Asking recent graduates where they’ll be in five or ten years can be its own form of cruelty. Some may return a quick answer and others a blank stare. In any case, the question is central to another often-stressful topic: How to handle student debt.
In a previous post, I analyzed one dimension individuals should consider when evaluating whether to refinance student loans: the potential savings. However, it is equally important to consider the benefits that federal student loan repayment options offer and evaluate the likelihood that you will want or need to utilize them.
The two key dimensions to consider before refinancing your student loans are the potential savings and your risk tolerance or degree of certainty in your current situation
You have more choices today to tackle student loans than ever before, including the option to refinance with private companies like CommonBond, SoFi, Earnest, and First Republic. In addition to determining whether you qualify for private refinancing and calculating your potential savings, it behooves you to weigh these questions before deciding to refinance:
1) Am I comfortable giving up the benefits and protections of federal student loans?
The potential to save thousands can be enticing, but you should give serious consideration to whether the savings outweigh the benefits and flexibility that federal student loan repayment options afford. For example, if you have federal undergraduate loans and decide to attend graduate school, your loans can enter deferment so you don’t need to make payments while you are studying and potentially without a source of income. This option isn’t generally available with private companies that refinance your student loans (It should be noted that some companies have begun trying to mimic federal benefits and provide graduates with some protections. SoFi, Earnest, and CommonBond, for example, all have programs to pause payments if you are unemployed).
2) Would I save more under any of the federal student loan repayment options?
While the government’s student loan system is needlessly complex to navigate, the most meaningful benefit of its programs, such as Public Service Loan Forgiveness (PSLF) and income driven repayment plans, is the potential to reduce graduates’ monthly payments and ultimately forgive a portion of their loan balance. These options disappear if you refinance in the private market and should not be discarded in haste. (If you need help evaluating the merits of different federal repayment options, I like NerdWallet’s question-based guide created by Brianna Mcgurran and Teddy Nykiel.)
PSLF is especially attractive for those who qualify because of the shorter repayment time-frame (120 required monthly payments), the ability to make non-consecutive payments, and because the forgiven balance isn’t taxable. You might be surprised by who may qualify for PSLF. For example, many doctors who graduate and work at non-profit hospitals – including many academic hospitals – may qualify. A recent Brookings Institute report found that 25 percent of the American workforce qualifies under PSLF.
Repayment options such as Pay As You Earn (PAYE) and Income-Based Repayment (IBR), may be advantageous because they cap monthly payments and leave more cash in a graduate’s hands. Moreover, part of the loan balance may ultimately be forgiven after a certain repayment period, resulting in tremendous savings (It is important to remember and prepare for the fact that in most cases, the forgiven balance is treated as taxable income). Finally, if you are unemployed, you may find that your payments under the income-driven repayment plans are $0.
Each program has its own nuances, which are important for a borrower to understand and consider. For example, REPAYE considers not only your income, but also your spouse’s income, even if you file taxes separately, while PAYE only considers your income. Additionally, once you opt for and are approved for one of the repayment plans, make sure to read all the ongoing requirements. Ron Lieber of The New York Times recently highlighted troubling cases of individuals who were initially told by the Department of Education (DOE) that they qualified for PSLF, only to be told years later that the DOE had changed its mind.
In my last column, I gave a hypothetical example of someone starting to repay a graduate school loan of $50,000 with a 6.8% interest rate and a standard 10-year (120 month) repayment term. I showed how loan refinancing could hypothetically save the graduate over $10,000 (chart replicated below).
Before pulling the trigger on private refinancing, evaluate options against savings from federal income-driven repayment options.
To this table, we would want to add columns showing the details of the various income based repayment methods. The Federal Student Aid Office, part of the Department of Education, offers a repayment estimator to help one decide between various repayment plans. The estimator asks you to input information about your loans (loan type, interest rate) and yourself (tax filing status, family size, state of residence) and spits out a table showing monthly payment amounts as well as the total one would pay over the life of the loan and the project loan forgiveness.
Unfortunately, this table is highly misleading and could easily lead you down a sub-optimal path. To understand why, you need to ask yourself another important question: