Repaying Dr. Bisutti's $555,000 Medical School Debt
Trouble with Medical School Debt
In 2010, the Wall Street Journal published a story about a doctor with $555,000 in medical school loans. After graduating in 2003 with a total debt of $250,000, Dr. Michelle Bisutti’s debt more than doubled due to a series of mismanaged payments and defaults. And while this type of debt level has become quite common for medical school graduates, congress has since instituted a number of programs which make repayment far more reasonable and affordable.
But this begs the question, why do student loans, and more specifically a borrower’s ability to repay student loans, continue to get primarily bad press? Today’s news is filled with stories of borrowers just like Dr. Bisutti; well intentioned people who took out a lot of loans to pay for an education they knew was necessary. Few if any of the stories outline how the borrower can efficiently pay these loans back. Instead they focus on how they are now hamstrung with debt. American Student Assistance went as far as to produce a short film, Face The Red (below), about a recent grad who is petrified of her student loan debt.
Admittedly, the cost of education is rising faster than wages, a problem for which I won’t pretend to have the solution. With the advancements in repayment options though, there is no reason for federal student loan payments to become an overwhelming financial burden, regardless of the loan balances.
Student Loan Relief through IBR and PAYE
Currently, a federal loan borrower who exhibits a Partial Financial Hardship would be eligible for the Income Based Repayment (IBR) or recently released Pay as You Earn (PAYE) programs. This hardship is based on the idea that the borrower’s debt exceeds their available income. Both of these programs allow borrowers to make monthly payments based solely on their prior year’s income; not what they actually owe. IBR requires 15% of discretionary income be contributed to the loans, PAYE requires only 10%.
In other words, a student could take out $152,000 in federal loans, as Dr. Bisutti did, and be obligated to pay only in the neighborhood of $400 a month in IBR and $260 a month in PAYE. These payments are based on the national average salary for a medical resident, $48,000. Using that salary, the borrower could owe $50,000 or $350,000 in federal loans, and the payments would remain the same.
As you can see, the monthly payments are more than reasonable considering the income
level and the fact that the borrower may owe amounts well into the six
IBR & PAYE REPAYMENT TABLES
So why is it that Nobel Prize winning economist Joseph Stiglitz fails to acknowledge any of these repayment options in his student debt focused New York Times article “Student Debt and the Crushing of the American Dream”? The opinionated piece covers a variety of topics ranging from a comparison of educational debt to the mortgage crisis, to how Australia has helped its students finance their educational debt with income based programs quite similar to IBR and PAYE. Yet he never mentions the American versions of these programs. While I hope Dr. Stiglitz is aware of these programs, evidently they weren’t compelling enough be included in his assessment of our student loan predicament.
Sadly this perception is shared by many borrowers around the country, as these payment relief programs are grossly underutilized.
New Market-Based Rates
With President Obama signing the Student Loan Certainty Act in law on August 9th, things are only getting better for new borrowers. The act effectively ties student loan interest rates to financial markets, specifically the 10-Year T-Bill. The interest rates are fixed once the loans are disbursed, but they will be adjusted each year in line with the performance of the 10-Year Treasury Note.
This change has resulted in interest rate reductions on all federal loans for at least the coming year.
NEW STUDENT LOAN RATES VS. OLD STUDENT LOAN RATES
To be clear, our educational financing system is far from perfect. Private student loans continue muddy the repayment waters as they typically don’t offer the same type of income based repayment options which the federal government does.
Crippling Private Student Loan Debt
Even in the current loan environment, the combination of federal and private loans can be crippling for a borrower. The root of the problem lies in the fact that neither federal nor private loans acknowledge each other during repayment. In other words, the borrower is left with two entirely separate repayment plans, the aggregate of which may be unmanageable.
Worse yet, private loans often carry variable interest rates which can get as high 15% and beyond depending on the interest rate environment. This is essentially the equivalent of financing an education with credit cards. However, private loans typically don’t offer as many options during times of financial duress as credit cards do. Bottom line, borrowers who are taking out high levels of federal student loans should avoid supplemental private loans as much as possible.
Dr. Bisutti admits that she should have more closely examined the fine print when taking out the loans, but the fact is that in 2003 there were fewer repayment options available to borrowers. And while this may still be the case for some private loans, as we’ve seen, federal borrowers now have very reasonable options for repayment.
Ideally, Dr. Bisutti would have been able to utilize one of these two programs to minimize her federal loan payments, and then focus on paying down her less flexible private loans with the money she saved.
Conventional wisdom says that making such low payments would result in excessive interest accrual. However, both IBR and PAYE include provisions to minimize this. With either option, the federal government will cover any unpaid, subsidized loan interest, for the first three years. Additionally, no interest would capitalize on her loans as long as Dr. Bisutti continued to demonstrate a partial financial hardship. These benefits help ensure that $250,000 in loans doesn’t turn into $555,000 over the course of residency.
Furthermore, both IBR and PAYE offer the borrower the opportunity to have any outstanding federal balances forgiven after 25 (IBR) or 20 (PAYE) years of paying. In other words, if a graduate makes on time payments for the required amount of years, anything remaining on the loans is wiped off their balance sheet. Currently this forgiveness is a taxable event, but nonetheless it allows people the chance to get out from under their debt burden.
Public Service Loan Forgiveness
Moreover, the Public Service Loan Forgiveness (PSLF) program allows borrowers to have their federal loans forgiven after 120 qualifying monthly payments (10 years) provided they are employed full time at a governmental or non-profit entity. Both IBR and PAYE are eligible repayment programs when pursuing PSLF. When you consider that over 80% of hospitals in the U.S. are non-profit, clearly this is an attractive option for physicians like Dr. Bisutti.
That’s not to say that the program was intended only for doctors. In reality, teachers, social workers, police officers, public defender attorneys, hospital employees, those working at charitable agencies, or any government employee to name a few, would likely qualify for PSLF.
Given that the borrower may verify their income with a prior year’s tax return, most graduates wind up with a very low monthly payment in their first year out of school. Considering that many people don’t work much while in school, it’s quite possible that they’ll be entitled to a “$0 payment” for their first 12 months after graduation. These “$0 payments” even count towards the 120 necessary to reach forgiveness.
Furthermore, since they’ll only work half a calendar year coming out of school, the second year’s payment is generally quite low as well.
The table below outlines what Dr. Bisutti could have expected to pay if these programs had been available when she graduated.
MONTHLY REPAYMENT TABLE
As you can see, if these programs had been available in 2003, Dr. Bisutti could be closing in on the 10 year loan forgiveness. Though her monthly payments will go up substantially, so too does her income. Again, the payments are never overwhelming. Using salary projections based on national averages, she could have potentially had up to $151,293 wiped off of her balance sheet. Essentially, Dr. Bisutti would have covered the interest accrual for 10 years and had the federal government pick up the tab for the principal balance.
If she had graduated 10 year later, Dr. Bisutti may have completely avoided the need to deal with defaulted loans, collection agencies, or liquidity issues.
Despite all the negativity surrounding student loans, it is crucial for borrowers to investigate the current repayment offerings. By avoiding private loans, reading the fine print, and having a strategy in place, today’s graduates can ensure they don’t fall victim to the same repayment pitfalls as their predecessors. Wouldn’t that make for interesting news?
About author Alex Macielak
Alex is a Regional Manager for GL Advisor. He previously spent time at Morgan Stanley-Smith Barney and holds a degree in Economics & Finance from Bentley University.