Seek Forgiveness or Pay off Your Student Loans Early?

Disclaimer: From discussions that I have had on this subject in the past, I realize that this is a controversial topic. I have never been one to shy away from discussion on touchy subjects whether ethical or financial in nature. This post will be about the financial side of the decision that I have made, but I can always write about the ethical side in the future if there is interest.

This is a subject that I have spent a very long time learning about, pondering, and crunching numbers on. No matter how many times I revisit the topic, I come to the same logical conclusion. For my situation, it is financially in my best interest to seek student loan forgiveness. As much as the thought of watching the balance of my student loans grow over the next twenty years sickens me, I know that it is in my best interest based on the calculations that I have performed. You may be wondering, how will the balance grow if you are making payments on the loans each month? The answer is that my minimum payment, based on the Pay As You Earn plan (that I have determined is the best choice for me), is not enough to cover the interest that is accruing each month. Although this is the path that I am choosing, there are a number of factors to consider in your own situation about what is the best option. Some of these include:

  • Is working at a nonprofit an option for you in order to seek Public Service Loan Forgiveness*? (The best option for most if this is plausible)
  • Are you able to be responsible with money that you have left over from choosing to have a lower student loan payment? (If you spend the extra money, from choosing an income based repayment plan, on unimportant things, then it is probably better to go with standard repayment)
  • What will be your estimated adjusted gross income? (this is important to determine what your income based payment amount would be)
  • Do you believe that your income will increase significantly over the next 20 years? (As your income increases, so does your income based payment)
  • What are the interest rates on your loans? (With low interest rates, you may be better off investing the extra money than paying off the loan early)
  • What will the balance on your loans be at the end of 20 years? (Based on the current tax laws, the amount forgiven at the end of the 20 year period will count as “unearned income” and lead to a significant tax bill)
  • Which income based repayment plan would be best for you if you choose to go that route? (Check out the student aid website if you have no idea about this)

* Public Service Loan Forgiveness does not require taxes to be paid on the forgiven loan amount, in addition to having the loan forgiven 10 years earlier. Obviously a very good option if possible.

As a travel PT, I consider my situation to be somewhat unique in the loan repayment regard. Since part of my pay is untaxed, for living expenses while away at an assignment, my adjusted gross income (AGI) is less. I have also been contributing a significant amount to my 401k which further reduces my AGI. Both of these things combined, give me a somewhat low AGI. This makes my student loan payment low while also allowing me to save a significant amount of money. So I was then faced with the decision to either pay the minimum and invest the rest, or pay extra on my loans and pay them off as soon as possible. This is where the calculations came into play and helped me make the decision. Of course all of the numbers I used are estimates because there is no way to know what my exact pay will be in the future.

To give a little context without going too in depth, I currently owe just below $100,000 after accumulated interest while in school. My average weighted interest rate is a little over 6%. I had no debt from undergrad and lived at home during PT school in order to save on living expenses. For the most part, I lived as cheaply as I could, so the figure above is mostly from tuition, books, and food.  Based on my estimates, if I put all of the money that I possibly could into paying off my loans quickly, I would be able to achieve that goal in around two years if everything went according to plan. This would lead to total payments of about $103,000. On the other hand, I could make minimum, income based, payments on the loans for 20 years, and then have the balance of the loans forgiven. The forgiven balance will count as “unearned income” and will be taxed. This means a big tax bill at the end of the 20 year period. For my calculations, I assume a 30% tax rate on the amount forgiven. The actual rate is unable to be determined because tax rates will be different at that time, and I am unsure of exactly what my income will be then, but I believe that 30% is a conservative estimate.

Using the studentloans.gov repayment estimator, it is estimated that over the 20 year period, making the minimum payments on the Pay As You Earn plan, I will pay about $88,000 and be left with a balance of about $126,000 to be forgiven. At first this seems like a much worse option but keep in mind that this is 20 years in the future. Based on an average 3%/year inflation rate, $103,000 is worth more today than $126,000 will be 18 years from today. Let’s look at the calculations to determine the total paid in this scenario.

$126,000 * 30% = $37,800 owed in taxes for forgiven debt

$37,800 (tax bill from $126,000 forgiven) + $88,000 (amount paid in minimum payments over a 20 year period) = $125,800 paid in total at the end of 20 years

This means that I could pay about $103,000 over two years’ time, or I could pay a total of $125,800 over a 20 year period. In the 18 year period between the two estimates, it would only take an approximate 1.1% annualized interest rate to grow $103,000 to $125,500. If I am able to earn anything above a 1.1% interest rate on my money in that 18 year period through investments, then it is in my best interest to wait the 20 years and pay the tax bill at the end while making minimum payments along the way. I am confident that, with the asset allocation that I have chosen, I will earn a much better return than 1.1% over an 18 year period and therefore will be better off investing my money instead of paying off my loans early.

For the sake of comparison, if I were to choose the standard 10 year repayment plan, I would pay a total of $129,000 over a 10 year period. This is clearly worse than both of the options discussed above.

Now let’s consider another factor. Imagine that two years from today I pass away due to some unfortunate event. In the first scenario, I have my student loans paid off in full, but nothing to leave to my family. In the second scenario, I have paid very little toward my loans, but have somewhere around $100,000 in retirement and investment accounts. Since student loans are discharged upon death, I will leave my family with $100,000 and the loans won’t matter anymore. In this way, the second scenario can be viewed as a life insurance policy of sorts. Although the chance of death is much lower for younger people, you never know what may happen in life and the second scenario is clearly better in this regard.

But wait, there’s more. There is also a tax deduction based on the amount of interest you pay on your student loans up to $2,500 per year, even if you don’t itemize your return. This deduction is phased out if your AGI is above $80,000, but I don’t think that will ever happen for me based on 401k contributions reducing my AGI. You do not receive that full $2,500 back on your taxes, but will receive some percentage of it based on your income, likely somewhere in the neighborhood of 20%-25%. That means somewhere around $600 being returned to you each year on your taxes. $600 x 20 years = $12,000. In addition to the deduction, there has been legislation proposed to no longer have the forgiven loan balance count as unearned income, which would make loan forgiveness a much better option. There is no way to know if this will ever go through, but I would imagine there is at least a small chance over the next 20 years.

Remember that all of the numbers above are approximate and are meant to illustrate my point. This can all be very confusing which is the reason that I have performed these calculations several times over the past year to make sure that I’m not overlooking anything. It is all further confounded by the fact that the future is so uncertain. Based on all the information available and my best estimates, I’m choosing income based repayment and hoping for the best. Keep in mind, this plan would completely fall apart if I wasn’t positive that I will be financially responsible with the extra money each month. If you are spending the difference instead of investing it then this option will turn out badly for you. What is your plan? Is there anything that I am missing? I would appreciate any feedback or discussion on the topic. Thanks for reading!

26 thoughts on “Seek Forgiveness or Pay off Your Student Loans Early?

  1. What you are not considering here is what happens if you were to get injured and could no longer be a PT? What about if 20 years from now the law is revised and you can no longer obtain loan forgiveness? What happens if some other life situation happens that compromises your ability to make payments? What will a loan underwriter think of your massive loan when you are trying to make a significant investment?

    If you have the opportunity to no longer be a debtor, I would not hesitate. As you said yourself, there are far too many unknowns going down the road. Bulldoze your debt and take control of your finances. With no payment to make after 2 years, why not put money into real estate with a couple of renters for additional monthly cash flow? To me a 401k is a long term hope the market behaves “normally” which as we see lately, it does not. Directly investing your money into real assets/business is taking control of your financial future.

    Just some food for thought: It took the Dow Jones Industrial Index over 25 years to make a new high. 1929-1954. History repeats itself all the time, create your financial future. Do not rely on something else to do that for you.

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    • I really appreciate your well thought out comment, Gabriel! Let me try to tackle this step by step.
      I believe that if somehow I become disabled in the future, income based repayment is still my best option. The reason for this is that student loans can be discharged if the borrower becomes permanently disabled. Even if that wasn’t the case though, I would rather have $50,000 in investment accounts than $50,000 less in student loan debt if something terrible happened to me. This would allow me much more flexibility to pay my living expenses.
      As for your next point, legislation being passed is always an option. That being said, I feel that there is a much higher likelihood of legislation being passed to benefit borrowers than to hurt them. i.e. Forgiven amounts not counting as taxable income. Also, I believe that if legislation were to pass that would affect borrowers negatively it is highly likely that those already going down the forgiveness path would be “grandfathered” into the forgiveness plan as it was outlined when they entered.
      Any other life situation that may arise, like in the example where I become disabled, I would rather have the money invested so that I can access it rather than tied up in paying off my loan balances.
      I do not believe that having a $100,000 student loan debt will cause too much of a hassle when seeking financing as long as my income and credit score are alright, but I could be mistaken here.
      As far as real estate and business is concerned, I believe that you are completely correct here. I plan to invest in real estate and possibly start a business in the future as well. I have done a significant amount of research and reading regarding real estate investing but as a travel therapist, I am not in a position where it makes sense to buy properties at this point. Business would obviously be a major undertaking and is not something that I plan on pursuing until after I finish traveling as well.
      I agree that the stock market is uncertain, especially at the high valuations that we are seeing today. At this point, with limited time and moving across the country several times a year, it is my best option. Although there are a lot of ups and downs, I think that a 5% average return over the next 30 years is still highly likely and that is about all I need in order to be in the position that I want to be in.
      I do not believe that paying off my loans and investing in real estate/businesses are mutually exclusive concepts. I plan to do both of those things at some point in the future while still carrying my student loan debt. If I am unable to receive financing from a bank due to the loan balance, then there are always others ways of investing in real estate/businesses.
      I don’t like the idea of carrying the loans for 20 years but the numbers don’t lie and I think that the pros outweigh the cons when all is considered. Like you said, the future is uncertain and it may end up being the wrong choice in the future but the only thing that I can do at this point is use my best judgement.
      Again, I really appreciate the thought provoking comment and questions.

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  2. I like your reasoning here and I like what you have talked about. I too am planning on doing the income based repayment plan. I am pretty sure that it is based on 25 years and not 20 years however. I might be wrong, but if I am, will you please reply and let me know where it says it is 20 years. Thanks!

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  3. Awesome post, brother. I am also on the Pay As You Earn, not only because of our current financial situation (with my wife still being in school and me being the sole income generator), but because of the same financial calculations that you had performed. As Gabriel mentioned above, there are always uncertainties when guessing what the laws will be 20 years from now, but I am in agreement with you that risk/reward ratio is definitely in the favor of having more money now than trying to pay off all loans immediately.

    The whole “take control of your debt now” idea is also much more necessary and beneficial for people who are unable to adequately live below their means

    All in all, well thought out article, as usual. I’m waiting for the day we disagree, haha.

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    • While in school I always thought that I would just pay my loans off as soon as possible but it just doesn’t seem to make sense to do it that way financially. I like the idea of having money that I can access quickly if an investment opportunity presents itself. That’s impossible if all the money is tied up in my loan balance.

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  4. Jared – great post and I like the calculations! The key is to be disciplined and to fully invest the differential, if you can do that then you should feel very confident to beat 1.1%! I just looked this up, the last (and only) time the S&P 500 had a 15 year annualized return of less than 1% was for the period from 1928-1943 where it averaged 0.64%. Ultimately, it’s still a personal decision that we all must make and the calculations definitely help to guide the process.

    I also strongly suggest long term disability insurance for all PTs. I think that would address Gabriel’s other concern about the potential for a decreased income. That might be another post that you do! 😀

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  5. You bring up good points. I recently started listening to Dave Ramsey, and what he speaks of makes sense. For instance, in order to reap the benefits of the debt forgiveness program, you have to remain in the same type of job (one that meets the requirements for debt forgiveness) for 10 years. This is difficult because your life situation may change over the course of the 10 years.

    I see the point of deferring full payment of your student loans in order to save money for family in case I meet an ill fate, but 100,000 will not pay the bills for long with a growing family. Having term life insurance is relatively cheap for 1 million dollars at my age. I would rather pay the small portion of my income to ensure that my wife and children have a strong future should I die and then use the remaining money to pay off the student loans.

    When looking at how quickly you talk of paying off the student loans. The small amount of money saved over the long term doesn’t make up for the need to stay tied to a particular job. Think of taking all of your money after having paid off your student loans and then applying that to a Roth IRA and then the rest to a 401K and mutual funds. At your age (or mine), you will be a millionaire either way.

    Finally, the tax break: it doesn’t make sense to send (keeping the numbers simple) 10,000 dollars in interest to the government in order for them to give me 2,500 dollars back in tax breaks. I would rather just keep the 10,000 and pay the 2,500 in taxes.

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    • Good points! The 10 year forgiveness plan that you’re talking about is the public service loan forgiveness plan which requires that you work at a non-profit for 10 years. In that case, you would be tied to a job but there is some flexibility because you could always move to a different non-profit and pick up right where you left off. The forgiveness program that I’ve chosen is a 20 year loan forgiveness that does not require any specific job and would even apply if I wasn’t working at all. Your statement about the tax break not being worth it would be true but since over the 20 year period I will end up paying around the same amount as I would if I paid the loans off now, that makes my effective interest rate 0% over the life of the loan. That means that any tax break I get along the way is directly saving me money and not really adding anything since in the end I will end up paying the same amount. I agree that life insurance is a good move in your situation but you could get life insurance and go with the loan forgiveness and end up paying the same amount of 20 years and basically have an extra 100,000 of “insurance” with the money you save in investments instead of putting toward your loan payments.

      Liked by 1 person

      • To further illustrate what I mean regarding your last point, I’ll refer back to my numbers above. If I paid off my loans in two years, the total cost to me would be around $103,000. If I were to seek forgiveness over 20 years, my total cost after interest and the tax bill on the forgiven amount would be $125,800. Now, due to the fact that both of these numbers have all of the interest and taxes accounted for, any reduction in yearly taxes would lead to a direct reduction in the total amount paid. Since in two years, the amount of interest paid will be only around $5,000, that would reduce my tax bill by about $1,250 (assuming 25% tax bracket) bring the total paid to $101,750. In the 20 year forgiveness example, the savings will be a lot more pronounced. I will pay a total of $88,000 in interest over that period based on the studentloan.gov website projections. $88,000 * 25% = $22,000 reduction in total paid over the 20 years. Now, when this is taken into account the total amount changes much more in favor of the forgiveness plan and leads to total of $101,750 (pay in two years) vs. $103,800 (20 year forgiveness). Only $2,000 difference but 18 years extra to have the money compound in the forgiveness scenario. For you in the grand scheme of things, if you plan to work a 20-30 year career, it might not make a big difference as you stated “you will be a millionaire either way” but for me, I plan on my “working career” to only be about 4-5 more years and then only working PRN or not at all if I choose. For more on that, check out these posts if you’re interested: https://fifthwheelpt.wordpress.com/2016/04/16/what-financial-independence-means-to-me/ and https://fifthwheelpt.wordpress.com/2016/05/01/progress-to-financial-independence-april-2016/

        Thanks for your comment!

        Liked by 1 person

  6. For travel therapy and pay as you earn, do they only look at your taxable rate? Or do they include stipends as well when they figure out the monthly payment? I am a travel therapist and doing the pay as you earn and need to resubmit my income. I wasn’t sure how that worked because my income has increased since going from a permanent job to travel over the past year.

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  7. I am so happy to have come across this discussion! I am also choosing the tortoise route by way of pay as you earn and PSLF to chip away at my student loan debt. I graduated in 2011, am a 35 year old married home owner with a 1 year old baby and unwilling to pay $1800-$2000 p/month for 10 years or standard repayment. I work the 32 hr minimum, pay $220 per month in fed loans and have the ability to invest in a variety of lucrative assests including my happiness and family time. These income based programs are in place are available bc of current unrealistic constraints on student loan debt. I whole heartedly agree that slaving away to repay debt without considering the uncertainties of life and family is a greater burden than a low and maneagable monthly payment. The low payment does not impact
    my QOL, ability to buy, refi or sell my home, or my ability to save and invest in the future. The numbers don’t lie. For most of us with the 130k + debt, PAYE for 20yrs (or 10 with PSLF) and paying the potential tax penalty is far cheaper than any 10 year option – and you get to enjoy your life and all of the sacrifice and hard work you have put in to get where you are. It’s so unfortunate that we even have to scrutinize these life choices, but it is nice to hear other intelligent people (in a great profession!) making similar financial decisions. Cheers!

    Liked by 1 person

    • Thanks for reading, Danielle! I thought long and hard about it but as you said, the numbers don’t lie. Also, the peace of mind associated with having extra money liquid, or in assets, instead of stuck in a student loan balance is priceless. I’m at the point now where I’ve saved enough that I could have paid off my loans a few months ago but I’m much happier with the money in productive assets and accessible.

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  8. Great post! Do you know for the 10 year rural area repayment program do you have to be working full time in order to receive it? I was also not sure if it was “guaranteed” to be approved either?
    I have never heard of the 20 year repayment no matter what. I am definitely planning on looking into that!
    I am still in school and weighing the options with a family. I like what Danielle said about being able to enjoy family and not worrying about such a large payment.
    Thanks for crunching the numbers for us!

    Liked by 1 person

    • Thanks, Kirsten. I’m glad you liked the post. The only program for loan repayment for working in under served areas is through the National Health Services Corps. Unfortunately this does not apply to PTs, OTs, or SLPs. Here is more info on the program. https://nhsc.hrsa.gov/loanrepayment
      Assuming you are a therapist of some sort, this will not apply to you. You may be talking about the public service loan forgiveness (PSLF) which I mentioned in the post. In that case, you have to be working for a qualified non-profit or government organization for 10 years and your loans will be forgiven with no taxes owed. Full time for this program is defined as, “…if you meet your employer’s definition of full-time or work at least 30 hours per week, whichever is greater.” I think the loan forgiveness options are definitely something to consider for everyone.

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  9. I’m an OT with slightly over $100k in federal student loan debt and my plan was the same as yours, but since the election I’m having second thoughts and anxiety about what this Republican administration might do to student loan debtors. They seem to be on a mission to destroy everything the previous administration created, starting with the ACA, and what if Income-based Repayment plans are next? What are your thoughts on this? I know Trump said he’s on board with Income-based Repayment, but Trump says a lot of things that he doesn’t actually intend to follow through on and then denies ever having said them.

    Liked by 1 person

    • I have some doubts as well but there is no way to predict what will happen. When I think about it, I always remember that no matter what changes occur, those that are currently already enrolled in an income based repayment plan seeking forgiveness will more than likely be grandfathered in if any changes occur. Only a few times in history has this not been the case with changes that effect millions of people. Also under the REPAYE program, your effective interest rate is significantly reduced if you have a low income. My effective interest rate is only 3% right now, so worst case scenario, everything is repealed and everyone is placed on a 10 year repayment plan, I’ve gotten a better than 3% return on my investments and still come out ahead. I think it’s worth it to stay in the income based plans and ride it out. Don’t let it keep you up at night.

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    • Good question! It actually depends on the income based repayment plan you choose and when you first starting taking out student loans. PAYE is 20 years, REPAYE is 20 years for undergraduate loans and 25 years for graduate loans, and the IBR plans can be 20 or 25 depending on the date you took out your first loan. All different options and rules make it confusing.

      Liked by 1 person

  10. Thank you. I thought I was losing my mind after seeing almost everyone advise us to pay as much as possible. The loan forgiveness programs may be a risk but seem to be the best option financially!

    Liked by 1 person

    • I agree, Karl. Thanks for reading. Check out my follow up to this post: “revisited: seek forgiveness or pay off your student loans early.” The REPAYE plan seems to be the ideal option since half of accrued interest is forgiven each month.

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  11. Thanks for the post, Jared. Question here…My girlfriend (also a PT) are going to be pursuing travel therapy in the next 12-18 months. I am fortunate enough to have had my parents cover costs of DPT program and I pay them back interest free. My girlfriend, however, is currently participating in income based loan forgiveness plan and is signed up for the 10 year repayment plan meaning a high monthly contribution. She is currently employed by a non-profit. A BIG barrier for us pursuing travel therapy is the fact that she will not be working for a non-profit company so she will essentially be throwing money away while we are traveling (plan on traveling for about 2 years) in addition to a higher gross income which will further inflate her monthly contribution. Would you suggest switching to a 20-25 year plan? Other thoughts? Thank you for your time.

    Liked by 1 person

    • Hey, Andrew. Thanks for reading! That’s a very good question. If your girlfriend is planning to go the PSLF route, then she should be on an income based payment plan, right? Otherwise if she’s on the standard 10 year plan, there won’t be anything left to forgiven at the end of 10 years because it would be completely paid off at that point. If she’s not already on an income driven repayment plan, switch to that ASAP. As far as traveling goes, you’re right, the two years that you’re traveling won’t count toward PSLF. The good news though is that while on an income driven repayment plan while traveling, her payment will be very low. Mine is currently $86/month while on REPAYE. The reason for this is that a large portion of your pay will be tax free as a traveler and won’t be counted toward your AGI when determining your student loan payment. This is even more true if you max out pre tax accounts (401k, traditional IRA, and HSA) since that will further reduce your AGI.

      She won’t be making progress toward PSLF while traveling but she will only be paying a small amount each month toward her loans so the money she’ll be throwing away is minimal. I would go for it! She can always pick back up on the PSLF where she left off when you guys finish traveling. Best of luck and feel free to reach out to me with other questions or for recommendations on recruiters/travel companies if you guys decide to go that route!

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