Hey! I'm Robbie, the founder of Roots Financial Planning, a fee-only, fiduciary advisor located in San Antonio, TX working virtually with dentists across the United States. When I'm not helping dentists live their best life, you can find me making pizza, swimming, or skiing.
Acquiring student loans to pay for school isn’t nearly as difficult as navigating the repayment of student loans once you are a dentist. In this post, we’re going to focus on student loan terminology and the basics of repayment.
Student Loan Terminology
Principal
The original balance you borrowed when the loan was first issued. If you needed $100,000 to pay for all school costs in one year then your principal balance would be $100,000.
Interest
The cost to borrow the principal amount expressed as an annual percent. Student loans use a simple interest calculation. Simple interest means the accumulating interest calculation is only applied to the principal balance and not both the principal and accumulating interest as it builds up. Let’s use an example principal balance of $100,000 at an interest rate of 5%. After one year you would have a principal balance of $100,000 and an interest balance of $5,000. After two years the principal balance would be $100,000 and the interest balance would be $10,000. It would continue to grow at this linear rate until further action is taken.
Capitalization
This is when the interest accumulated on your student loan is added to the principal balance creating a new, higher principal balance. Capitalization occurs when loans enter repayment, deferment ends, you change repayment plans, or when you consolidate your loans. Imagine that your D4 student loan need was $100,000 at an interest rate of 5%. After one year the principal balance is $100,000 and the interest balance is $5,000. If capitalization were to occur for any reason the principal balance becomes $105,000 and the interest balance is reset to $0.
Consolidation
This is when you combine multiple federal student loans into one new loan that is still within the federal system.
Refinance
This is when you exchange one or many federal student loans for a private student loan that is not held by the federal system. This is most common after school is complete and you are seeking a lower interest rate in order to pay the loan off faster.
Deferment/Forbearance
This is a temporary postponement of your obligation to make payments on your loans. The most common form of this is the in-school deferment. You are never required to make payments while still in school.
Default
This occurs when you fail to make payments on your loans for 9 months (270 days). If you are doing everything right and making on time payments you won’t every have to worry about default.
Grace period
This is a six-month time frame that occurs after you graduate, leave school, or drop below half-time enrollment in which you are not obligated to make payments on your loans.
Discretionary Income
This is your Adjusted Gross Income (AGI) minus 150% of the poverty line for your state and family size. This is used for the calculation of payments when using an Income Driven Repayment (IDR) plan. This isn’t something you will have to calculate, though it is important to know how it is derived for planning purposes.
New Borrower
This is a borrower who does not have an outstanding student loan balance at the time a new loan is received. You’re also a new borrower if you had already repaid older loans and had a new one issued. For example, if you were to pay back undergraduate loans and start with a $0 balance when entering dental school.
Types of Student Loans
Federal Student Loans
Most student loans are issued under the federal system for the initial funding of education. There are many types of federal student loans. However, the majority of those federal loans fall under the following three categories:
- Subsidized/Unsubsidized Federal Stafford Loans
- Direct Subsidized/Unsubsidized Loans
- Direct PLUS Loans
Student loans that are in the federal system are eligible for certain types of forgiveness, deferment, and flexible repayment plans.
Private Student Loans
Loans issued by any company that is not the federal government fall into the private category. Private loans are usually not used for the initial funding of education. They are more commonly used after education is complete to achieve a lower interest rate when refinancing and paying the loan back. The downside to private student loans is that they are not eligible for any government benefits like forgiveness, deferment, or flexible repayment plans.
Federal Repayment Plans
conventional Plans
Standard (10 year)
This is generally the default plan you are placed on when you enter into repayment. It features fixed payments over 10 years. At the end of the 10 years, you will have paid off your loans in full. From the start you’ll know exactly how much you will pay each month and for how long.
Graduated
This plan features payments that start lower than the Standard 10-year plan and increase every two years paying off the loans in 10 years. By the end of the term the payments will be greater than the Standard 10-year plan.
Extended
This plan features fixed payments over 25 years. At the end of the 25 years, you will have paid off your loans in full.
Income-Driven Repayment (IDR) Plans
Under the IDR plans your payments are based on your income and family size. Payments are not fixed like the Standard Plans. Each year you will be required to recertify your income and family size which will set your payment for the following 12 months. It is also possible that you will not pay off the balance in full by the end of the loan term.
Income Based Repayment (IBR)
In this plan, payments are 10% of your discretionary income if you’re a new borrower after July 1, 2014 (generally 15% if you’re not a new borrower after this date). Your payment on this plan must be less than the Standard 10-year plan to be eligible. Once you are on this plan, your payment can never rise above what your Standard 10-year payment would have been. You will receive taxable forgiveness on the remaining balance after 20 years of payments. If you are married, you can use the Married Filing Separately (MFS) tax status and base payments on your income alone rather than your combined marital income.
Pay As You Earn (PAYE)
In this plan, payments are 10% of your discretionary income. Your payment on this plan must be less than the Standard 10-year plan to be eligible. Once you are on this plan, your payment can never rise above what your Standard 10-year payment would have been. You must be a new loan borrower on October 1, 2007 and also have a loan issued after October 1, 2011. You will receive taxable forgiveness on the remaining balance after 20 years of payments. If you are married, you can use the Married Filing Separately (MFS) tax status and base payments on your income alone rather than your combined marital income.
Revised Pay As You Earn (REPAYE)
In this plan, payments are 10% of your discretionary income. Any borrower with eligible loans can make payments on this plan. Once you are on this plan, your payment can rise above what your Standard 10-year payment would have been. You will receive taxable forgiveness on the remaining balance after 25 years of payments (20 years if only paying undergraduate loans). Half of the unpaid interest that is above your required monthly payment will be covered by the government. If you are married, you must base payments on your combined marital income even if you use the MFS tax status.
Loan Forgiveness
Public Service Loan Forgiveness (PSLF)
PSLF is tax-free forgiveness granted after certain circumstances are met. You must make 120 on time payments (10 years of monthly payments). While making these payments you must be employed at a 501(c)3, non-profit, or government employer. The payments must also be made on an IDR repayment plan.
Taxable Forgiveness
Taxable forgiveness is granted after making 20-25 years of qualifying payments on any of the IDR plans. There are no additional employment requirements to be eligible. At the end of the repayment term the remaining balance is cancelled and added to your income for tax purposes. This means you will owe extra in tax payments that year even though you didn’t make more money to cover them.
Private Refinancing
When you refinance your federal student loans into private loans you are issued a brand-new loan with a new repayment period and lower interest rate. Refinancing should not be considered if you can’t acquire a lower interest rate. Once you leave the federal system there is no going back. You must be sure this is the direction you want to pursue before committing to it.
The student loan world is a complicated place. In future posts we will take a deeper dive into more specific areas of student loan planning and repayment.