Written By Travis Hornsby, CFA®, CFP®
You might assume that if you go to a top Master of Business Administration (MBA) school, you should take out all private loans with a place like Sallie Mae or Earnest because of lower origination fees and interest rates compared to federal loans.
It might be true that you’d end up paying less in interest with private loans. However, almost no top graduate business students understand the hack available with the Revised Pay As You Earn (REPAYE) interest subsidy.
Here’s how students from top-20 programs can save a lot of money on MBA student loan repayment with this little-understood trick.
How the REPAYE interest subsidy works
Editor's note: The REPAYE plan was replaced by the Saving on a Valuable Education (SAVE) plan. Learn how the SAVE plan can save you money on your MBA.
When you sign up for REPAYE, the government pays half of all interest that’s not covered by your required monthly payment.
Pretend you earn $150,000 and have $200,000 of federal debt at an average interest rate of 7%. Your annual REPAYE payments would be $13,179. If the stated interest charged is $14,000, then after you subtract $13,179 from $14,000, the government would pay 50% of the remaining $821, which would be $410.50.
That’s not much of a subsidy. You could refinance to a 4.5% fixed rate in 10 years and get an interest charge of $9,000.
However, what if your income was $0? Then your interest charge under REPAYE would be 50% of $14,000 (or $7,000), which is even cheaper than refinancing. Plus, the interest that accumulates on your balance accrues at a simple rate of interest instead of a compounded rate.
Why consolidation is needed for the REPAYE interest subsidy hack
If you graduated with a $0 income, then you’d be pretty upset about spending six figures on B-School. However, if you consolidate your federal student loans immediately after graduation, then you’d be filling out the forms before you actually have an income.
Of course, most top business school students could have maybe $30k or $40k of income from their summer internship. That means you could use a prior year tax return and certify your payments for 12 months after graduation.
In the example above with a $200,000 loan balance at 7%, with a $30,000 adjusted gross income (AGI) from the prior year tax return, your required REPAYE payment would be $98 a month. The interest subsidy you’d receive would be 50% * ($14,000 – $1,179) = $6,410.50.
If you wait the standard six months for your grace period to end, you’ll be in a gray area where you might feel compelled to report your paystubs since they show more pay than when you were an intern. Some borrowers feel like it’s OK to report prior year income anyway since you haven’t earned the full year of income yet at your new job.
If you consolidate at graduation or soon thereafter, though, your required payments are safely based on the prior year tax return.
For the following year of certifying your income, you could use a return showing only half a year of full income, since our tax system goes from January 1 to December 31. That means you’d still get a subsidy in most cases on REPAYE, although it would be smaller than the first year and probably give you a worse interest rate than refinancing.
Total MBA student loan repayment cost: Private loans vs. federal
Let’s look at the Wharton School of the University of Pennsylvania as an example of how this subsidy could work.
I pulled the year-one cost from the school’s website. Without any finance charges added, two years at Wharton would cost $229,792.
Here’s a summary of the cost below:
| Wharton MBA 2019 cost | Year 1 | Year 2 |
|---|---|---|
| Tuition and fees | $81,378 | $81,378 |
| Room and board | $22,670 | $22,670 |
| Books and supplies | $1,494 | $1,494 |
| Personal, health and other expenses | $9,354 | $9,354 |
| Total | $114,896 | $114,896 |
Federal loan funding for top MBA programs
If you used federal loans to fund Wharton (or Stanford, Harvard, Columbia, etc.), then you’d have a max of $20,500 per year of Stafford loans and the rest would be Grad PLUS.
Stafford loans have an interest rate of 6.08% for the 2019-20 school year; Grad PLUS costs 7.08%.
The origination fee for Stafford loans is about 1.06%, and for Grad PLUS, it’s about 4.24%.
I’m going to approximate the math for simplicity’s sake. For year one, you’d borrow about $95k of Grad PLUS and the rest in Stafford Loans. Same for year two. Plus, you’d have accrued interest on both to consider. The weighted average interest rate would be about 6.9%. The weighted average loan origination fee would be 3.7%.
After year one, you’d have $127,484 of total borrowed, including finance charges. For year two, you’d borrow that again, but your $115,000 would accrue another year of interest. So the total you’d leave with would be about ($127,484 * 2) + (0.069 * $115,000) = $262,903.
Private loan funding for top MBA programs
Let’s assume you take out an MBA loan through Earnest. Pretend your interest rate after the 0.25% autopay discount is 5.25%. Earnest also doesn't have an origination fee and offers a nine-month grace period after graduation.
Year one total cost of a Wharton MBA would be approximately $123,458. Year two would be the same, plus an additional year of interest on the first-year borrowed amount. The total you’d leave Wharton with would be around $252,954.
That’s roughly $10,000 cheaper than funding your Wharton MBA with federal student loans.
Adjust for the REPAYE interest subsidy in year one
After graduating, your MBA student loan repayment with private loans would most likely start with refinancing when you land your first job. Pretend you get a 4.5% fixed rate for a 10-year term. Let’s say your first-year interest is around $11,383.
Under the REPAYE option with the interest subsidy, based on a $30,000 intern income from the prior year, your interest cost on the $261,970 would be $9,627. That narrows the savings from doing the private loan route, then immediately refinancing from about $9,000 to a bit over $7,000.
When federal loans beat private loans for top-20 MBA programs
If you wanted to work at a startup post-graduation with private loans, you better hope you’re joining a well-funded one. Without a debt-to-income ratio of below 2-to-1, you probably wouldn’t be able to refinance. So your required monthly payment would be $2,714, assuming you kept the Earnest 10-year private loan at 5.25%.
In contrast, the REPAYE payments would be about $100 a month for the first year. After that, it would be no more than 10% of the quantity of your AGI, minus about $20,000 (you get a bit of a deduction before the 10% is taken).
You could work at a startup with a relatively low salary and a lot of stock options for several years after school. Under the REPAYE plan, you wouldn’t suffer much stress about your personal finances.
The balance of your loans would be slightly higher than if you had gone the private loan route, but you would have gained invaluable flexibility.
Private MBA student loans make running a startup tough
Many venture capital-funded startups offer attractive starting salaries — and stock options, too. That said, if you wished to start your own company, you might wait a couple years before breaking a profit.
If you wanted to pay yourself a salary, you’d probably have to sell equity in what could be a very valuable idea to investors. That might be massively more expensive than an extra few thousand in student loan interest.
What could be even more expensive is if you didn’t pursue the startup idea at all because the big required monthly payments made you risk-averse.
How many times have you heard of people working to “just pay the mortgage?” When you owe over $2,500 a month, that’s very similar to a mortgage-level payment. You might feel pushed into certain career decisions you might not otherwise take.
Private Loans are a clear winner for traditional MBA career paths
Alternatively, if you want to do the consulting / investment banking / private equity employee type of route for the first 5 to 10 years after business school, taking out the cheapest private loans you can find makes the most sense, which saves a few thousand dollars of interest.
Considering that student loan interest isn’t deductible at salaries earned by top-business-school grads, the savings in pretax salary dollars is perhaps as much as $10,000 to $15,000.
However, the savings aren’t in the mid-five figures or above. Cutting your interest rate on your loans does matter, but it’s not as important as choosing the right job, negotiating your salary and having a high savings rate.
Verdict: More top MBA students should use federal loans
For MBA student loan repayment, more students should consider using the REPAYE interest subsidy, especially those in startup-type environments who earn relatively low incomes for the first few years after graduation.
To get that subsidy started, consolidate your loans at StudentLoans.gov and select the REPAYE plan for the consolidation loan.
While not many MBA grads take jobs in the government or nonprofit sector, those who do could potentially even receive loan forgiveness under the Public Service Loan Forgiveness program.
Regardless of what job you take, my guess is that the lower required payments under an income-driven repayment plan would allow more MBAs to take risks that would pay off in the long run.
That flexibility is impossible with private loans, which must be repaid right away with large monthly payments. Of course, if you plan on a traditional career path, then you might as well use private loans in school and take advantage of the lower interest costs.
Just remember: It doesn’t make sense to care so much about the higher interest on federal student loans that you avoid founding the next big company because you’re so worried about making your monthly payments.
That’s the real lesson a lot of top MBA students should think about when deciding how to fund their education.
If you’re trying to figure out what loans to take or you already have a bunch of debt, check out our consulting service or reach out to us by email.
Should more top-20 MBA students take out federal loans instead of private loans? Why or why not? Do you wish you had taken out different kind of loans? Comment below!
Not sure what to do with your student loans?
Take our 11 question quiz to get a personalized recommendation for 2024 on whether you should pursue PSLF, Biden’s New IDR plan, or refinancing (including the one lender we think could give you the best rate).
