These are the debts and loans that we are looking to eliminate. Before we figure out how to get rid of them, we need to identify the loans and make an inventory of them. I really believe that being organized is more than half the battle. After getting this done, you will be well on your way.
We will need the following information about your liabilities: description, company, principal owned, interest rate, maturity date, minimum payment, current payment, loan type (house, consumer, or business), fixed versus variable, and if variable, when it changes.
To be clearer about what we are looking for, here are a few pointers:
- If you have a credit card that you pay off monthly and that does not have a continual balance, you don’t need to include it here.
- We include minimum payment versus current payment because some folks pay more than the minimum and we want to make sure you understand the difference. Perhaps, you could pay less to some liabilities and more to others.
- If you own rental homes, consider business debt rather than house debt. House debt is meant to show the tax- deductible debt on your primary residence. Likewise, we consider 401(k) loans, life insurance loans, and student loans to be consumer debt.
- The reason why we consider student loans to be consumer debt is that they stop becoming tax deductible once the borrower’s income reaches a certain level. Currently, that level is $65,000 for single people, or $130,000 for married people.
- Lastly, to understand whether a loan is fixed versus variable, the main question to ask is if the interest rate could change sometime in the future. Home equity lines of credit (HELOCs), adjustable rate mortgages (ARMs), credit cards, and business lines of credit are all common examples of variable loans.
Due to the extremely high level of student debt that most physicians hold, many physicians are eligible for several types of forbearance programs and debt-reduction programs. The difficulty lies in choosing among them.
Truly, physicians have a wonderful opportunity to enroll in debt forgiveness programs. Later on, we’ll ask you to think about and explore whether a loan forgiveness program may make sense for you.
Here are a few factors that you may want to consider when looking over the possibilities:
- Does the program cover your field of practice?
- Does the program apply only to a specific loan or does the forgiveness program cover multiple loans?
- Is this an employer or a state funded program?
- Are the benefits taxable or not?
- What is the length of the commitment?
- Does the employer or the state pay down the loan each year or wait until the end of the commitment?
Let’s look at a couple of examples of debt forgiveness programs.
First, the most common debt program that physicians look into is the 10-Year Public Loan Forgiveness program.
This is sponsored by the federal government and can cover virtually any field of practice. You don’t have to specify a specific loan because it can cover all of your loans (assuming they are Stafford, Perkins, or other federally backed programs). The benefits are currently not taxable, but this could change in the future.
As the title of the program indicates, it is a 10-year program. The federal government will not forgive the balance until the end of the program.
HOW THE 10-YEAR PROGRAM WORKS
While you are employed full-time by a public service organization, you must make 120 on-time, full, monthly payments (employment includes residencies and fellowships).
Think about this for a minute. This is just seven years out of a residency, or maybe only three, four, or five years out of a fellowship.
Note that if you have Federal Family Education Loan(s) (FFEL) and/or Perkins loans, you need to consolidate them into a direct consolidation loan to take advantage of the program.
Qualifying employment is any employment with a federal, state, or local government agency or a nonprofit that has a 501(c)3 status. But the program also covers certain nonprofits that aren’t 501(c)3s.
Let me emphasize strongly that if you are employed by a hospital that has a nonprofit 501(c)3 status, you are probably eligible for this program.
Be aware of whether the arm you are working for is a nonprofit or a for-profit. Some nonprofit hospitals can have a for-profit subsidiary, for tax reasons.
Note that your monthly payments are substantially lower while in residency and fellowship. Later, we will go through some examples covering after-residency employment and fellowship.
Think about this for a minute.
If you are in residency for three years, you will only have seven years remaining on payments.
Meanwhile, if you have a fellowship for three years in addition to three years of residency, you only have four years remaining on payments.The bottom line is to make sure you enroll while you are in residency and fellowship.
If you have FFEL and/or Perkins loans, you need to consolidate them into a direct consolidation loan to take advantage of the program. This process will take one to three months to complete, depending upon your situation.
HOW REPAYMENT WORKS
As you complete the direct consolidation loan, you must pick a repayment program. The four most common programs are the Income-Based Repayment (IBR) plan, Pay-As-You-Earn (PER), plan, Income-Contingent Repayment (ICR) plan, and the 10-Year Standard Repayment plan.
In this book, we focus on IBR and PER, as they require lower payments in residency and fellowship, which can lead to greater debt forgiveness.
Next, you start to make on-time monthly payments for the ensuing 120 months.
Make sure every year, or whenever you change jobs, to complete, with your employer’s certification, the Employment Certification form. Submit the completed form to FedLoan Servicing (PHEAA), and the Public Service Loan Forgiveness (PSLF) servicer, following the instructions on the form.
FedLoan Servicing (Pennsylvania Higher Education Assistance Agency—PHEAA) will review your Employment Certification form, ensure that it is complete, and, based on the information provided by your employer, determine whether your employment qualifies for the PSLF program.
DIFFERENCE BETWEEN INCOME-BASED REPAYMENT AND PAY-AS-YOU-EARN REPAYMENT PLANS
The most common program is the Income-Based Repayment (IBR) plan. The second more recent program is the Pay-As-You-Earn Repayment (PER) plan.
IBR and PER both accomplish the same goal of minimizing your student debt payments while in residency/fellowship and having you pay back your student loans at a higher rate once you are making more dough.
Note that IBR and PER both require a “partial financial hardship.” This means payments of a federal student loan under the 10-year Standard Repayment plan are higher than under IBR or PER.
The commitment for IBR is a monthly payment of 15 percent of discretionary income whereas, under PER, the commitment is only 10 percent of discretionary income. Note that discretionary income has a very specific definition: your income minus the poverty level as specified in guidelines published by the government.
You will be asked questions about your household income—for example, your spouse’s income and their school loans, your kids and so on, as those things affect the poverty guidelines.
How does the government determine your income? It looks at your tax return.
This is an important distinction because the government is looking purely at your adjusted gross income (AGI).
This means that it is taking a snapshot of your income after pretax deductions for 401(k)/403(b) contributions, after pretax deductions for health-savings accounts, and after deductions for any active business losses.
Also, this means that if you ended your residency/fellowship in June and started your first contract in July, you would likely not have to start making higher payments until the following year. For example, if you finished your residency in June 2013, your higher payments would not take effect until past January 2014.
However, the payments do not take into consideration your overall student load debt or your age or whether you have a car loan, mortgage, and so on. The student debt load is particularly interesting as we explore debt forgiveness programs.
Below is a table that I composed by entering information on the calculators at studentaid.ed.gov.
Note that I assumed that this hypothetical borrower is married, has no kids, no spousal school loans, the original loans were $20,000 to $30,000 below the current loan amount, and the loans carry an interest rate of 6.8 percent.
Although this borrower could easily qualify for IBR while in residency, the calculator on the website doesn’t allow me to calculate the payment at a $200,000 income level, which is a $150,000 loan amount for IBR.
However, we could safely assume that the payment should be $2,216/month given the example below, because the monthly payment fluctuates with compensation but not with the loan amount.
Note the tremendous difference between IBR and PER: over $500/month at the $150,000 compensation level and over $700/ month at the $200,000 compensation level.
See how the IBR or PER amount does not change as the loan amount goes up? This is because it is primarily dependent on income.
There is one big caveat between the two programs. To qualify for PER, you must not have any current student debt that originated before 2007.
How does all of this tie in with loan forgiveness programs? Let’s take a look at an example of two physicians, Dr. Smith and Dr. Jones, who began PSLF at the very start of residency. They each had an equal amount of student debt when they came out of medical school.
Dr. Smith has been in residency for three years, has made 36 payments toward PSLF, and has gone right into practice. He is making $150,000 per year.
Meanwhile, Dr. Jones has also been in residency for three years, has made 36 payments toward PSLF, and has also just entered practice. He is now making $200,000 per year.
Let’s examine what would happen if each of them enrolled in IBR or PER at the start of residency.
The table below adds up the monthly payments from the previous example and multiplies them over seven years. There is no increase in salary. I’m keeping it simple and flat. The lifetime payments in the table are the combination of interest and principal over those seven years.
At the end of the seven years—assuming continued nonprofit employment—the remaining portion of their debt would be forgiven.
For example, with $250,000 of loans and $150,000 worth of compensation, after seven years in practice, they will have paid about $90,000 in the PER program compared with about $130,000 in the IBR program, assuming taxable income is $150,000.
After Dr. Smith completes 84 remaining payments, now that he is in practice, he will have approximately $225,000 worth of forgiveness with IBR versus $265,000 of forgiveness with PER.
This is why PER is superior to IBR when the student debt forgiveness programs are tied in with them.
Additionally, the higher the loans, the more beneficial PER enrollment will be.
Let’s say that you have $250,000 in student loans. Consider this: At an interest rate of 6.8 percent, you are accruing interest of about $17,000 annually, or $1,416 monthly. With PER, you would have been paying $1,478/month, barely tapping into principal.
Then, over seven years, you will have paid about $124,000 and will have debt forgiveness of almost $250,000 of the principal and, likely, tax-free!
Giving up this gift is the tax equivalent of almost $360,000, or $51,000/year over seven years, assuming a 30 percent tax bracket.
Even with IBR, you would still have debt forgiveness of nearly $200,000, or the approximate tax equivalent of $285,000.
Either scheme is wonderful, but PER is better for debt forgiveness purposes.
Remember, as we mentioned earlier, to qualify for PER, you must have student debt that originated after October 2007. This will likely affect residents and fellows who started in 2012, and even more so over the next few years.
WHAT CAN WE CONCLUDE FROM ALL OF THESE PROGRAMS?
If you are working for a nonprofit entity, PER is probably a better option, unless you do not qualify due to the origination of your student debt. IBR will still be a fine choice.
I would strongly suggest not putting extra payments toward your debts if you are enrolled in the 10-Year Public Loan Forgiveness program unless you think you may not be ready to make a 10-year commitment to staying in the nonprofit community.
If you are currently working for a nonprofit and are considering transitioning to a for-profit practice after residency, IBR would be my recommendation. Keep in mind that you can make extra payments beyond the minimum that IBR requires to pay it off sooner, once you are in practice.
EXAMPLE OF A STATE SPONSORED FORGIVENESS PROGRAM
There are also many state-sponsored programs.
The following is an example of a current program in Minnesota, the Minnesota Urban Physician Loan Forgiveness Program.
Who can apply to this program?
Applicants are primary-care medical residents, including those working in family practice, obstetrics and gynecology, pediatrics, internal medicine and psychiatry. You would apply between July 1 and December 1 while completing medical residency training.
Following completion of the residency, the participant must plan to practice for at least 30 hours per week, for at least 45 weeks per year, for a minimum of three years in an underserved urban community.
THE NITTY GRITTY DETAILS
The state will repay up to $25,000 per year of service, not to exceed $100,000, or the balance of the designated loan, whichever is less. These payments are exempt from state and federal income taxes. $25,000 is the taxable equivalent of $35,700 (assuming a 30 percent tax bracket).
You must serve at least three years or, otherwise, repay the loan plus interest on what the state paid toward your loan.
Gather together the data that you will need for all of your liabilities.
We’ll cover how to prioritize liabilities in step three, but for right now, just get the information.
We have included an example for your review. Note how nearly every spot has something in it. Of course, fixed loans don’t have anything in the final column since that column is only for variable loans.
I entered “n/a” for the maturity date for the lines of credit since there is no definite maturity date.
One of our goals will be to set a specific maturity date once we have identified the loans that are priorities.
Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation.
Please consult with your accountant or tax advisor for specific guidance.