[Editor’s Note: Re-posted with permission from Ben White. It first appeared here. Ben’s book, Medical Student Loans: A Comprehensive Guide, is available for purchase or to read for free in your browser.]
When you get federal student loans from the government for medical school, you don’t just get one loan: you get at least one per year. Back in the day when graduate students still received subsidized loans, many borrowers would receive three: one subsidized, one unsubsidized, and often a small “low-interest” (5%) Perkins loan. Now, in practice, holding on to multiple loans doesn’t really affect your daily life much. Your federal loan servicer (the company that takes your payments) will apply your payments automatically across all of your DIRECT loans for you (your Perkins loans, if you have any, will be due separately from the rest).
Consolidating your federal loans into a DIRECT Consolidation from the federal government (as opposed to private refinancing) does make things look nice and tidy in that you’ll now have a single loan with a weighted-average interest rate based on the rates of the individual loans it replaced, but this paperwork trick isn’t particularly meaningful in and of itself. Unlike private refinance options, you’re guaranteed to not save a single dime on the interest rate. In fact, a slight rounding change could give you a trivially higher rate (it’s rounded up to the nearest one-eighth of 1%).
But there are definitely a few reasons to consider consolidating your loans, particularly as early as you can, in large part due to the government’s newest income-driven repayment plan: REPAYE (REPAYE is generally a good idea for residents if you’re not already familiar with the program). And there’s a double reason if you’re considering PSLF.
In short, starting a consolidation when you finish medical school will do four things to save you money:
- Reduce the amount of capitalized interest on your loan, which reduces the rate at which it will grow for a long time
- Temporarily increase the amount of your REPAYE unpaid-interest subsidy
- Help you achieve loan forgiveness a few months faster
- Automatically max out the student loan interest deduction on your taxes for the year
We’ll discuss each of these in detail followed by brief step by step instructions. Stay with me.
Consolidating to Make Your Loans IDR & PSLF Eligible
The first benefit of DIRECT consolidation is that it can make more of your debt eligible for income-driven repayment (IDR) and public service loan forgiveness (PSLF). Not all loans you can get for financial aid are eligible for PSLF, only DIRECT loans are: DIRECT loans are those provided “directly” by the federal government: Stafford (for older borrowers), DIRECT Subsidized (for undergrads only), DIRECT Unsubsidized (the most common med school loan), PLUS (higher interest rate for big borrowers), and DIRECT Consolidation.
So if you want to try to have your Perkins loans forgiven, then consolidation is the only way. Consolidation is also the only way to have Perkins loans included within an income-driven repayment plan, which would reduce the amount you pay monthly if you’re worried about cash flow problems (Perkins are normally put on their own separate 10-year repayment.). Most medical students won’t get a ton in Perkins a year, so we’re not talking about huge amounts of money. That being said, having my $4,500 in Perkins forgiven would be another $4,500+ that I didn’t have to pay and $50/month less in payments.
Important caveat: If you’ve already been repaying your loans and are wondering if you should consolidate in order to add your Perkins: Achieving loan forgiveness through the PSLF program is based on making 120 qualifying monthly payments on a given loan. When you consolidate, the feds pay off your old loans and create a new consolidation loan in their place. Because the consolidation is a new loan, the monthly payment count resets to zero. Any payments you’ve made towards your loans prior to this do not count toward the PSLF required 120.
Consolidating at the End of School Saves You Money
The key facet to saving money with federal consolidation is that consolidation loans have no grace period. Normally, you have a 6-month grace period starting at the end of graduation before you begin paying back any money. So if you graduate at the beginning of May, you normally won’t be paying anything until November. During this grace period, interest continues to accrue and is then capitalized (added to the principal) at the end when you enter repayment. Of course, you also won’t start making any payments toward PSLF until 6 months after graduation either.
For the following example, let’s assume you file for consolidation at the end of school in May, which is then processed in June. So you’ll probably lose one month out of the 6-month grace to the consolidation process. Another 4 weeks later to set up repayment, and your first payment will probably start in July, which coincidentally is when you start working. The example numbers here are based on a $200,000 loan at 6.8% with an intern salary of $50k and a household size of 1 (some reasonable numbers for purely illustrative purposes; do your own math).
1. Less capitalized interest. The interest accrued during school will capitalize when you consolidate instead of after an additional five or so more months of accrued interest. With $200k @ 6.8%, that’s $5666 of interest that won’t be part of the principal accruing its own interest. That change in capitalization would result in around $385/year less interest accruing at the above rate.1In other words, it’s better to have a $200k loan than a $205k loan. Note: If your loans are eventually forgiven as part of PSLF, this part would be irrelevant.
2. The REPAYE interest subsidy kicks in earlier. This assumes, of course, that you don’t have a low-debt/high-income mismatch and will be receiving one in the first place. In our above example with a solo $50k intern salary, the projected monthly payment is ~$270/month. $1133 of interest accrues per month on the $200,000 loan. $863 of that is unpaid, and thus $431 is forgiven. Every month. So an extra four months in REPAYE could save you $1,724 (again, I’m assuming you’ll lose a couple of months in the consolidation/repayment process).
But it’s actually better that: you typically certify your application for income-driven repayment plans using last year’s tax filings. The tax year prior was half of your MS3 and MS4 years, when you probably had little to no taxable income, which would result in a $0 monthly payment: $566 would be forgiven each month ($2264 over 4 months) while making $3,240 ($270*12) less in payments during your intern year.2$0 PAYE/REPAYE payments are actually what’s calculated for incomes up to around $18,000, so don’t worry about that side hustle.
A few years ago, some of the servicers wised up to the $0/month trick that people were commonly using when they filed for IDR at the end of grace period, and they began asking for pay stubs from your intern year (the application also now asks if your income has “changed significantly” since your prior tax return), which means that people who wanted a $0 qualifying IDR payment had to start fibbing and hope no one asked for proof.
But by consolidating early and applying for your repayment plan before you start your intern year, you actually don’t have any income to report, your circumstances haven’t changed since last year, and a $0 should be totally kosher again. By the federal government’s own rules (see #46), you don’t have to update the servicers with new income numbers if your income changes before the annual income recertification, so once you have $0/month payments for the year, you’re safe until the following year.
2019 update: the income certification form has changed and now only asks if your income has decreased (not changed) from the previous year. Very reassuring! This should make the timing a little more forgiving as well.
3. Earlier qualifying PSLF payments. Waiving the six-month grace period means a few more months of making payments as a low-income resident and not a high-earning attending. As an example, the standard 10-year repayment on that $200k loan is $2302/month. If you were able to start repayment in July instead of November, those 4 months at $0 instead of $2302 could save you $9,208 when it comes time to file for PSLF.
Note: The government specifically states that $0/month payments count toward PSLF when that is the calculated payment under a qualifying repayment plan (see #24 on this FAQ).
4. Max out the student loan interest deduction. If you have $0 payments, you’d think that you would pay no interest and thus get no deduction on your taxes. However, long story short, the consolidation loan “pays” off all of the interest on your loans that accrued while you were in school, to the tune of likely far more than the $2,500 maximum deduction.
To do it
- File taxes on time in April of your 4th year (or at least before you graduate). You can do this for free in multiple ways, probably easiest using the free 1040-EZ TurboTax edition. File even if you didn’t make money; it’ll make things easier, as it will document your (lack of) income. You won’t have paystubs yet, so your taxes are all you got.3Of course, in the future, it’s theoretically possible that servicers could begin asking for a certified letter from your residency to document your future salary in advance, but you should be ahead in the arms race for now.
- Your loans must be in grace period status to file for consolidation. So once you graduate, immediately file for a federal loan consolidation by visiting studentloans.gov. Note: do not fill in the box with your “grace period end date” as this will delay the consolidation from taking place until the end of your grace period (i.e. item 17 on the paper application), which is exactly what we’re trying to avoid. More information about which loans are federal consolidation-eligible is available here in case you have some rare ones. Note that you can see all of your loans listed, their total amounts (principal and interest), and your “enrollment status” (to confirm that the feds know you’ve graduated) at NSLDS.
- You get to pick your servicer as part of your application. If you’re considering PSLF at all, you may as well pick FedLoan, as you’ll be transferred to them whenever you submit your first PSLF employment verification form anyway.
- At the same time as your consolidation, you’ll also be applying for the IDR plan you want to use to pay off said consolidation loan, which will likely be REPAYE. When they ask if your income has significantly changed, the answer will hopefully be no. If it’s April, May, or June, you probably haven’t earned a cent, so of course it hasn’t. Wait again for approximately 30 business days.
- Ideally, after two or so months you’ll be the proud owner of a lot of debt in one place and a payment plan to start taking care of it. Once your servicer lets you know that you’ve entered repayment, try to sign up for their auto-debit program to make payments automatically through your checking account. If your payments are $0, they may not give you an option, but if you can, definitely do it: auto-debit usually gets you an additional 0.25% interest rate reduction.
- Things may go wrong, so follow up if things don’t start moving after 6 weeks. If you have multiple loans from multiple schools with multiple servicers, you may run into more problems. Note that it’s possible your school and servicers won’t update your loan status from “in-school” (not consolidation eligible) to graduated or grace period (consolidation eligible), so check on NSLDS and call your school and servicers if things don’t progress.
- If you have undergrad loans, you could consolidate those prior to graduation and then file a “Direct Consolidation Loan Request to Add Loans” for the med school loans. I’m honestly not sure how much if any time that will save you but it could potentially help prevent some of the difficulties associated with your servicer finding and paying off a bunch of different loans in a timely manner. I’d personally just go with the one-step method after graduation.
- None of this deal-breaking stuff. If you’re already in repayment and haven’t done this, don’t kick yourself. You’ll note that getting PSLF negates some of the extra plusses while not doing PSLF nullifies others. Early consolidation is a great return on a small investment of time, but the fact that you’re thinking about your debt and seriously want to take care of it is more important than the money you’ll save.
- So, in the end, the take-home points: Most of the loans that can be forgiven are automatically PSLF eligible. Perkins loans are the exception, which if you have them are typically a small fraction of your total debt. Consolidating your loans immediately after graduating medical school can allow you to enter repayment immediately at the start of residency by foregoing/erasing the traditional six-month grace period, which can save your money by reducing interest capitalization, likely increasing your REPAYE subsidy, likely allowing $0/month payments, and helping you reach loan forgiveness (if applicable) with a few fewer attending-sized payments.
- If you won’t be eligible for a significant REPAYE subsidy and thus a low effective interest rate and aren’t PSLF bound, you can consider looking into private refinance to reduce your interest rate when appropriate (but don’t pull the trigger unless you are absolutely sure; it’s a one-way street).