Consolidation. Refinancing. Deferment. Forbearance. Federal versus private loans. These are just a few of the things you should be knowledgeable about and consider before you sign to take out loans and later on as you plan your repayment strategy.
In an episode of the AMA’s “Making the Rounds” podcast, Laurel Road’s Alex Macielak and anesthesia fellow Chirag Shah, MD, shed light on items to know before putting pen to paper. Macielak works in business development for Laurel Road, an FDIC-insured bank that offers student-loan refinancing.
Dr. Shah: What options do I have, exactly, in order to repay my loan? I've heard of the terms consolidation, student-loan refinancing, income-driven repayment plan. How do you think about those three buckets?
Macielak: It's your career goals. If you anticipate working in a nonprofit, or a position where your income is going to fluctuate greatly—federal programs, income driven repayment, those tend to be a good fit. If you plan on paying this loan back, if you want to do so as economically as possible, with as little interest as possible, refinancing tends to be the best bet. Regarding forbearance, I think that should be the absolute last outlet that people seek.
Dr. Shah: Does that hurt your credit score at all if you put your loans into forbearance for a year or certain amount of time?
Macielak: It doesn't hurt your credit score. It hurts you in the interest that's accruing. You're making no progress towards forgiveness. You're not even making a dent in the accruing interest. There's no interest subsidy. Interest accrual is the growing of the loan via your interest rate.
If you had a 10% interest rate hypothetically, and you had a $100,000 loan, you multiply that 10% by the 100,000 every year. That's how much annual interest you're accruing. To find out how much you're paying each month, you just divide that number by 12. And the interest that's accruing is capitalized at the end of each year. It's still sort of staggering to me that people will utilize forbearance.
Dr. Shah: When you say it's capitalized, what do you mean exactly by that?
Macielak: If you accrued, you're paying nothing. Let's say you accrued $10,000 in interest. The end of that year of forbearance, the $10,000 gets added to the principal balance of the loan and then that next year you're going to accrue even more interest because now the principal balance has grown. And that's how the loan really snowballs in residency.
You're going to accrue more and more interest each year of training. I look at it as the easy way out. You just forget about your loans while you're in training and you deal with them thereafter. Certainly, there are a number of financial consequences to doing that. You're not set up for forgiveness. If you forebear for all of training, you basically can't pursue forgiveness because you're going to be earning an amount as an attending such that you'll pay the loan off before you get to that tenth year if you haven't accrued three, four years of progress as a resident, nor have you locked in a lower interest rate if you chose to refinance during that time.
And in terms of a cash-flow standpoint, you're really only saving yourself a couple hundred dollars a month. I mean the monthly payment if you were to refinance is $100. Monthly payment if you utilize income-driven repayment is probably $300 a month. It's not as though as you're saving yourself a ton in the short term to really cost yourself a lot longer term.
Dr. Shah: Right. So definitely avoid forbearance. That's the key takeaway here.
Macielak: As much as possible. Forbearance is an agreement with your lender that you're going to make no payments on the loan. The loan is still current, you're not in jeopardy of going delinquent or defaulting, but you're making no payments. Interestwise, you are responsible for all of the interest which is accruing while you're in forbearance. And as I mentioned, at the end of your forbearance term, which is 12 months, all of the interest which is accrued gets capitalized, added to the loan balance, and then if you were to forebear again you're going to accrue even more interest in subsequent years because it's a larger principal balance now.
So, avoid forbearance if at all possible. I think it's something that really should be a last resort. If you need short-term payment relief, you don't want to go through the whole income-driven repayment application, that's fine. But again, the reality is if you're using it because you're struggling to make payments, you can use one of these income-driven options which will yield a monthly a payment that's in line with your income. It won't be unbearable, I'll say.
Deferment and forbearance are quite unique from a cash flow perspective. Both options have the borrower making no monthly payments on the loan.
Deferment is most common while you're in the school. While you're in school, your loans are in what's called in-school deferment, and that means there's still accruing interest and you're not making any payments on them. However, you're not responsible for paying any subsidized loan interest which accrues during that period of time. Conversely, with forbearance, the interest is accruing and you're responsible for its entirety.
That's the main difference between the two programs, as the subsidized loan interest being charged to you in forbearance. It’s worth noting that it's difficult to qualify for deferment once you've graduated. That's a status that's most common for folks while you're in school.
Dr. Shah: OK. And then when you go on the Laurel Road calculator or any other consolidating website for private loans, you often see something called a fixed rate versus a variable rate. What are the key differences? What do you recommend students or residents pick or go towards?
Macielak: Fixed rate is going to stay the same rate the whole life of the loan. The rate which you're offered, which you’re given when you're taking out the loan—let's say it's 5%—will be 5% for the entirety of that loan's life. It'll never change. Variable rates are going to adjust at some frequency.
For Laurel Road loans, it's every quarter, and they're based on LIBOR. So as LIBOR—which is a basic interest rate tracker in the economy—as LIBOR goes up and down, so too will the interest rate on your loan, so too will your monthly payment. Variable interest rates inherently carry a bit more risk. Rates could skyrocket at some point. You'll wind up paying more interest, and your monthly payment will wind up being higher. We see about nine out of 10 borrowers take fixed-rate loans. If you have a very large-balance loan that you are able to pay off quickly should rates rise dramatically, fixed rates are going to be a lot safer option.
I think folks who do take variable rates—and variable rates, so we're clear, are priced lower to begin with. If you got a 5% fixed offer, your variable rate offer might be 4.2% or something like that. If rates didn't change for the life of the loan, you come out ahead—people who do take variable rates tend to be those planning to pay it back in a short period of time. That's where we see the most variable-rate traffic.
Dr. Shah: I actually did refinance my loans and I ended up going with a variable rate because it was half a percent lower and my thought process was: I'll be an attending, or I am an attending now, and I can pay it off a lot sooner and save that interest over the life of the loan. For me, a variable rate made a lot of sense because my thought process was that I wanted to pay off my debt as soon as I could.
Now in many ways that doesn't necessarily make sense financially. I have a background in economics, and if I'm taking a loan at 3%, it's actually a very low interest rate and there's no harm in accruing that debt. But to me my student loans with the federal government were at 6.7% or 6.8%, which I thought was quite a bit of money that I was paying in interest every month. At that point I decided to refinance. And since the rate was so much lower for me variable versus fixed, and I wanted to pay it off quicker, I chose the variable route.
Of course, I also have a family, I have a wife and a kid ... but even with that, the initial payments are only $100 a month until I reach an attending salary. And at that point the payments will jump up, but so will my salary. And it's kind of a nice forced mechanism to start paying off some of the debt that I personally accrued. That was more or less my thought process when I went through refinancing my loans.
One thing a lot of my friends are worried about is ‘I have $200,000 in loans. Am I going to be able to pay this off?’ As someone that's in the same shoes as a lot of my colleagues, it honestly isn't that big of a deal, which is a bold statement to make. But as a physician, even if you have $200,000 in loans, you should be able to pay them off as you live within your means, and especially when you're an attending making at least $150,000, or most of us will be making something a little bit higher than that, but in that ballpark. And if you take your $200,000 and split it over 10 years, it's only $20,000 a year. And, of course, there's interest, there's capitalization, there's a bunch of other factors that go into it, but if you're making $150,000-200,000 a year, your loans shouldn't really be the thing that scare you. You're going to be completely fine, and that's how I look at it.
Macielak: Do you think your loans have impacted other financial decision you've made?
Dr. Shah: To be completely honest, no. I ended up getting a doctor's loan. I even took out more loans to buy my first house, which is where we currently live. There's of course good debt and bad debt. I don't have any credit card debt because the interest rates are a lot higher. The debt I've accrued is mortgage debt, which is appreciating interest in the form of a house, and obviously student loans, which are a down payment on future earnings. That's how I look at it. What I've tried to avoid is buying a nice, fancy new car, or getting your first attending car, or what have you. I'm still in my 2011 Mazda, which runs just great.
Macielak: It's a fine automobile.
Dr. Shah: It's fine, exactly. But I do want to, at some point, you do want to see the fruits of your labor, and you may want to go splurge on a Tesla, or what have you. But I've held off on that just until I feel like I can pay off some of these loans. But again, my refinancing is at 3% and if you're getting anything at 3%—if you take into account the inflation that occurs every year, let's call it 1.5%–2%—you're essentially getting money at 1%, which is unheard of pretty much in the history of finance. It's essentially free money.
Macielak: Free cash.
Dr. Shah: Free cash. These down payments on your future education, or on a mortgage, everything is so low right now that I feel you can accumulate assets and try and pay off things when you do start getting your attending salary. That's personally just how I think about it, and that's how I encourage my friends to think about it if they talk to me about needing any help with loans or anything like that.
Macielak: To that point, do you see many colleagues going the other direction and maybe spending less frugally?
Dr. Shah: Yes, people do tend to do that. But again, I think living within your means is something that either you'll learn through a harder lesson or that you'll just accept. I have definitely seen people make purchases—a new car, for example—but I don't think there's anything wrong with treating yourself, especially if your interest rates are this low.
Like I mentioned, my goal was to do a variable rate and pay off my loans quicker, but again, at 3%, that shouldn't be a stressor in my life. If I extended my original plan five years to eight years or nine years, and if my interest rates remain low in the current economy the way things are, there isn't a lot of LIBOR shift, I'm not very worried about it. If they increase by quite a bit, I would try to pay it off quicker than my original plan. I think that's the right approach for my family. It may be different for others, but that shouldn't be something that scares you. That shouldn't be something that embarrasses you or makes you nervous, especially in the current economy.
If you refinance 6.8%–7%, that's a little bit scarier, but even then, it's not as high as rates used to be, I'm sure, 10–15 years ago. And the other thing is, I used to work in investment banking, so one thing we always learned or stressed is that if you have extra money you can put that in the market and historical returns in the market have been higher than 7%.
There are different ways to use your money, and I think you have to realize that getting rid of debt, if it's at a very low interest rate, doesn't have to be the No. 1 priority. You can prioritize your own interests. You can prioritize investments. You can prioritize for education for your kid and whatever other needs you may have.
Macielak: That's great to hear. I mean, I think many people aren't quite as pragmatic as you, but it's refreshing to hear someone with that level of financial background say that you're not stressed about your loans.
As I said at the beginning of the podcast, I was surprised when we did the survey how many people said they were embarrassed about their loans. I think you take a really pragmatic look at them, and you're not letting it impact other areas of your life, which you shouldn't. You've made a sound financial decision to get a medical degree. It's going to pay off. There's no use in stressing over it in the meantime.
Dr. Shah: Yeah. I'll get a piece of advice from you then. If you had one piece of advice to give to anyone that's about to take a loan or refinance, what would that piece of advice be?
Macielak: Yeah, I guess if you're about to take out a loan, you're in school, I would stress that you should be aware of the long-term consequences of this. And not that those consequences should sway you from taking the loan, but don't be surprised five years later, or four years later, when you're being asked to repay it. I think this is probably less so in the medical profession, but undergraduate borrowers, other degree types, taking loans is such a norm now and people have no choice, so they just sign on the dotted line at the registrar's office at school and go off to class.
Dr. Shah: And those are mostly federal loans, is that right? Now, are there different rates among federal loans? Are there are some Stafford, or anything like that, worth avoiding or worth trying to get? And how should students or residents even think about that aspect of the loan cycle?
Macielak: Yeah, undergraduates by and large take Stafford Loans. Undergrad Stafford loans offer lower rates. Graduate school Stafford loans have higher rates. Those are taken typically for the first portion of tuition costs and then the remaining gap, which can be sizable—$30,000–$40,000 a year depending on where you go to school—is typically filled with grad plus loans, which are also federal loans but come at an even higher rate. I believe the grad plus rate currently is over 7%. It's a high-rate loan for sure, but it's often the default option that a financial aid office would discuss with a student.
Financial aid offices by and large are very trained and used to talking about federal loans, and taking federal loans, and there's a lot of merit to that. I mean, certainly, they're more flexible as a student. You really don't know what you're going to be doing thereafter. Are you going to be working at a nonprofit? Are you not? You know, nothing wrong with taking the federal loans even with the higher rates.
Laurel Road, along with other lenders, also offers private, in-school loans. So, if you wanted to take a private loan while you're in school, you're able to do so. It comes with a lower rate than the grad plus offering as well as no origination fee. There are origination fees associated with federal loans, but you have an opportunity to get loans forgiven in the future. That's one consideration for people to keep in mind.
If loan forgiveness could possibly be on your roadmap for the future, you want to take as much federal debt as possible because that can all be forgiven. But I'm sure there is a portion of the population that says, in year one of medical school, I know I'm never going to do loan forgiveness. I want to be an anesthesiologist, and I want to work for a private group. I know this is my path. Let's just lock in as low an interest rate as possible right now. That could be a great scenario for taking one of these in-school private loans.
Dr. Shah: And it's funny you mention that because when I started residency, I thought for sure that I would go towards the public service loan forgiveness. So, for my four-year residency in anesthesia, I was under pay as you go.
Then, when I got closer to accepting a job—and it turns out that I'm not going to be at a not-for-profit group and essentially private practice—it didn't make sense for me, obviously, at that point. So, I ended up refinancing during my fellowship, and I wish that I had the foresight to do it earlier because I was paying a much higher interest rate. But, of course, hindsight is 20/20.