Medical school loans during residency: IBR/PAYE or forbearance?

There were several things about dealing with an unhealthy amount of student-loan debt during residency that I never learned in medical school. In fact, I’d venture that the vast majority of medical students have very little idea how to approach their loans. After all, it’s not on the boards (updated November 2016).

While this post has been updated, you’ll also want to read my posts on prompt federal student loan consolidation and the pros/cons of the REPAYE program to get started.

For starters, the AAMC has an excellent and concise debt fact card to introduce you to the topic. The numbers are sobering. But what’s missing are a couple of specific benefits of income-based repayment (IBR) as well as why most people should do it for at least the first year (if not two). As of May 2013, the federal government has off-loaded loans onto various servicers and changed the application process. As a result, the benefits of “free” money and $0 IBR payments for interns are gone (unless you consolidate promptly or wait and then want to be willfully and blatantly dishonest).

When you decide to enter IBR or PAYE instead of forbearance:

1. The government pays the interest on your subsidized loans for 3 years (however much is left over after your payments). Unfortunately, as of 2012, medical students won’t be getting any more of those (which was $8500 per year, meaning that another $34,000 of those loans will be unsubsidized/accruing interest at 6.8% during school than used to be the case). Even on a resident’s salary, most of this subsidy will be eaten up by IBR payments (which preferentially pay off subsidized interest first) now that IBR will require legitimate payments from day 1. 

2. All monthly payments during residency count towards the 120 monthly payments (10 years) needed for public service loan forgiveness (more on planning for PSLF here). PSLF itself is not worth entering academia if you otherwise want to be in private practice (the pay differential is way too high), but it’s a nice reward for those entering academic or county jobs and something to keep in mind if you are undecided. Even if you switch to forbearance later, the qualifying payments you make still count (they don’t have to be consecutive). Since your remaining loan balance after 120 payments will be forgiven, it is in your best interest to have these payments be as small as possible, so don’t waste your low-pay years as a resident unless you need to.

Let’s say you want to enter private practice and plan to make enough money that you just don’t care about your loan amount. You just want to maximize your lifestyle during residency when money is tight and that $400 a month will make a big difference. That’s fine too. Some private practice programs will even pay off your debt for you. Even so, there’s reason to do IBR for at least a year (when your payment is zero). (There’s still a reason to do it for a year if you consolidate; read more about it here)

3. During forbearance, interest does accrue on both subsidized and unsubsidized loans and is capitalized (gets added to the principal). This means the amount of money accruing interest does not remain stable (not simply the original loan amount) and adds significantly to the total cost of the loan. This calculator can determine how painful capitalization will be for you. While in IBR, interest never capitalizes until you’re an attending making enough money that you no longer have a “partial financial hardship.” 1A partial financial hardship is when the 10-year standard monthly payment on what you owed when you first entered repayment is more than 15% of discretionary income. That 6.8% only grows from the original loan amount, it never compounds.

Also note, there is something called “deferment” which is similar to forbearance but has better terms (particularly when subsidized loans were still commonplace). Very few residents qualify for the economic hardship deferment anymore, so you might as well forget it exists.

Why the first year of IBR is excellent

Your monthly payment under IBR is calculated from the previous year’s tax return. So for your intern year, IBR monthly payments are calculated from the tax return reflecting the second half of third year and the first half of fourth year. If you barely made any money (a bit from tutoring, part-time work, work study, etc won’t matter), then your calculated IBR payment will be $0. Since there is no “minimum” payment for IBR, this $0 per month is a valid payment and contributes to the 120 required for PSLF. Therefore, for many interns (single people, married people who file separately, and married people where the spouse also didn’t work), the first year of IBR is free. So there’s really no reason not to do IBR for a year, as otherwise you lose out on free government money (for now). If you have the full $34,000 in subsidized loans, for example, then the subsidized portion accrues $2320 in interest over the course of one year, and the government pays all of it. Any dollar extra you put into the loan goes straight to the interest first, so it’s one less dollar you get from the government. If you have extra cash, save it or invest it and put it into your loans later (or enjoy it now, why not). The IBR application now generally requires an Alternate Documentation of Income (ADI), which requires you to state your new job and how much you earn. This income, instead of your empty tax return, will be used to calculate your IBR payments for your first year. Hence, IBR will no longer be free for the first year if you apply during residency. Instead, if you want the free money discussed in the strikeout text, you’ll need consolidate when you graduate and enter repayment promptly.

If you didn’t file your taxes because you didn’t make any money and didn’t think you had to, that’s okay. You can file them as late as October for no penalty (as long as you didn’t owe the government any money, which you probably didn’t).

Why the second year of IBR is still pretty good

The tax year used for your second year of IBR payments is the one made up of the second half of fourth year and the first half of intern year. During this tax year, you actually only made half of your intern salary (i.e. ~$25k, not the full $50k). Therefore, the calculated IBR payments will be in the neighborhood of $200 per month instead of $400. Not bad. It’s not clear how often servicers will require the ADI for the second year of IBR. Theoretically, payments could be low (see the strikeout text above). In all likelihood, the payments will remain accurate to your adjusted gross income.

The long-term plan

Once your payments supersede the yearly amount of subsidized loan interest or after three years, there is no more free money to be had from the government unless you’re in the new REPAYE program. At this point, there’s no harm in trying to pay off your loans as fast as possible. Except:

• If you plan to do PSLF, then never put more than you have to. It’s less money to be forgiven. PSLF probably isn’t going anywhere in the short term, and you will not be taxed on the forgiven amount at the end (unlike if you made 25 years of IBR payments, which is the other way to earn loan forgiveness from the government [practically impossible for physicians]. When the government makes changes to the loan programs, they rarely retroactively do bad things, only good things. If you enter PSLF while the program is in effect, you’ll likely be grandfathered against any future cancellation.
• If you want to do private practice and know where you might be doing it, ask around to see if loan forgiveness is typically part of the signing package. If the place you’re likely to work is going to pay it off for you, then there’s no reason to do so yourself. Keep in mind getting your loans paid for you sometimes involves some undesirable contract obligations.
• If you’re not interested in PSLF, then you might consider trying to refinance your loans with a private company. I recommend reading the post (which is very detailed about pro/cons), but for example, Laurel Road currently has a resident-specific program that includes $100/month payments during residency and interest rates as low as 1.9% variable / 3.5% fixed. Even a 1% decrease in your loan amount may be worth thousands per year, and they offer a $300 bonus for refinancing via a referral link.
• If neither of the above scenarios applies and you can’t refinance, then start paying down your loans. At 6.8%, that’s probably higher than your mortgage (if you have one) and probably higher than most investments you’ll be involved in, especially in the current economic climate. The exception to this statement is setting aside for 401k/403b/Roth-type retirement contributions, especially if your program will match your contributions up to a point. If your program offers you this free money, put as much away for retirement as it takes to maximize your employer contributions (if possible). A Roth IRA is also worth investing in, as a low-cost mutual fund will earn 7% per year (on average) and the first dollar invested will earn the most money.
• You can always pay more down on your loan and still be in IBR. There’s no penalty for doing so. (In fact, you can always make payments while in forbearance too for that matter, which can help tamp down the interest). Keep in mind that the IBR payments during residency still often result in negative amortization: your payments reduce the amount of interest accruing, but the amount owed will continue to grow because the amount of interest accruing is higher than the payment amount. Without significant extra income from moonlighting, you will not make much progress on your loans if you’ve borrowed a large amount.

Keep in mind your reality

The debt fact cards and most AAMC materials always compare strict-IBR versus forbearance followed by standard repayment, which minimizes the long-term benefit of making payments during residency by following it up with the extended (lazy) repayment term of IBR and its consequent rise in interest payments. However, someone who is willing to put money down in residency is also someone who is likely to want to pay down their loans quickly. The bigger your salary, the higher your payment (until it reaches the size of the standard repayment). If you make additional payments as an attending (to make them the same size as the standard repayment), then you don’t lose any of the money you save by using IBR: making interest payments, getting government money, and avoiding capitalization. The longer your residency, the greater this difference is. Don’t be discouraged by looking at the official materials, the numbers are unlikely to reflect a physician’s IBR-in-residency total repayment plan.

In the end, IBR itself during a 3-4 year residency (without PSLF) may save you somewhere in realm of $30-60k if you have a commonly large loan burden, which is not negligible but may be a pittance compared to your long-term future income. If making payments will crush your lifestyle as a resident and you don’t plan on working for a non-profit after training, then forbearance (or even private refinancing) may be the right choice for you. You can use this accrued interest calculator to figure out roughly how much interest will accrue during forbearance.

• The longer your residency/fellowship, the more money doing IBR/PSLF can save you and the more ridiculously your loans will balloon while in forbearance.
• The more expensive your college and medical schools loans are, the more IBR/PSLF can save you and the more ridiculously your loans will balloon while in forbearance.
• The higher you will be paid as an attending relative to as a resident, the less meaningful the money saved and the more significant the money spent during residency.
• In the long run, money invested wisely in a retirement account (especially if matched) will earn more than the equivalent amount of money spent on loans (not taking capitalization into account). This is especially true if you are able to obtain a lower rate through private consolidation/refinancing.

You can read my further thoughts on PSLF and planning for it during residency here. More information about refinancing as a resident is available here and about refinancing in general here.