Private Refinancing and the Unintended Consequences: Part 2

So Why Might Private Refinancing Be a Bad Idea? You Lose Your Government Benefits

This blog post is a follow up to my previous post on private refinancing which can be found here.

Any time you refinance your loans with a private lender, those new loans are no longer eligible for income-driven repayment plans. And because of the substantial debt load carried by most graduating dentists, income-driven repayment plans can offer substantial benefits.

A graduating dentist with $450,000 of debt at 8% and a job making $130,000 (AGI) would have a standard 10-year repayment amount of about $5,460 per month. Not very many dentists are going to be able to make that payment, especially on that income.

So let’s say this person refinanced the debt over 15 years and was also able to lower the interest rate to 5.5%. The payment would drop to $3,797 ($46,000 a year) and would have to be made every month for the next 15 years with little to no exception. And remember, that $46,000 a year is after-tax money, so it would actually consume a much larger portion of your salary ($55,000-$65,000, depending on your tax rate).

Conversely, this person could have joined an IDR plan and only been required to pay 10% of their income under the new RAP plan ($1,083 per month). Additionally, they could pay more if they wanted to, albeit at a slightly higher interest rate.

Now let’s imagine things don’t go as planned. Because sometimes things don’t work out the way we expect.

Maybe you find out you don’t actually like patient care and want to do something (in dentistry or out) that pays less? Maybe you decide you want to be a stay-at-home parent and only want to work part-time or not at all? Maybe you end up with rheumatoid arthritis or a shoulder injury that keeps you from practicing dentistry? What then? (These are all actual scenarios I have seen.)

If you refinanced your loans, your option is to keep making that $3,797 payment. Bankruptcy is usually not an option. Reducing your payment based on your income is not an option. And there is no potential forgiveness.

With direct government loans, you can reduce your payment based on your income. And while bankruptcy is usually not an option, under current legislation, any outstanding debt can be forgiven after 10, 20, 25, or 30 years, depending on the program you are eligible for.

It is really important to think long and hard about giving up these government benefits for a 1% or 2% interest savings.

Are You Actually Saving Interest?

One of the other things you need to consider is the fact that certain government loans and repayment plans have interest subsidies.

Under the new RAP plan, for example, the government subsidizes your unpaid interest. In the example above, this person would be charged about $36,000 a year in interest (8% of $450,000), but the government would offer a subsidy of the unpaid interest in the amount of about $23,004. This makes the effective interest rate in this particular year 2.9%.

This subsidy goes down as your income goes up, but it is still helpful to understand.

There are many cases in which refinancing makes sense. Just make sure you understand all your options. Contact us if you have questions.