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How would you like to save $10,000 a year, simply by switching the loan forgiveness program you are on? We know we did! A recent conversation with Travis Hornsby of Student Loan Planner informed us that we could speed up our loan repayment simply by switching from IBR to REPAYE! The information that Travis shared with us was so valuable, because it could in fact save us tens of thousands of dollars on our student loans! That’s equivalent to refinancing to a lower rate, thus cutting down our repayment timeline by over a year, while still allowing us the safety net of being in a loan forgiveness program. After conversing with Travis for an hour, I would highly recommend Student Loan Planner as the starting point for any student or new grad looking for student debt advice.
So how do we save $10,000 this year? It’s simple. All we need to do is to switch from IBR to REPAYE. Today, I will outline why.
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A Case Study: IBR VS REPAYE
We were under the IBR program since we embarked on this journey to repay our student debt of $574,000. Before you consider which loan forgiveness program you want to choose, you should probably read Finance: Student Loan Forgiveness Options: IBR VS PAYE VS REPAYE. We had initially chosen IBR despite the fact that the monthly payments would be 15% of discretionary income vs REPAYE’s 10% of discretionary income because of this one factor: IBR allows you to file taxes separately as a married couple and it will only consider the loan holder’s income, versus REPAYE which will consider the income of your spouse as well. Since Mr. Debtist also makes a six figure number, we figure that we would have the better deal using solely my income.
Here is an example of how to calculate that:
Let’s use estimates from our personal story to calculate the difference.
Assume that our loan is an even $550,000, my income (the debt holder) is $125,000 and Mr. Debtist’s income is $120,000.
Under IBR, they would calculate our yearly loan payment by multiplying my income by 15%.
125,000 * 0.15 = 18,750
Now we divide that by 12 months to find the monthly payment.
18,750 / 12 = 1,562.50
Therefore our monthly payment would be $1,562.50 under IBR.
Under REPAYE, we need to use the total household income of $245,000 to calculate the yearly payment, however we will only be paying 10% of our household income.
245,000 * 0.10 = 24,500
To find the monthly payment, divide by 12 months.
24,500 / 12 = 2041.67
Therefore our monthly payment would be $2041.67 under REPAYE.
As you can see from this example, IBR would be the better payment plan because you would be paying the cheapest amount per month and allowing the program to forgive as much as possible.
HOWEVER, there is a rule with REPAYE that IBR does not have. REPAYE will subsidize 100% of the interest accrued for the first three years, and 50% of the interest accrued after the first three years, which changes the game. Let’s see how.
Under REPAYE, the government will subsidize the interest that does not get covered by your minimum payment. We have already calculated the monthly payment to be $2041.67, and we know that each month, we are accruing about $3,000 in interest. Let’s convert that to yearly payments.
$2041.67 * 12 months = $24,500 owed this year under REPAYE
$3,000 * 12 = $36,000 of interest accrued.
This year, based on last year’s income, we owe $24,500 in total payments under REPAYE. At $3,000 per month, the total interest accruing this year is $36,000. Therefore, our payments under REPAYE are not even enough to cover interest, as is usually the case with a loan this large.
So the difference is calculated as follows:
$36,000 – $24,500 = $11,500.
Which means that for the first three years, the government will subsidize $11,500 (and if it’s been more than three years, then they will pay $5,750) per year! You would be missing out on tens of thousands of dollars just by being on the wrong program! We certainly did.
Why We Didnt Make the Switch
We decided to be under IBR right when I got out of dental school, BEFORE we decided to pay back our loans aggressively. The reason being in my first year, I only worked for the last three months of the year, having waited for my license to be approved after graduating in June. In my first year’s taxes, I made $25,000. So taking 15% of $25,000 would be cheaper than 10% of $145,000. Now in the second year, the numbers completely changed since I started working full time for the entire twelve months. My salary jumped from $25,000 to $125,000. The ultimate question: Why didn’t we make the switch?
In April of my first full year of work, we had decided to pay back the loans aggressively. Meaning, our monthly payments were MORE THAN the minimum amount required. In order for there to be excess interest accrued on the loan, our monthly payments should not exceed the interest gained, which was about $3,000. But since we were paying our debt like CRAZY, we were actually paying $6,500 towards the loans, so no interest was accruing and it did not matter if we stayed in IBR or went to REPAYE.
Or so we thought…
We were VERY wrong!
A Common Misconception
According to Travis Hornsby of Student Loan Planner, REPAYE calculates the difference between the interest accrued and the amount paid back on the loan at the beginning of the year. REPAYE assumes that you will only make your minimal payment each month, which means that they lock in the assumption that $11,500 would be accruing in interest (for our particular example). Every month, they will subsidize a portion of your loan to make up for the interest that will supposedly accrue, REGARDLESS OF THE MONTHLY PAYMENT YOU ACTUALLY PAY. It doesn’t matter if we pay $6,500 towards the loans or if we pay the minimum amount. Either way, REPAYE will subsidize the difference between the minimum payment and the interest that’s being charged. So we have actually missed out on an opportunity here! What’s passed is past, but we are definitely jumping from IBR to REPAYE ASAP!
What Switching from IBR to REPAYE will save us.
We need to make this jump because of the following:
- It will save us tens of thousands of dollars in the long run.
- Making the change will be the equivalent of refinancing to a lower rate without actually having to refinance! Which then gives us the safety net of staying in a loan forgiveness program. If ever life throws us a curveball (such as an accident, layoff, disability, sickness, or our worlds fall into chaos and we cannot work), then the loan forgiveness program will give us the flexibility to not HAVE to pay $6,500 per month.
- After all the money we save, we can cut our repayment timeline down to 7.5 years!
Off course, not everyone under IBR should automatically jump to REPAYE! You have to pick the financial path that is right for you, considering your personality, your goals, your lifestyle, and more. If you are looking for sound advice on how to create a student loan repayment plan customized for your situation, don’t hesitate to contact Travis Hornsby, founder of Student Loan Planner, using my affiliate link. It will be a very rewarding hour! And check out my second podcast episode with Travis, to be released in 2019! Stay tuned.