How To Pay Off Student Loans After The Supreme Court Decision
July 2023 ISSUE July 1, 2023Personal Finances Debt Management
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The Supreme Court recently struck down the Biden administration’s plan to cancel up to $20,000 of student loan debt for certain borrowers.* While this ruling is important, it’s just a drop in the bucket for most newly minted dentists, who are graduating today with student loan debt averaging over $300,000. Worse yet, many graduates from specialty residency programs have student loan debt totaling $400,000-$600,000 or more.
Interest And Payments Resuming Shortly
Of much greater importance is recent legislation ending the pause on interest accruals and student loan payments, which began on March 13, 2020. The new law ends the moratorium, effective August 31, 2023, and applies to 42 million borrowers who owe about $1.4 trillion in federal student loans. The moratorium saved borrowers about $5 billion a month, or approximately $400 a month per borrower on average. Fortunately, the forgiveness clock has continued to run during the moratorium on the total time needed for Public Service Loan Forgiveness (PSLF) and for the Income-Driven Repayment plans (IDR) forgiveness as discussed below, which is exceptionally good news for many young doctors burdened with large student loan balances.
Fortunately, you’ve got some time to prepare for the coming shock to your wallet! While the student loan pause expires August 31, 2023, it will take some time for the Department of Education (DOE) and its contracted loan servicers to generate and distribute billing statements. Accordingly, the DOE expects the first payment due date to be sometime in October of 2023. That means it’s time to log into your student loan account to review your payment history and verify your required monthly payments that will be due. Call your loan servicer now with any questions.
With the repayment resumption date rapidly approaching, here’s what you need to do now.
- Establish a spending plan (budget) – Once you determine your student loan payment amount, you need to build that into your monthly spending budget going forward. This requires determining what other spending/savings areas you need to cut to make room for this recurring bill. If you don’t have an existing budget or understanding of your current cash flow, now’s a great time to develop one including the new payment. Another option – increase your income!
- Purchase a practice – What’s the fastest way to get out of debt? Make more money! And the best way to make more money? Become a practice owner, rather than a renter (associate). Why go into more debt when you’re trying to get out of debt? That’s simple, because practice owners typically earn more (even after paying for the practice) than they do as an associate. This not only provides increased income, but also allows you to build equity in your practice value, which increases each month as the debt is paid down.
- Consider an income-driven repayment plan – If your monthly payment is still too high, consider an Income-Driven Repayment (IDR) plan. Most federal student loans are eligible for at least one of the four income-driven repayment plans. These include the Revised Pay As You Earn Repayment Plan (REPAYE), Pay As You Earn Repayment Plan (PAYE), Income-Based Repayment Plan (IBR), and the Income-Contingent Repayment Plan (ICR). Your payment amount under an income-driven repayment plan is tied to a percentage of your discretionary income (generally 10%), and any debt remaining at the end of 20 years is forgiven, (10 years if you’re working toward loan forgiveness under the PSLF program). To determine if you qualify, and for more information about these plans, review the details at www.studentaid.gov.
- Cautiously analyze debt consolidation/refinancing – When interest rates were low, borrowers could consolidate their student loan debt and refinance with private lenders for significant savings. Unfortunately, the rapid rise in interest rates over the past 18 months has significantly reduced the attractiveness of this option. Current refinance interest rates range from 5-12% from most lenders and require a credit score of at least 650 and a repayment term of 5-20 years. In order to qualify for interest rates at the lower end of this range, you’ll need an excellent credit score (above 650), and agree to a much shorter loan term (5-10 years). As a result, the interest savings will be minor and your monthly payment may increase substantially, rather than decrease. Worse yet, you’ll lose the option for loan forgiveness after 20 years in most cases, or 10 years under the PSLF.
- Prioritize your debt reduction/savings plan – Your emotional reaction is likely to throw as much cash as possible against your student loan debt, in order to eliminate it quickly. However, you’ll grow your wealth much faster by using your available savings (cash) to fund the maximum tax-deductible Health Savings Account (HSA) contribution first, maximize your tax-deductible 401(k) salary deferrals next, then fund IRA contributions, before applying the balance to debt reduction or personal investments. Applying your available cash in this priority provides the greatest federal and state income tax savings, allows your wealth to grow tax-deferred/tax-free, while preserving your chance for debt forgiveness.
- Prepay student loan or invest? – Once you’ve fully funded your HSA, 401(k) salary deferrals, and IRAs, your remaining available cash should be applied to either prepaying your student loan debt or investing. Which is best? It depends on your after-tax rate of return. If your student loan debt carries interest rates above 5%, it’s best to prepay them, starting with the highest interest rate first, to receive the best return. To create the greatest wealth possible, we create debt payoff schedules for our clients showing them which debts to prepay and how much, in order to generate the highest after-tax rate of return. Otherwise, invest the funds to earn a higher after-tax return over the long term by dollar-cost-averaging into the stock market.
- Enroll in auto pay – This is a financial “slam dunk.” By signing up for automatic payment by bank draft you’ll qualify for a 0.25% interest rate reduction, with no downside risk!
*Applies to those earning less than $125,000 a year (single) or $250,000 a year (married), based on your 2020 or 2021 income, whichever is lowest.
The McGill Advisory content Is provided For informational purposes only And does Not constitute legal, accounting, Or other professional advice.
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