REPAYE vs. Refinancing for Medical Residents and Fellows

2016-01-19-1453214149-8959491-shutterstock_107834555.jpg

This is the final installment of a two-part series explaining everything a physician should know about the new federal student loan repayment program, REPAYE. Part one can be found here.

With the recent introduction of REPAYE, many student loan borrowers are faced with some new considerations when determining their ideal repayment strategy. Medical and dental trainees are no different. Until now, low rate refinancing seemed like the best option for medical and dental residents who were not planning to pursue Public Service Loan Forgiveness (PSLF), because it allowed borrowers to obtain a lower rate on their loans and required low payments (~$100/month) during residency. Under income-driven repayment plans, interest accrued at a high rate and many residents were unlikely to receive loan forgiveness because their high income after residency would pay off their student debt before they would be eligible to have their loans forgiven.

Under REPAYE, however, a resident's decision to refinance during training is more complicated. Because the government will forgive 50% of unpaid interest that accrues while in REPAYE, a resident's effective interest rate is lowered during the training period, potentially to a point that could be lower than the rates offered by a private lender. As such, a resident should consider the following factors when deciding between REPAYE and private low rate refinancing.

Do I plan on pursuing Public Service Loan Forgiveness?

If the answer is yes, then utilizing one of the relevant income based repayment options (IBR, PAYE, or REPAYE) is the clear cut option. While PSLF comes with its own set of question marks (potential legislative limitations), you need to enroll in one of the aforementioned programs if your goal is to get your loans forgiven through non-profit employment.

Do I plan on pursuing long-term forgiveness through IBR, PAYE, or REPAYE?

If yes, then you must remain with the federal government, as no private lender would be willing to forgive your debt for any reason other than death or permanent disability. IBR allows for loan forgiveness to take place after 25 years of payments. PAYE forgives your remaining balance after 20 years of payments. REPAYE allows undergraduate borrows to have loans forgiven after 20 years, while borrowers with post-graduate loans (like physicians or dentists) won't see relief until they have made 25 years of payments. It is important to keep in mind that each of these forgiveness benefits are considered taxable events, which could lead to a large tax bill due immediately in the year the loan is forgiven.

I plan on paying my loans back myself, and simply want to minimize interest accrual. How does REPAYE affect me?

This is where things begin to get more complex. One attractive new benefit of REPAYE is that for borrowers whose payment is not covering all of their monthly accrued interest (like many house officers), the government will forgive 50% of the difference. For example, a resident accruing $1,000/month in interest, and paying $200 based on 10% of their discretionary income, would have $400 in interest forgiven monthly ($800 in interest difference, multiplied by 50%).

The more you owe in federal loans, the more you stand to benefit from this new feature. For many residents and fellows, this interest subsidy will lower your effective interest rate during training from 7%, to 4-5%. Let's assume that a 1st year resident earns $55,000, and owes $200,000 at a weighted average 7% interest rate. Using REPAYE during training yields an effective interest rate of 4.43%. It's important to recognize that for most doctors and dentists, this interest subsidy will disappear once you begin practicing, as 10% of your now substantially higher income will be covering all monthly interest. While REPAYE may lower your effective interest rate during training, you probably will not continue to capture this benefit once you begin practicing, and your effective interest rate will return to 7%.

I'm married and my spouse earns more than I do during training. Does REPAYE still make sense?

It depends. REPAYE takes into account your spouse's discretionary income regardless of whether you file your taxes together or separately. Thus, residents who make an average of $55,000 and whose partner earns $60,000 (and does not have loans of their own) could be forced to pay around $700/month instead of $250. The higher payment also negates some of the benefit of the previously explained interest subsidy. In this circumstance, the aforementioned borrower with $200,000 in debt at 7%, sees an effective interest rate of about 5.53%. Residents and fellows in this position would be better off pursuing PAYE or refinancing with a private lender. Remember, refinancing with a private lender would allow you to lock in a rate near 5.5% (if not lower) for the entire duration of repayment, not just training.

If your spouse does have their own loans, REPAYE may still make sense as a repayment option. In that scenario, your servicer will calculate an overall monthly payment based on household income and divide it between partners based on the percentage of the overall loan portfolio that each partner owes.

Is there a simple bottom line?

The simple answer is that, as a resident, you likely would want to use REPAYE during training to capture the interest subsidy and obtain a low effective rate, and then refinance your loans through a private lender once you become an attending physician or dentist. However, this strategy runs several risks, including the risk that interest rates go up while you're in training. You may not be offered the same low rate from a private lender in the future that you could have locked in during residency or fellowship. While REPAYE's interest forgiveness may offer the lowest effective rate during training, it is crucial to keep in mind that once training is complete, your rate will effectively return to the 6% - 7% that is written on your promissory notes.

Again, let's examine the 1st year resident with $200,000 in debt at 7% interest. After a 3 year residency earning $55,000 and utilizing REPAYE (effective interest rate of 4.43%), the borrower switches to a 10-year repayment plan, and repays the remaining balance at 7%, with total out of pocket cost equaling $300,115. If that same borrower were to lock in a rate of 5.75% with a private lender at the beginning of residency, he or she would be able to pay $100/month for all of training. The resident would then begin on a 10-year repayment term as an attending physician with his or her interest rate still locked in at 5.75%. In this case, total out of pocket cost would equal $304,150.

In this example, REPAYE saves the borrower more money, however this will not always be the case. There are several factors that could actually cause a resident to favor private refinancing: If the borrower were to earn more income during training (or had a high-earning spouse), if the borrower was able to make extra payments while in residency, if the residency period was shorter, or if the loan was smaller. Factoring each of these considerations into a repayment decision can get complicated, so we recommend working with an experienced professional before making a final decision.

The introduction of REPAYE has made choosing a student loan repayment strategy more complex. Residents and fellows should contact their current loan servicers, as well as private lenders who specialize in working with medical trainees (such as DRB Student Loan), to investigate their options.

About DRB
DRB (Darien Rowayton Bank) is a leading bank, national marketplace lender, and the fastest lender in industry history to reach $1 billion in student loan refinancings. FDIC-insured and established in 2006, DRB has helped thousands of professionals with graduate and undergraduate degrees across the country to refinance and consolidate federal and private student loans, saving these borrowers thousands of dollars each.

For more information, visit https://student.drbank.com/.