Dear Dr. Debt: Which repayment strategy is more sensible?
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Dear Dr. Debt is a new monthly advice column about student-debt management in the veterinary community. It is adapted from Veterinary Information Network and VIN Foundation message boards where veterinarians and veterinary students ask questions and get answers to help them approach borrowing and repayment strategically.
Over the years, thousands of conversations in the online discussions have enabled the VIN community to learn the good, bad and ugly aspects of student loans. With Dear Dr. Debt, the VIN News Service extends the conversation to the wider veterinary community, with advice from student debt expert Dr. Tony Bartels.
I am a 2019 graduate of a foreign veterinary school accredited by the American Veterinary Medical Association. I work in an emergency and critical care practice in the U.S. My partner and I are currently very stable financially, with $160,000 invested through a financial planner, $60,000 in savings (more than six months' savings for an emergency), and $10,000 in U.S. Series I Savings Bonds.
After graduating, I consolidated my federal student loans into a Direct Consolidation Loan and skipped the grace period, entering the Pay As You Earn (PAYE) income-driven repayment plan with a monthly payment of $0. This has continued unchanged through the pandemic. My partner has no debt beyond our shared mortgage and two car loans. We have £50,000 in England, if that's relevant — my spouse is from Britain. Here's a breakdown of my finances:
Federal student loan principal: $224,336
Unpaid interest balance: $9,619
Weighted average student loan interest rate: 6%
Repayment plan or strategy: PAYE, enrolled for three years
Anticipated minimum monthly payment: $1,650
I do not make above-minimum monthly payments on the loan.
Amount of time expected to repay the loan: 25 years
Personal debt: home mortgage of $194,255 at 3.2% interest, and $28,097 in auto loans at 2.9% and 2.5% interest
Pay structure: salary and production bonus, plus employer-provided benefits that include a continuing education allowance, paid maternity/paternity leave, license fees, health insurance, liability insurance, pet insurance and retirement plan
Tax status: married, filing jointly; no children
Adjusted gross income from most recently filed tax return: $214,000
Spouse's annual income: $45,000
Average monthly expenses: $3,000
I would like to repay the loans in a way that makes the most financial sense, whether that is super-aggressive repayment or income-driven repayment.
— Financially Stable and Want to Stay That Way
Dear Financially Stable,
You're the poster veterinarian for how focusing on financial wellness can help you outgrow your student loans. In your case, it's happening quite quickly! Excellent!
You've done a great job following the VIN Foundation New Veterinary Graduate Student Loan Repayment Playbook: graduating, quickly consolidating into a Direct Consolidation Loan, applying for PAYE and securing a $0 monthly payment. After the pandemic payment and interest pause, scheduled to end Dec. 31, your payment will resume at $0 a month until you're due to recertify your income to the U.S. Department of Education. Based on the most recent recertification guidelines posted by the department, we know that July 2023 is the earliest date that borrowers will be required to recertify. In your case, judging from details you've provided to the VIN Foundation My Student Loans tool, it looks like your next renewal date is not until March 2024.
That means you'll have at least four years of qualifying PAYE time before you are required to make a payment. PAYE runs a maximum of 20 years, so you will be 25% through repayment without a payment greater than zero. Pretty amazing deal.
You're also in line to receive $10,000 in a one-time debt cancellation that was announced Aug. 24, but you'll need to pay close attention to your recent combined household income, as you're close to the income-eligibility threshold of $250,000 for married, joint-filing households.
Your tax filing status and adjusted gross income (AGI) will determine what your PAYE payment will be going forward. Working with a financial planner is great! I'm guessing that planner also is helping you to minimize your taxes and allocate some of your respective earnings into your available retirement plan options, like a 401K and a Roth individual retirement account (note that you're very close to Roth income-eligibility limits).
Earnings and expenses
According to your Student Debt & Income Signalment Form submission, you've outgrown your student loans — your net worth exceeds your loan balance just three years after graduation. Wow! Plus, you've established an emergency fund greater than six months of your major monthly expenses. Excellent!
We don't get to talk about this very often with borrowers: Once you meet/exceed that emergency fund threshold, look to invest your money in something that increases your return. You've reached the limit on I bonds for this year, so explore tax-advantaged retirement options first, then expand, based on your comfort level with investing.
You could also consider paying down your auto loans aggressively, especially since you're charged interest on them. Usually, car loans exceed the value of the car right away. We have seen some auto-oddities lately with supply chain disruptions pushing up motor vehicle values, but auto loans still are riskier than student loans. The sooner you eliminate them, the sooner you'll have more cash flow for other areas of your financial wellness.
Considerations for renewing PAYE
Let's come back to what your PAYE payment will be once pandemic benefits end, and what your payment might be after you recertify your income. Again, this will depend on your taxable income and most recent tax filing status at your renewal time. Since that won't be until at least early 2024, you've got time to work through the details.
The application for a one-time cancellation of $10,000 on your student loan debt became available just this week. As long as your combined household income is less than $250,000 (based on 2020 or 2021 AGI), after you apply, you should have $10,000 removed from your student loan balance.
Once repayment resumes, even though your payment remains $0 per month until you recertify your income, enroll in autopay. That will knock 0.25% off your interest rate.
Now let's explore what happens if you file taxes separately from your spouse for 2022 to see what your respective taxable incomes would be. Using the VIN Foundation Student Loan Repayment Simulator, we can see how your PAYE payment would be affected. That will show whether changing your tax-filing strategy might make sense.
Here is a saved simulation using your signalment form responses that presumes you file taxes separately for the duration of repayment. It shows that you still come out ahead by remaining in PAYE, continuing to pay the minimum based on your taxable income and planning for potential taxes on forgiveness. If you flip the tax-filing switch to "jointly" in the "family information" section of the simulator, then your remaining PAYE costs are a bit more than a standard 10-year plan payment. That's where the cost-benefit analysis for filing separately is important.
It's too soon to tell whether you should move to an aggressive repayment strategy. We need more information on your taxable incomes, and particularly what that will be for your 2022 tax return, which you'll probably use to renew your PAYE plan in early 2024.
We do know that even your combined projected incomes will not generate a payment obligation equal to a standard 10-year plan payment, about $2,458 a month for you. That suggests to me that you should continue with PAYE so that you're not paying more than 10% of your discretionary income toward your loans. When we project that out with the simulator, you still are on track to reach forgiveness even in the joint-filing analysis, which indicates that you should stick with your strategy: paying the minimum required by your taxable income and planning for the potential tax on forgiveness.
As you have brilliantly demonstrated over the past three years, you can find better things to do with your money than to pay more toward your loans than required. Imagine how much more you'll have saved compared with your student loan balance during the next three years if you keep doing what you've been doing. Soon, your student loans will represent an insignificant amount of your overall financial wealth and wellness.
One way or another, your student loans will go away — either your income will generate a payment obligation that will reduce the balance to zero before you reach forgiveness or it won't, and you'll have the remaining balance forgiven in 17 years. Right now, reaching forgiveness looks to be your path, and PAYE seems still to be the best plan for you.
Keep up the great work on your overall financial wealth and wellness! Check back in next year, and we'll rerun the numbers.
Dr. Tony Bartels is a 2012 graduate of the Colorado State University combined MBA/DVM program, an employee of the Veterinary Information Network and a board member of the VIN Foundation. He and his wife, Audra, a small animal internist in Denver, have more than $400,000 in veterinary-school debt that they manage using federal income-driven repayment plans.