Student Loan Interest Rates and Repayment — Don’t listen to your parents!
Veterinary educational debt is a complex and continually evolving topic impacting all colleagues, not just current students and new graduates. A recent Merck Animal Health study named student debt as the biggest stressor reported by colleagues. That study also indicated that fewer veterinarians are recommending the profession as a career choice.
Practice owners hire indebted associates, more seasoned associates work alongside indebted associates. Given the magnitude of this issue — many call it a crisis — and the fact that the gap between veterinary educational debt and income continues to widen, most colleagues are coming to recognize that saying “It’s not my problem” is no longer an option for any of us.
It’s not surprising that most borrowers, their parents, other advisers and even the leadership at veterinary schools and organizations struggle to understand the topic and various options for managing the debt.
Seeking a lower interest rate or paying more towards loan payments almost always makes sense when managing traditional debt, such as a mortgage or business loan. However, it often results in higher monthly payments, reduced flexibility, or a higher total repayment cost when managing veterinary student debt.
Tony Bartels and I have made helping colleagues understand and manage their student debt a focus (some call it an obsession) over the past six years since Tony graduated with and married into Federal educational loans exceeding $400,000. In recent years the VIN Foundation has taken this on as part of its mission to help colleagues in all stages of their careers from pre-veterinary candidate through retirement.
The good news and main takeaway for veterinary borrowers is student loans are about more than interest rates. For most, despite higher interest rates, staying in the Federal student loan program and using income-driven repayment plans to their full benefit will result in increased financial flexibility and a much lower total repayment cost than they would experience at lower interest rates outside the Federal student loan program.
Educational cost and student debt repayment is not unique to veterinary medicine. However, the magnitude of veterinary student debt and the high debt-to-income ratios carried by most recent veterinary graduates make repayment particularly challenging.
Despite several meetings focused on the veterinary student debt crisis, no one has found a workable solution. Recently, at the July 2018 AVMA House of Delegates meeting, possible solutions to the veterinary student debt crisis were discussed. This is wonderful to see.
Given that veterinary students graduating in 2017 had a collective debt of over $400 million, it is difficult to see how we would fund this magnitude of debt from within the profession.
The topic of lower interest rate student loans was raised as a fix. This is not a new idea. Several companies offer private student loans and refinancing, advertising lower interest rates; and some veterinary schools offer or are considering offering lower interest rate loans directly or in partnership with a bank.
We applaud the intent of these organizations and celebrate that the conversation has moved beyond how many coffees veterinary students are buying during school. Lower interest rate private student loans may benefit some. However, even if we could immediately swap out all of the Federal student loans used by most veterinarians with lower interest rate private student loans, it would not benefit colleagues with average or higher than average student debt. In fact, doing so would be detrimental to their financial well-being and likely cost them more to repay. Read on and we’ll explain why.
The predominant source of veterinary student loan funds is the Federal Direct Loan Program. The Department of Education makes funds available to almost every U.S. student attending an AVMA accredited veterinary school. The amount veterinary students can borrow is limited only by the cost of attendance (COA) determined by each veterinary college. Veterinary programs have increased the COA aggressively over the past few decades and veterinary students have demonstrated a willingness to pay any COA.
This cycle produces graduates with higher student debt payments than their veterinary incomes can support using traditional repayment plans.
Since 2012, Federal Direct Loans for graduate/professional school loans have been unsubsidized, meaning interest accumulates from the date the loan is received. This can add significantly to a student’s total educational debt.
Federal Direct Unsubsidized loans cover either a maximum of $20,500 or $47,167 per year depending on the school and yearly term length. The remaining COA can be covered through Direct PLUS loans.
Further adding to the veterinary student debt burden, for the last several years the majority of first-year veterinary seats are priced at the much higher non-resident or private tuition rate. A veterinary student paying a non-resident or private tuition rate can experience interest charges in excess of a year’s tuition before starting repayment.
Direct loans have fixed interest rates for the duration of repayment. The rates are updated each summer and applied to the loans disbursed for the upcoming academic year. The current Direct Unsubsidized interest rates for the 2018-2019 graduate/professional academic year are 6.59% and 7.59% for Direct and Direct PLUS loans, respectively.
Some may consider, 6.59% and 7.59% to be high interest rates in today’s market. If students could borrow at lower interest rates, or our graduates could refinance their debt at lower interest rates that would surely be a good thing, right?
Unfortunately, unless they could get the lower rates through the Federal student loan program (which can’t happen without the help of Congress) the answer is almost always, no.
Federal Direct student loans come with a host of benefits, including income-driven repayment (monthly payments are a percentage of your taxable income), public service loan forgiveness, an interest rate reduction for automatic payments, favorable delinquency terms, and discharge upon death or disability, to name a few.
However, other than the 0.25% autopay discount, obtaining a lower interest rate requires a private student loan or a private refinance (ReFi) of Federal student loans. The terms of a private student loan or Refi depend on the debt amount, the borrower’s credit score, income, and ability to negotiate certain terms. Veterinary students or veterinarians without significant assets, spouses, or collateral are not offered the attractive teaser rate advertised by these companies.
Also, private loans do not come with the safety nets provided by Federal student loans, such as income-driven repayment provisions or loan forgiveness. Nor do they provide public service loan forgiveness eligibility. They also have less favorable delinquency terms, minimal deferment provisions, variable discharge provisions, and often require a cosigner to obtain a lower interest rate.
Is a lower interest rate worth a less flexible, higher risk, student loan?
No, not for veterinarians with a student debt balance greater than their income. In fact, besides giving up the invaluable safety nets of the Federal student loan program, the lower interest rate, less flexible loan will also be more expensive than their higher interest rate, more flexible, Federal student loan for most veterinary graduates with student debt.
For example, let’s say a veterinarian graduated in 2018 and borrowed $220,000 for veterinary school. If they utilized all Direct Loans to finance their education, they would accrue about $30,000 of interest before entering repayment. The starting loan repayment balance would be $250,000 at 6.1% (5.85% with autopay discount). If that graduate earns $80,000 per year post-graduation and has no family, their minimum monthly payment using an income-driven repayment plan like Pay as You Earn (PAYE) would be $515/month.
If we run a simulation, using the VIN Foundation Student Loan Repayment Simulator, of this scenario over 20 years (Scenario 1), assuming the new graduate’s income increases by 3.5% per year, and they have no spouse or children for the duration of repayment, their total estimated repayment cost is $244,134 using PAYE. The estimate assumes a forgiveness savings plan of $262/mo earning an average of 5% return per year on the amount they need to save for the estimated 30% tax incurred by student debt forgiveness 20 years after repayment starts. The effective annualized interest rate (the total amount paid above what was borrowed averaged over the number of years in repayment) for this scenario is 0.55% per year. The monthly student loan impact (payment plus savings for forgiveness) to their budget during the first year post-graduation is $777/mo, or 11.7% of their gross monthly income.
Alternatively, let’s imagine a world where a private lender will offer the same 24 year old veterinary student with little or no credit history $220,000 with a 0% interest rate during school. After graduation, their interest rate is fixed at 5% for a repayment period of 20 years. They earn the same $80,000 per year income after graduation. However, their minimum monthly payment is now $1,452/mo with a total repayment cost of $348,457. The monthly student loan impact to their budget during the first year post-graduation is 21.8% of their gross monthly income.
Let’s indulge in one more scenario (one playing out at a couple of schools and states and proposed by others), where a private lender finances $100,000 of the veterinary educational debt at 0% interest during school and 5% after school with a 20-year repayment term. The other $120,000 is coming from a Federal Direct Unsubsidized loan that accrues about $17,000 of interest during school. The graduate now has two loans to satisfy with their $80,000 income. The private $100,000 loan at 5% requires a monthly payment of $660/mo. The $120,000 at 5.84% (5.59% with autopay discount) Federal student loan balance paid using PAYE will have a minimum monthly payment of $515/mo. The monthly payment under PAYE is the same regardless of the student loan balance, however, additional private student loan balances are not accounted for in the monthly payment determination.
In this second simulation (Scenario 2), there will still be a balance forgiven on their Federal student loan portfolio requiring an $74 monthly allocation earning an average of 5% return per year to handle the estimated 30% tax due 20 years after starting repayment. In this scenario, the monthly student loan impact to their budget is $1,258/month, or 18.9% of their gross monthly income. The total estimated repayment cost will be $356,705.
First, do no harm.
In a traditional loan repayment scenario, seeking a lower interest rate will almost always save you money. After running thousands of scenarios for thousands of veterinary students and graduates, Tony and I have learned that rule of thumb does not apply to the typical veterinary graduate scenario eligible for income-driven repayment
Trading a low or no interest rate loan for less flexibility and higher costs after graduation is not helpful in the current veterinary economic landscape.
Yes, interest accumulation on Federal student loans during school is not helping this crisis. Weshould do all we can nationally to advocate that Congress return to an era where graduate/professional school loans are at least partially subsidized. In the meantime, as attractive as it might appear at first glance, leaving the Federal Student Loan system for less flexible loans at lower rates with fewer safeguards is not a financially sound solution for most. We need to get more creative to make a dent in the veterinary student loan crisis.
There are three solutions to “fixing” the veterinary student debt crisis:
- Reducing the cost of becoming a veterinarian
- Increasing subsidies to educate veterinarians
- Increase the short and long-term earning profiles for veterinarians
Lowering interest rates in the era of income-driven repayment does not do any of the above for the majority of future and recent graduate veterinarians. Let’s focus our efforts elsewhere.
If you have any questions about the simulations, assumptions, or any of the resources available in the VIN Foundation Student Debt Center, please send us an email. If you or your colleagues need any personalized student loan repayment help, we encourage you to post (anonymously if you wish, you will need access) your loan history and signalment in the VIN Student Debt Folder and we’ll help you work through your options. We look forward to helping in any way we can!