This is a follow-up to the March 20, 2017, blog post “The unintended consequences of private refinancing.”
So why might you want to think twice about refinancing your student loans through a private lender?
You lose your government benefits.
When you refinance your loans with a private lender, those new loans become ineligible for income-driven repayment (IDR) plans, which offer substantial benefits to graduating dentists. An individual with a debt of $450,000 at 6 percent and a job making $130,000 (adjusted gross income) would have a standard 10-year repayment amount of about $4,996. Not many dentists are going to be able to make that payment, especially with that income. Let’s say this person refinanced the debt over 15 years and was also able to lower the interest rate to 5.5 percent. The payment would drop to $3,676 ($44,000 a year) and would have to be made every month for the next 15 years with little to no exception. And remember that $44,000 a year is after-tax money, so it would actually consume a much larger portion of your salary, between $50,000 to $60,000, depending on your tax rate.
Conversely, this person could have joined an IDR plan and only been required to pay 10 percent of their income. They also could pay more if they wanted to, albeit at a slightly higher interest rate.
Now, let’s imagine things don’t go as planned (because sometimes things don’t work out the way we expect.) What if you find out that you don’t actually like patient care and want to do something (in dentistry or outside of it) that pays less? What if you decide to be a stay-at-home parent and only want to work part-time or not all? Maybe you end up with rheumatoid arthritis or a shoulder injury that keeps you from practicing dentistry — what then? These are all scenarios that I have actually seen.
If you refinanced your loans, your option is to keep making that $3,676 payment. Bankruptcy is not option. Reducing your payment based on your income is not an option. And there is no potential forgiveness.
With direct government loans, you can reduce your payment based on your income. And while bankruptcy is not an option, under current legislation, any outstanding debt can be forgiven after 10, 20 or 25 years, depending on the program. It is important to think long and hard about giving up these government benefits for a 1–2 percent interest rate savings.
Are you actually saving interest?
One of the other things you need to consider is the fact that certain government loans and repayment plans have interest subsidies. Under the Revised Pay as You Earn (REPAYE) plan, for example, the government subsidizes half of your unpaid interest. In the example above, this person would be charged about $27,000 a year in interest (6 percent of $450,000), but the government would offer a subsidy of the unpaid interest in the amount of about $7,800. This makes the effective interest rate in this particular year 4.23 percent. This subsidy goes down as your incomes goes up, but it is still helpful to understand.
There are many cases in which refinancing makes sense. Be sure you understand all your options.
About Ryan Schulte
Ryan Schulte is a CERTIFIED FINANCIAL PLANNER® that specializes in working with dentists. He is also the founder of StudentLoanAnalysis.com, a student loan consultant group that works with dentists across the country to help them gain an understanding of their debt, their various repayment options and to create a plan for repayment. You can learn more at studentloananalysis.com and contact Ryan at email@example.com.