. 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. So if you earn $70,000 a year, your annual discretionary income would be $51,790 ($70,000 –(1.50* $12,140)) or ~ $4,250 a month. Thus your monthly payment would never be more than ~ $430 a month (rounded). But here is the real magic of the REPAYE: 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. So assuming you have $300,000 in direct subsidized loans at 6.25% interest in the first year would be about $18,750 but you paid only about $5,184. In the first 3 years the government will pay all the unpaid interest – about $13,566 a year ($18,750 – $5,184). After year 3 the government will pay 50% of the unpaid interest while the rest accumulates and here is where the trouble begins.
Weddings and REPAYE – a dangerous mix!
Let’s take Sally – she graduated 8 years ago with $300,000 of subsidized loans at 6.25%. She makes $70,000 a year. Her monthly payments are $430 a month. For the first 3 years the government paid 100% of the unpaid interest and for the past 5 years paid 50%. There is ~$34,000 of unpaid interest. As long as sally stays in REPAYE the unpaid interest just accrues. If she fails to re-certify annually or leaves the program voluntarily then the $34,000 becomes capitalized (is added to balance of the loan). Interest would then be charged on the new loan balance ($334,000) dramatically increasing monthly interest expense. The longer Sally has been working, the more her loan balance will increase should she leave REPAYE. Sally’s significant other proposes and she said “Yes.” (gosh that was painful to type) Her significant other is in finance and earns $100,000 and has no significant student loans. If Sally stays in REPAYE and gets married, her monthly payment jumps to $1,211 a month! If she was in PAYE her monthly payment would only be only $378 a month. Why the difference? Because in REPAYE you MUST include your spouse’s income and student loans while in PAYE you have the option of including only yourself if you file your taxes “married filing separately.” Sure there are some tax disadvantages to “married filing separately” – but not $833 a month of a disadvantage. The more she and her significant other earn, the worse REPAYE gets. There is no limit to the monthly payment and at some point they could end up paying MORE than under a standard repayment plan.
What can Sally do? Well, she can leave REPAYE and drop into PAYE. The first problem is that the $33,000 of accrued interest – it will become added to the balance of the loan! While this won’t increase her monthly payment it will increase the amount to be forgiven at the end as the 6.25% will now be compounded on the balance of the original loan +$33,000. More importantly, Sally will lose the benefit of having 50% of her interest paid for by the government. The end result will be a significant increase in the balance forgiven (> $130,000) at the end of the loan. Since forgiven loans are treated as income, there will be more federal tax to pay and the amount she will need to save to pay the tax will increase dramatically. Also, since PAYE has a shorter repayment timeframe – there will be less time to save. Lastly, if she doesn’t file taxes in the first year of marriage as “married filing separately” Sally will likley no longer qualify for PAYE as the combined income will be too high to qualify. So planning is essential.
What should Sally do? Well first she should read our explanation of the various student loan repayment plans. Then she should spend some time on the federal student aid loan repayment calculator and see what works best for her and her significant other. Lastly, she should speak to a financial advisor who specializes in student loans. There isn’t “one plan fits all” solution to this problem and timing is essential so planning ahead is essential.