The Best Way to Pay Off $250,000 in Student Loans
There are many ways to pay off your student loans, but the “best” way for you may not be the cheapest at first glance. Three doctors’ stories show how income-driven repayment plans and loan forgiveness programs can play key roles in the decision.
Anyone who graduates with a massive pile of student debt has some tough choices to make. Refinance to a seemingly cheaper private loan? Keep your federal student loan and pay it off in the standard way? Take advantage of forbearance to put payments off? A look at three new doctors, each facing $250,000 in debt, highlights some shocking differences between each choice.
As their cases illustrate, oftentimes the best option isn’t the most obvious, and one repayment method could save almost $200,000 over the life of the loan.
Sarah Was Tempted to Go Private, But Then …
In my previous article about private student loans, I stressed that students should consider taking out federal student loans before taking out any private loans. Federal student loans have protections and benefits that private student loans most likely don’t. Federal loans can be discharged if the borrower dies or becomes totally and permanently disabled. Also, borrowers may have access to income-driven repayment (IDR) plans and loan forgiveness programs.
Sarah was my example in that article. She is a physician making $250,000 a year and has a federal loan balance of $250,000 with a 6% interest rate and monthly payments of $2,776 over 10 years. Sarah learned she could lower her payment to $2,413 a month by privately refinancing her federal loans — potentially saving her $43,000 over 10 years. But are there any benefits for Sarah to keep her loans in the federal system?
What if she were thinking about starting a family and possibly working part time in a few years? If she refinanced to a private loan, her payments would be locked in at $2,413 a month even as her income temporarily fell while working part time.
If she kept her loans under the federal system, Sarah would have some flexibility over the amount she must pay every month. First, she can pay more than her minimum monthly amount in any repayment plan if she wants to pay her loans off faster. She may also have the option to enroll in an income-driven repayment plan and make much lower payments when and if her income decreases.
Under income-driven repayment (IDR) plans, the borrower’s minimum monthly payment is calculated based on a portion of their income. The borrower may not be required to pay back the full amount of the loan. That is unlike the federal standard repayment plan or private loans, which require the borrower to pay the principal and the interest of the loan in full over a specified term. For example, if Sarah got married, had a child, and her income temporarily decreased to $150,000, she may qualify for one of the IDR plans, such as the Pay As You Earn (PAYE) repayment plan. Then her monthly minimum payment could be reduced to $978.
So, for Sarah, the possibility of $43,000 in savings from a private loan might not be as good as it sounded at first glance. The federal loan’s flexibility for changing life circumstances may be worth it for her.
Jimmy and Tom Are Leaning Toward Forbearance (But That Would be a Mistake)
To see how income-driven repayment (IDR) plans and forgiveness programs work together, let’s look at another example. Jimmy is a recent medical school graduate making $60,000 a year in a residency program with $250,000 of federal student loans. He feels that it would be difficult to pay $2,776 every month in the 10-year standard plan or $2,413 a month after refinancing. He is wondering if he should apply for forbearance to suspend payments until he can afford the high payments as an attending physician, just as one of his classmates from medical school, Tom, decided to do after graduation.
