How to Strategically Pay Down Your Student Debt with Tyler Olson (EP.114)

0:28We all need to make smart decisions with our money. professionals are thinking about as the student loan payment pause is ending on September 1st. This week, I'm joined by Tyler Olson, who provides financial advice and education for early and mid-career physicians. And in this episode, we talk about how to choose the right repayment plan, when refinancing or consolidating loans is an effective strategy, and whether the debt snowball or debt avalanche approach is best for paying off your loans. As always, you can find links and resources at the show notes at thelongterminvestor.com. And now here is my conversation with Tyler Olson.

1:09Tyler Olson, welcome to The Long-Term Investor. Thanks, Peter. Great to be with you and talk about student loans. Well, I don't love student loans, but I love talking about it and figuring stuff out. Well, you are somebody who came highly recommended on the topic, and I'm very excited to get your perspective really on how people can strategically pay down their student debt, you know, balancing both the debt pay down with wealth creation and living in the moment. And I guess a good place for us to start would be just in your opinion, what are some major obstacles borrowers face when repaying their student loan debt?

1:42I think the fundamental issue is that most people do not understand how debt works and that if left unattended to and you just kind of ignore it and then you're like, well, I'm going to start funding my 401k, my Roth IRA. It can actually have sort of an internal rotting effect because especially if we're talking about federal student loans, interest rates are anywhere from four and a half percent now up to over 8 % for graduate loans and letting that sit without a plan in mind, it makes investment returns. The net benefit is just not as good if it's unattended to. So understanding how debt works and understanding how the federal loan system works so that they can know what their options are.

2:29That's like the main thing that comes to my mind. Well, and I'd like to dig into, we're going to talk about a lot of how some of these things work and different strategies, but aside from everybody listening and perfectly learning everything that we talk about today, what do you feel like is the best way for people to go about understanding their loans? Well, you want to appreciate the type of loan repayment options that are available to you. And this is presuming that one has already determined, hey, I'm going to go to college and it's worth it, or I'm going to go get my MBA, it's worth it. I'm going to go get my MD at medical school.

3:04That's because that's what I want to do. The accumulated cost is something that has to get paid off one way or another once they start working. And so understanding what are my repayment options and what is the best one for me based on one, future income after school, two, what's my debt burden, and three, what type of work am I doing? And then four, how does my cash flow look in terms of ability to repay my loans because we have shorter term needs. We've got to pay for ourselves to live, perhaps a mortgage, car payment, just whatever stuff we have to pay for in life, investing in ourselves for the future.

3:47And then where does the student loan payment come in? So including that, giving it a respected place and a financial plan is critical to being able to understand the best way to handle their student loans. That's really interesting. And I think In my experience, I feel like people just run into problems because there are so many different details and ways to repay their loans. So even getting your hands around just the different repayment plans seems like a necessary step in order to incorporate it into your financial plan. I mean, how does someone go about picking the right repayment plan one?

4:24And are there any, in your opinion, that are more beneficial to the borrowers than others? Oh, absolutely. There are many, there's a few plans that are designed to just pay off within a certain period of time. There's the standard, graduated and extended. I actually don't deal with those types of repayment plans very often because a lot of times the federal interest rates are higher than what a private lender can provide. And so when I like, cause I work primarily with physicians, when they're done with training, if it is the right decision for them to pay off their loans. In times past, interest rates have been low enough that they would be better off refinancing to a private lender because the interest rate is lower.

5:15And if they're going to pay it off anyway, you might as well just try to save on interest expense. But those are available so that if you want to stay under the federal umbrella, you can do so. And Tyler, real quickly, before you go into some of those other plans, do you mind just sharing some of the features that a federal loan has versus a private? So while the interest rate is lower, sometimes there's a trade-off in losing some of those federal loan features. Yeah. So the main fallback benefit of being on a federal loan is that if you were ever to lose your job or have some sort of income reduction for any reason, you can fall back into one of the income driven repayment plans.

5:58Those three I mentioned, the standard, graduated and extended repayment plans, those are not income-based. They're designed to have a fairly straight path to pay off. But if you lose your job or something happens to the point where an income-based plan would allow you to save money in order to get through a crisis, then being within the federal system can be beneficial. And now, actually, now that interest rates have come up, the idea of refinancing is not as appealing. The lowest I've seen for, we did one, we're actually in the midst of doing one right now, and it's about 5.05%. But it used to be like, you should have seen like three years ago, there's this one EM doc I was working with who had a variable, it was a variable rate, he has since gotten onto a fixed rate, but at the time it was 0.95 % interest.

6:52And so it was like, it was a no brainer for him to refinance. But once you refinance, that's it. You cannot go back into the federal system. So if you're going to leave, you have to be confident that your loan repayment plan is going to work. And so I appreciate that detour. You were kind of in the midst of explaining, are there plans that are more beneficial and what the different types of repayment plans are. Let's keep going down that track a little bit. Yeah. Yeah. So there are four income-driven repayment plans. There is pay as you earn, which has an acronym P-A-Y-E. There's revised pay as you earn, R-E-P-A-Y-E.

7:34And then there is IBR and ICR. And they all have somewhat different features. And then to complicate things further, repay, the second one that I mentioned, is being renamed and benefits of it are improving substantially. Repay is now going to be called SAVE, S-A-V-E is the acronym. And I can explain the distinctions, but basically just like a week ago or a week and a half ago, the Biden administration came out with this new repayment plan option to make it more amenable, especially to low income families who have gone on to like go on to undergrad and they have undergrad debt and their income is, you know, anyone who's like making less than$60 ,000.

8:25If you have a family of like three or more, you're pretty close to paying nothing on this new plan. Like your monthly payment is pretty close to nothing, but all four of these are available and they, they appeal to different people. IBR and ICR are the ones that I've dealt with the least because ICR, which is an abbreviation for income contingent repayment, it's the basis of either 20 % of your discretionary monthly income, a minimum that would pay on a 12-year plan. And of course, this is also based upon your income and it's updated annually and based on family size. But ICR tends to not be as low in payment amount as the other three.

9:09IBR is probably going to be getting more attention because it is very, very similar to pay. And pay is going to be sunsetted next July 2024. So there's a lot of people, especially in medicine, who are debating what should I do with my loans? Because not only is the federal student loan pause coming to an end at the end of August, but now a lot of people are trying to decide, well, what income-based plan should I pick, especially now that this new one is out. So there's a lot of different options. Do you want me to go deeper into each of them as far as how they appeal to people? Or do you have any questions about what I mentioned so far?

9:51No, that would be great. So for those listening and watching, we certainly will have everything here in the show notes at thelongterminvestor.com. In fact, there's going to be a real nice table outlining some of these basic options. But yeah, Tyler, I would love if you went deeper explaining who they benefit most and how that is true. Yeah. So I'm going to approach this from the perspective of a hypothetical person that I'm very familiar with. And that would be someone who is currently making about$70 ,000. And in, say three years, they're going to be making like$200 ,000. And this is not an uncommon income trajectory for a physician who is currently in residency training.

10:37And after they're out, their income has the potential to go up much higher. If they are of the disposition that I want to train in medicine, and then once it's over, I want to open up my own private practice. They want to own their own business. That's an important point because they will not be working in a nonprofit setting. And that matters relevant to the public service loan forgiveness program, which we can talk about shortly. But in this hypothetical person who's making$70 ,000 now, they're going to make$200 ,000 in three or four years. What repayment plan should they pick? And what I'm seeing is most people in this situation would be served well to pick the new plan called SAVE.

11:29And the reason why is because any unpaid interest on their loans is forgiven. And when you're making$70 ,000, your payment amount, regardless of how much debt you have, is going to be relatively low. So for example, the new plan save, it has a threshold that's based on the poverty level of income, which is currently for repay and pay has been 150 % of that. And so someone who's single, the first$20 ,000 or so would not be counted in the calculation. But then above that, it would be. And so if they made$70 ,000,$20 ,000 isn't counted. They have to pay 10 % of their income above that threshold. So in this scenario, on the 150 % market that I mentioned to you, they would have to pay$5 ,000 per year broken out into monthly payments.

12:34But now with save, that threshold is being increased to 250 % of the federal poverty line. So for a single person, that is now going to be almost$34 ,000. So now their payment would be$3 ,500 per year. So like around 300 bucks a month. And let's say they've got$300 ,000 in debt and their average interest rate on their federal student loans is 6%. That being$18 ,000 in interest per year, they're only knocking down$3 ,500 per year on their interest. So what's happening to the other$14 ,500? In the past, some of it would be forgiven, but the rest of it would just be tacked on. And so that's why there's a lot of physicians who go, they graduate medical school with $300 ,000 in debt.

13:25And by the time they're in a position to actually pay down their loans, it could easily have grown to nearly$400 ,000. in debt. But now with this new save plan, they pay that$3 ,500 per year. The rest of it is forgiven. And so the loan will not balloon. And that applies to anybody who's on this plan. It doesn't have to be a physician, anyone who picks save. If they make the minimum payment based on their income, every additional dollar in interest accrual will be wiped out. And so what they were at, at the completion of school or wherever they're at right now in the stream of time, their loan balance will not go up if they're making that minimum payment, which makes the save plan, it makes it very appealing.

14:11That is pretty incredible. And again, for those listening or watching, you can go to the longterminvestor.com. We will have some of this laid out as well as some links to other resources. And Tyler, people who choose a plan or have been going down a path, or even if they choose this new save plan, is there ever a time when it makes sense to adjust which plan you're using for pay down? Yes. Anytime there's going to be a meaningful difference in income, it's a good time to at least review. And so, you know, for example, if someone, they're going from a$70 ,000 income to 200, what I would typically do if it were me is I would look at the average interest rate of my federal loans, look at my ability to pay off that debt and how many years.

15:05So there's lots of very straightforward, simple loan payoff calculators you can find online and you could just input your numbers. My average interest rate is 6%. I owe$190 ,000. How long would it, if I were to refinance and say you find a rate that's 5%, So you're saving a little bit on interest expense and just plot out what the monthly payment would be and then compare it to your cashflow. Like, what do I have available that after my family is cared for, after I've taken care of myself and my other necessary expenses that I can't change, what is my additional income availability? And then make a payoff plan timeline based on that.

15:45But that, you know, as long as you're in a place where the income based is best for you, it's good to just stick with that. But like once your income is in a position where, hey, I could actually do something more aggressively, then it's good to take a look and decide if it's still good to stay on that income-based plan, stay within the federal system, but then aggressively pay off anyway, or refinance and aggressively pay off because you have a meaningfully lower interest rate. And I sort of asked you a question like this earlier, but I'll just be more specific in, And when we get to that point of consolidating and refinancing student loans, could you maybe explain what the pros and cons of doing that might be?

16:32It's important to make a distinction here. Consolidation of federal student loans is one action that can be beneficial. Refinancing is a very different situation because that means you're moving away from the federal loan system. federal loan consolidation it's a fairly common practice because you know when kids go to school and they're taking out loans they get an individual loan for every semester that they go and so you could potentially have eight loans from undergrad and if you go to some form of graduate school if you go to medical school you're going to have another you know you could have i think they have like 16 the way it's broken out it can be like then like up to 16 different loans and And consolidating doesn't save you money on interest expense.

17:19In fact, it might go up slightly by like 0.125%, like an eighth of a percent by doing the consolidation. But the benefit of doing so really lies for those who are considering going for public service loan forgiveness. Public service loan forgiveness is a federal program where if you work full-time for either a nonprofit entity or a government entity for 10 years and you report that employment and you get verification from your employer that based on making a payment that is determined by your income driven repayment plan choice, whatever's left over at the end of the 10 years is forgiven tax free.

18:03It is not a taxable loan forgiveness. The reason why this is relevant to consolidation is because if you graduate school and you don't consolidate your loans and you immediately begin working for a nonprofit organization or a government entity, you will not get PSLF, public service loan forgiveness, qualifying payments right away. They're by default, the first six months after school is considered a grace period. You don't have to make any payments, but you also don't get qualifying payments toward PSLF. If you do a federal student loan consolidation application, as soon as your loans are taken out of what's called in-school status and combine them, then you have the option in that application to jump out of the grace period so that you can begin having qualifying payments as early as two months after graduation.

18:59Now, four months of a difference, it seems like that wouldn't matter, but time and time again, on the track of a physician, like a career track of a physician, 10 years after they've graduated medical school, there's a very good chance that they're making two, three, four,$500 ,000 a year. And if they're still on an income based plan at that point, because they're trying to go for public service loan forgiveness, let's say they make$400 ,000 a year in year nine, that is going to be somewhere in the vicinity of like$3 ,000 per month in payments. If they can skip four of those because they started four months earlier, you're saving$12 ,000.

19:44So it's a PSLF relevant decision. It's also very time sensitive. I have graduating medical students right now, so it's mid-July right now, who are saying like, oh, should I consolidate my loans? And it's almost becoming a moot point for them because they graduated in May. Grace period ends mid-November. Their application for consolidation is going to take a couple of months. So at this point, if they did it right now, the earliest that they're going to get payments qualifying is probably October, possibly September, and now they're just saving two months. So it's like if they want to do it, they have to do it right away.

20:20Other than that, the only other benefit to federal loan consolidation is the simplicity. If you hate logging into your account and seeing like 16 different loans and it's stressing you out and you'd rather just get it into one federal loan, aesthetically that can be beneficial to some people. So that's the benefit of consolidation. The benefit of refinancing is simply for interest expense saving. If you can find a private lender who's going to give you a lower interest rate and save you money on interest expense over the remaining five, seven, ten years that you're going to be on track to pay off your loans, then it can be worth it.

20:56You just have to make sure that you're okay with it being a one-way street because then you will no longer benefit from the income-driven repayment plans, you will not be able to go for PSLF. And also, the other thing to consider with refinancing is that there are rules about extraneous circumstances that would cause one to default on their loan, like bankruptcy, if you die, what happens to your loans? And so there are some contracts out there where if you sign up with them, that your partner or spouse may be liable. whereas with federal loans, that's not the case. If you die, your loans are not the responsibility of anybody else.

21:36So you want to make sure to check those clauses to make sure that you understand the pros and cons of that decision. Wow. That is a whole bunch of incredible information and something that you were saying at the tail end of the conversation on consolidation, where people sometimes just prefer something to look different aesthetically. I see that happen all the time across all areas of people's financial life, including my own. So it kind of makes me wonder, it's a pretty broad question where I know there's not a black and white answer for everyone, but we'll see where you land is, do you have a preference for the debt snowball versus the debt avalanche?

22:13And maybe we ought to define those. I'll let you go ahead and define it since you're the expert here today. So I can appreciate the differences and pay off. Like, you know, debt avalanche, like where you're just like pelting the highest interest rate debt, whereas the debt snowball is addressing the smallest loan to try to build. It's some sort of momentum. It's like mental fortitude, like where you're like, I can do this. Right. You get a little win and that helps you keep going. Right. I guess I have to back up a little bit further because if we're in the realm of student loans, there are many people because of varying circumstances that they had to take out private student loans to begin with.

22:57And that is not a great place to be because you are already without the potential for income-based plans or PSLF and the interest rates tend to be higher. So the way that I address student loans is I view it as like a total debt management picture is that if you've got credit card debt, first of all, the higher interest rates, like that's got to go. I approach student loans the same way. If you have a private loan with like Sally May or Discover or some other private lender, and it's like 10%, that has got to go. Like I work with some people who they've got a bunch of medical school debt, and then they've got like a$30 ,000 private loan that's charging them nine and a half percent.

23:41We're going to keep the federal loans on an income-based plan until that private loan is gone because it's just hurting the most. And there isn't any sort of fallback. There's no income-based repayment plan options with those. And so they're also the most urgent problems that need to be resolved. And when you have interest rates that are that high, investing becomes somewhat prohibitive. Don't you agree? You're like, if you got that hanging out there, sure, you're like 401k if you have that or 403b plan and your employer matches, yeah, you should do that. But beyond that, if you've got debt that's charging you that much interest, it is very, very difficult to justify directing money into investment because we cannot expect our investments to perform that well every year, whereas the debt is going to charge us that much every year.

24:29Great point, Tyler. And another thing that I feel like comes up in conversation a little bit more now than I can ever remember at any point in my career, are people waiting around for possible future legislative relief? We never know what that's going to look like. But when somebody asks you that question, how do you respond to that? I try to respond with compassion because anyone who is in the situation where I'm waiting to see if there's something that's going to help me, the budget is probably pretty tight. And they're like, how do I navigate this?

25:10So understanding that they probably don't have a lot of movement, what I try to do is I try to say, well, let's approach this from the standpoint of what plan could I possibly create that is within my control? It might take a while. And in fact, there's someone that I was speaking with recently who they have the potential to go for that public service loan forgiveness. they're just starting out now but they hate their job they're three months into it like the 10-year time frame but this person told me they're so unhappy with their job and that is a huge marker as far as like what is the right thing to do because even if you could execute a plan where ultimately you'd get like a hundred thousand dollars in student loans forgiven if you are a shell of a person 10 years later, we got to look at other options.

26:05We got to see what, if there is a plan possibility that is within one's control so that even if it's not as financially superior, it is mentally a better plan because like, we got to be happy. We got to be happy with our money decisions so that even if we have less of it, if we are happier with our lives, like, and we feel like we have a bit more control of what we're doing, that is extremely important. So I guess what I'm saying in a nutshell is if you have no choice, but to try to wait and see what's available, then sure, you've got to do it. And actually being on the save plan for anyone who's truly in a difficult situation, being on the save plan is a good way to ride out storms.

26:52because like I said, if you're making$30 ,000,$40 ,000,$50 ,000,$60 ,000, even$70 ,000 a year on save, at least regardless of how much debt you have, your payment is not going to go over$300 a month. And it could be much lower than that depending on if you're married and if you have kids, that poverty line calculation, it goes up. I think if it's like a family of three, that threshold is$57 ,000. So like if you make 70 ,000 and you have like, you know, you're married and you got a kid, you're going to be paying less than a hundred dollars a month. So that is a good place to tread water. But otherwise, if you can create the income or you can create the situation where you can have more control, I say, don't wait any longer because especially now, because we've seen a lot of these legislative actions.

27:50Well, there's been no legislative action, executive actions that have been tried to try to forgive debt. And it is just a log jam. Nothing is happening. So outside of public service loan forgiveness and the merits of that and finding a way to get payments counted through prior work. and if you like working in the nonprofit setting or the government setting, then PSL is fantastic. And I know people and I've helped people have three, four, five,$600 ,000 in debt forgiven through it. That is worth looking into, but otherwise waiting to see if something's going to happen where they're just going to wipe out the debt.

28:30That's not happening. And so you've got to, you've got to rest control and take action. However you can. Tyler, I know that you exclusively work with physicians. So I'd like to focus this last question on this group, just because you have so much experience with them. How do you in general view the balance between debt repayment with other financial goals and this sort of social expectation of physicians to have a certain lifestyle? That's a great question. It's very, very important that they strike the balance between taking care of their immediate needs, taking care of their future selves through retirement planning, and taking care of their mental health.

29:18Because the physician career track is intense. And so being able to know oneself and what one is capable of, to me, that's rule number one in establishing a plan for like, how do I address these things? Like I've got debt to pay off. I am getting a late start in earning a professionally high income. And I've got a kid. What do I do about college? I need to get a new car. And like, we're renting now. I want to buy a home. there's a lot of pieces there and so what i say is for a physician that's in training there's not a lot to do except to tread water i consistently say you don't need to stress about investing as a trainee because there's just not a lot of extra income to work with anyway you want to focus on your learning you want to focus on your craft and take care of yourself and your relationships, when training is done, that's when you need to hit the ground running.

30:21I need you to look at, okay, this is what my income is. This is what I have available. What am I going to do with it? How do I parse this out? And finding a way to save for retirement right away while also simultaneously establishing a debt payoff plan. I don't think for most people that it's wise to do no retirement savings and just focus all on student debt payoff and then start because as you know very well time invested is really really important and so they want to get that going as early as possible but you don't want to leave the student debt hanging out there either so you have to address them both at the same time and it's very doable you just you look at the income total and what your current living expenses are, and then you identify, what am I going to need to pay off this student debt?