Financing a graduate school education has significantly different considerations from undergraduate and you should be well-informed before you begin to borrow.
Three types of student loans are available to fund graduate school:
- Federal — $20,500 per year maximum, eligible for income-driven repayment (IDR), fixed rate, low fees, discharged upon your death.
- Graduate PLUS — no maximum borrowing other than the full cost of attendance, eligible for IDR, fixed rate but higher fees, discharged upon your death.
- Private — may be lower cost than Graduate PLUS loans, but noteligible for IDR, may require a co-signer, may be fixed or variable rate.
IDR is a more important consideration with graduate than undergraduate school as you can finance an entire graduate school education with IDR-eligible federal loans. And, if you have IDR-eligible undergraduate federal student loans, these can be included with your graduate school IDR loans.
Depending on its length and cost, you can emerge from graduate school with hundreds of thousands of dollars of student loan debt that can be IDR-eligible. In this situation, IDR is almost certainly financially beneficial. An imprecise rule of thumb is that IDR makes financial sense if your annual income is less than your total eligible indebtedness. You can find more precise calculators on the internet.
Public Service Loan Forgiveness (PSLF) is another important consideration. PSLF has two critical advantages over regular IDR:
- It is a 10-year payment obligation, rather than 20 or 25 years.
- The loan write-off is not taxable income to you.
You should know the parameters of IDR and qualifications for PSLF before you make any decisions about how much to borrow for graduate school. Also, be aware that rules may change with future legislation.
Student loan debt is nearly impossible to discharge through bankruptcy. Any default will have lifelong negative consequences for you. Make sure you can re-pay this debt before you move forward with borrowing the money.
If you are certain when you enter graduate school that you will not be using IDR, then you may opt for private student loans instead of Graduate PLUS, because they have lower fees and rates. However, this is risky because you cannot later reverse that decision and make the private loans IDR-eligible.
You may consider Graduate PLUS loans as an insurance policy with the excess cost over private loans as the premium you pay. If, at a later date, you conclude you will not use IDR, you can re-finance the loans into a lower cost private loan (i.e., cancel the insurance policy).
Consider an example: Mary graduates from law school with IDR-eligible debt of $200,000, including some undergraduate loans. Her income is $75,000.
- Depending on the interest rates of her loans, her monthly loan payment for a standard 10-year term might be ~$2,100 — almost certainly unaffordable at her salary.
- Using IDR, her monthly payment could be ~$400 — a lifesaver for her. This payment will adjust each year as her income changes over time and will last for 20 years.
- At the end of the 20-year IDR term, her loan balance will likely be higher than when she began because the monthly payment may not cover the accrued interest. Depending on how her income changed over the 20 years, her final loan balance may have grown to, let’s say, $250,000. When the loan is written off, the $250,000 will be reported as taxable income and she will face a large tax bill.
- If Mary had worked continuously in the non-profit or government sector for 10 years and opted for PSLF, she would have two additional and very important benefits — 10 years of payments instead of 20, and the loan write-off would not be taxable. That difference is substantial.
In my example, IDR is better than standard repayment and PSLF is significantly better than regular IDR.
Unless you are certain that you won’t need IDR, I recommend that you finance graduate school using the following approach:
- Maximize use of federal student loans.
- Use Graduate PLUS loans to cover any remaining need.
- After graduation, evaluate whether IDR makes financial sense, given your income and eligible indebtedness at the time, including undergraduate debt.
- If IDR does make sense, assess how much better off you may be if you also enter PSLF.
- If PSLF makes sense for you, factor that into your job search and career direction.
- If you’re confident that IDR does not make financial sense for you, consider re-financing your loans if lower cost private ones are available, but recognize you cannot reverse this decision.
Questions on student loans or financing graduate school? Get in touch.
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Update: The Wall Street Journal tells the story of an orthodontist who has amassed $1+ million of student loan debt.