Are private student loans worth it in comparison to federal loans? In this episode, learn how your degree path and future plans affect whether private loans should be on your radar, whether they’re a good idea for parents and grad students, and situations where they’re the worst option.
In today’s episode, you’ll find out:
- How credit risk impacts your private student loan interest rate
- How your degree path affects whether private loans are a good decision
- Why you might take out a private loan instead of waiting to refinance
- Borrowing limits for Federal Stafford Loans
- How Parent PLUS Loans come into the picture
- Why Parent PLUS Loans are such a burden
- Is a private loan better than a Parent PLUS Loan?
- Should private loans be used for graduate school?
- Grad PLUS Loans vs. private student loans
- A rule of thumb for how much private loans can save you vs. Grad PLUS
- How a private loan payment could affect your financial goals
- Why an additive payment is bad news
- Fields with higher Stafford Loan limits
- Situations where private loans are the worst option
- Why overestimating your potential earnings can hurt you
- Why private loans might make a big comeback
- How an interest rate offer shows whether a degree choice is sound
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Episode 34 Transcript
Travis Hornsby [00:00:01]Welcome to another episode of the Student Loan Planner Podcast. We’re going to talk about private student loans today. Private student loans are the bane of a lot of people’s existence. You have to pay them back no matter what. You cannot really get rid of them in almost every single case.
Travis [00:00:16] There [are] a couple exceptions. Every now and then, I see somebody that lives in a place like New York City or some super-progressive area that has amazing consumer protection laws, and there’s these really complicated rules around statute of limitations. If you haven’t made a payment in, like, seven years, there might be ways that you could hire an attorney and potentially get some of that settled.
Travis [00:00:39] But by and large, private student loans are not able to be gotten rid of. You can’t just dump them and say, “OK, we’re done now.” That just doesn’t happen with private student loans.
Travis [00:00:48] Now, it doesn’t happen with federal student loans either, but federal student loans are very, very different from private student loans. Federal loans are owned by the government. I’ve got some good news. The government does not care whether or not they make a great return on their investment when they lend you money. Now, I’m not saying that is a bad thing. It’s just reality that the government is not an investor. The government does not care if they make a killing on their portfolio of federal loans. They care politically about what voters want. Right?
Travis [00:01:20] So some voters might say, “Hey, we don’t want to be involved in this. It’s too expensive.” Others might say, “We want to have cheap and affordable options to go to college.” So the government is motivated by different things than private lenders.
Travis [00:01:30] Now that said, also the government has this idea of fairness. Right? So the government wants to be fair to everybody, and so they have a uniform system of interest rates they charge people. That is certainly one way to do things. The problem there is, you know, it’s very clear that a degree in medicine has got lower risk than a degree in, you know, something else, perhaps. But yet you charge somebody the same percentage interest rate on that medical degree that you do other things that don’t have good employment prospects.
How credit risk impacts your private student loan interest rate
Travis [00:01:59] So, what that is, is basically different credit risk. Credit risk is what banks use to determine what interest rate they lend to you at. So think about it like this. This is why private banks do not lend to every customer at the same interest rate.
Travis [00:02:14] Let’s say we’ve got Jerry. Jerry has got a 600 credit score. He’s late on his credit cards a lot of times. You know, he works in construction, so sometimes he’s working, sometimes he’s not. And he’s generally good on his bills. You know, he generally does pay, but he’s kind of behind on a lot of things and you don’t know when the payments actually going to come in.
Travis [00:02:34] And in contrast to that, let’s just say that Tasha is on time with her payments all the time, and her credit score is 750. And Tasha is not going to be late. She’s always going to make her payments on time. Let’s say also that Tasha is a nurse in a bad economic environment. You know for sure that Tasha is going to keep her job. She’s not going to lose her job. She’s probably going to make on-time payments. And then Jerry’s probably going to fall behind, if not just stop paying completely because he might lose his job. Right? He’s got less stability going on.
Travis [00:03:04] So if you’re a lender and you want to make sure that you don’t lose money lending to Jerry, then you will have to charge him a higher interest rate than Tasha. So, for example, let’s say the chance of Jerry defaulting is 2%. So, you’re going to lose all your money you lent Jerry 2% of the time, and you’re going to lose your money that you lent to Tasha 0% of the time.
Travis [00:03:25] You might take that 2% default risk of losing your money and add that to the interest rate you charge Jerry for a loan. So instead, maybe you charge Tasha 5%, and you charge Jerry 7%.
Travis [00:03:38] And the reason for that is you’re looking at their histories, and you’re looking at what you would expect based off of their money histories and their relationship with money. And you’re saying, “Well, I want to give a better interest rate to Tasha because she’s on time with her payments, and I know I’m going to get paid back. And I’m not real worried about her giving me back my money that I lent her.”
Travis [00:03:52] And so that is why private lenders have the interest in offering better interest rates to some people than the federal government. There are a lot of Tashas and Jerrys out there, if you think about all the student loan borrowers.
Travis [00:04:06] So, there are a lot of people like Jerry and actually way worse off than Jerry that are going to school and getting educations. And the market interest rate, to reflect the risk that they’re not going to pay you back if you are a private person lending a student money: So the interest rate you’d have to charge would maybe be, you know, in some cases really, really high. Like 13%, 14%, 15% to justify lending money to somebody that you think is probably not going to pay you back.
How your degree path affects whether private loans are a good decision
Travis [00:04:33] Now, the interesting thing is there [are] a lot of Tashas out there that are going to very high ROI (return on investment) degree programs that are really careful with their money. They’re making great decisions investing in their future by getting an education that can allow them to be a skilled worker instead of an unskilled worker. So for that person, the government might be charging that person too much money. They might be charging them too much in interest.
Travis [00:04:57] And so what the current government policy allows is the private lender can pick off those people that — they’re going to have a much higher chance of paying back their full loan than the interest rate that’s offered by the government would imply. OK? That’s the rationale behind private student loans — why they even exist.
Travis [00:05:14] So, when you have a refinancing situation, you have interest rates at maybe 7%, and you find out that one of the lenders will give you a 4.5%. So you’re saving, you know, a 2.5% interest on your amount that you borrowed every year, and that’s going to principal instead of interest.
Travis [00:05:29] And the reason for that is because if you’re getting a good interest rate on a loan and you know you need to pay it back, you’re a Tasha. You’re basically somebody who’s got a good credit risk. The banks think you’re going to pay them back. And basically, the models are saying that the government is charging you too much in interest.
Travis [00:05:44] On the flip side, for a lot of those folks that — maybe you have a non-monetary passion in your life. Maybe you pursued a degree that does not have a positive ROI using traditional metrics. So, think about something like, you know, a very high-cost veterinary medicine degree at one of the private schools that’s going to charge you $300,000 or $400,000 for a degree that pays $80k to $120k. That is a bad financial decision from a traditional mindset. Like, if you’re just looking at ‘can I pay this debt back with my veterinary salary?’, that’s not a good decision.
Travis [00:06:18] But when you look at that in the lens of income-driven repayment options, it becomes a good decision because you’re paying 10% of your salary basically as a tax for 20 years in exchange for this education. And if you can make $80k to $120k a year and lose 10% of it to a tax and you’re happy you’re doing veterinary medicine than doing some sort of desk job, then that was a great trade no matter what you borrowed.
Travis [00:06:43] That’s what the current rules incentivize. It’s not necessarily to say that if you leave your loans with the government, you are a low-credit risk, you know, high-default risk kind of borrower. That’s not necessarily what I’m saying. I’m just saying that people have different situations. One person might need to use the forgiveness options because it makes more sense based on the math, and one person might want to go and pay it all back. And for somebody that wants to pay it all back, you obviously want to try to refinance it at some point if you can get a lower interest rate.
Why you might take out a private loan instead of waiting to refinance
Travis [00:07:15] And what we’re going to talk about today is refinanced loans or private loans. I’m not going to talk about that today. I’m going to talk about private loans that you take out on the front end of the borrowing. OK? So, in other words, when you’re going to school, what would lead you to take out a private student loan from a bank at the front end versus taking one out after the fact when you’ve already graduated?
Travis [00:07:38] So that’s a really interesting question. So here’s how the current system of borrowing works in the United States. If you are [an] undergraduate student, you can borrow Stafford loans. So a good number of these loans will be subsidized if you’re an undergraduate student, which means that they do not accrue interest during the time that you are in school. Which is really, really wonderful. And they also don’t accrue interest three years after school as long as you’re in on an income-driven repayment plan. So this is a very friendly kind of loan, really.
Travis [00:08:10] So, if you think about this kind of loan, what are the borrowing limits? I don’t know about you, but when I was in college, at least for the first couple years of college, my mom claimed me in her tax returns. She wanted the write off. She felt like she deserved the credit. In junior year, I finally won a battle with my mom. I basically said, “Well, Mom, you know, it says on the IRS form a student can claim themselves if they provide more than half of their support. I’d provide more like 80% of my support. So I think I should claim myself.” And so she finally agreed. Right?
Travis [00:08:38] So, you have that tug of war in college of who is going to claim you. Most people probably get claimed by their parents on their taxes, which makes sense because, you know, you’re probably not working and making much of an income anyway. And your parents are probably at a higher tax rate.
Travis [00:08:50] So, if you are a dependent on your parents’ taxes, then you can borrow $5,500 in the first year of college; $6,500 in the second year and $7,500 in your junior and senior year if you are not claimed as a dependent. In other words, if you are claiming yourself as an independent person on your tax returns, then you can borrow more Stafford loans.
Borrowing limits for Stafford Loans
Travis [00:09:11] So, for example, you can borrow in the first year — freshman year — $9,500 if you’re an independent student; $10,500 as a sophomore and $12,500 as a, basically, a junior and a senior. So, think about it, like, $5,000 to $7,000 a year if you’re claimed on your parents’ taxes. And then $4,000 to $5,000 a year extra on top of those borrowing limits if you’re an independent student.
Travis [00:09:34] So, the total borrowing that you can do under the Stafford program cannot be more than $57,500 in total. And what’s interesting is, if you look at the average student loan debt, the average student loan debt in America is about $30,000. That limit is almost the exact limit of what the caps are for dependent undergraduate students maxing out all their Stafford loans, maybe adding a little bit of accrued interest on top of that.
Travis [00:10:05] What we’re basically finding here is most people when they go to undergraduate, they take out a fairly modest amount of Stafford loans. Now, where is the gap coming from? OK? Because we have this huge gap of an average student loan debt of a $30,000, and we know a lot of these, you know, random schools, like — I mean, not random schools, I mean, I was going to say liberal arts schools, are, like, $40k a year or something, including living expenses.
Travis [00:10:31] But think about Penn State (University). I mean, Penn State is like $25,000 grand a year. University of Florida — When I started (at) University of Florida, it was like $3,000 a year. I think it’s like $10,000 now, and that’s, like, a good deal.
Travis [00:10:43] So why is the average student loan debt so low when that typical cost is really high? Well, you do get a little bit of grants. You get a little bit of work-studies. That counts for some of it.
Travis [00:10:51] And they come up with an expected family contribution number, and so a lot of times, the parents are supposed to contribute a certain amount of money. You know, most people in America, they have something like — 60% of people don’t even have $5,000 in the bank.
How Parent PLUS Loans come into the picture
Travis [00:11:03] So a lot of parents, you know, they can’t really fund their kid’s education without raiding retirement funds, which is always a terrible idea. So they come to the parents — the colleges do — and they say, “Hey!” You know, a lot of these places are basically sales departments. They plug on your — pulling your heartstrings.
Travis [00:11:17] And I get some of the impact of this [with] some messages people send me. They say things like, “Junior or your daughter, you know, can have their dream, but we need you to take out $10,000 a year of Parent PLUS Loans.” Parent PLUS loans are a different animal.
Travis [00:11:32] So here’s what Stafford Loans are. Stafford Loans are 6% interest with a 1% upfront fee — and then that’s unsubsidized. Subsidized is even cheaper than that. So subsidized loans cannot be beat. Subsidized Stafford Loans are the best kind of loan anywhere in the market. The subsidized Stafford Loans, it’s a no-brainer that you would take those.
Travis [00:11:50] Now the unsubsidized Stafford loans, if you think about that, that’s, like, 6% interest, 1% upfront fee. OK? So that’s a little bit of the extra borrowing that a student would have to do in undergrad.
Why Parent PLUS Loans are such a burden
Travis [00:12:01] Now, Parent PLUS Loans are more expensive than that. College says, “OK, you need more money to cover your kid’s school.” OK? So, the parent takes out Parent PLUS. Parent Plus — it’s not like highway robbery, but it’s pretty close. Parent PLUS loans have a 7% interest rate with a 4.25% origination fee.
Travis [00:12:20] So it’s almost like a load mutual fund, if you think about it. Like, it’s a super-high upfront fee. So if I borrow $1,000 bucks right away, they charge me, like, $42.50 of interest immediately. And then on top of that, they charge me 7%, or $70, per year of interest on top of that. So it’s really expensive. It’s pretty lousy.
Travis [00:12:41] And a word on Parent PLUS Loans. You know, a lot of the people out there over 50 that have the biggest student loan burdens, a lot of it is Parent PLUS debt. And the way that happens is Parent PLUS Loans are unlimited in terms of the borrowing capacity, but Stafford Loans for undergrad are not. So, if I’m a clueless 18-year-old, I can only borrow up to $57,500, and that’s if I’m, like, really trying. Basically, Congress is saying that 18-year-olds shouldn’t have an unlimited checkbook.
Travis [00:13:09] That’s good, except the parents unfortunately do have the unlimited checkbook, according to the government. And, you know, you can get a Parent Plus Loan pretty much if you have a pulse and, like, a credit score above terrible credit.
Is a private loan better than a Parent PLUS Loan?
Travis [00:13:20] And here’s some of the things that I’ve seen. So, if you have multiple kids and you are sending them to a private, high-expense school every time, then you could easily end up with $100,000 for each kid over four years. I’ve seen a couple of cases where parents will have, like, $200,000; $300,000; even $400,000 in Parent Plus Loans because of multiple kids, sending them to college. So, in that situation, you know, you can pay under the Income-Contingent Repayment program, which is a 20%-of-your-income program.
Travis [00:13:49] Now, these folks that do this, that saves their retirement by being able to pay 20% of their taxable income minus a bunch of deductions. They might only be paying $500 a month in retirement instead of if you had to pay back $400,000 grand, you’d pay $4,000 a month.
Travis [00:14:05] That’s an example of a high-interest-rate loan actually being better if you have a whole bunch of [them] because private loans, they want to be paid back. They’re trying to make the positive return there. They’re an investment company, basically.
Travis [00:14:14] Whereas, you know, the federal government, they have all these weird complicated terms and everything. But at the end of the day, like, they’re just trying to get some sort of payment. It’s kind of like a tax. That’s really how the system works right now.
Travis [00:14:26] Instead of the Parent Plus Loan, you know, let’s posit this scenario. If you’re only borrowing, like, $5,000 to $10,000 a year for your kid, you’re not going to be able to pay that back with a 20%-of-your-income monthly payment. You’re just going to pay the whole thing off, and then you’re going to pay, you know, an extra interest rate with a much-higher upfront fee for something that you could have taken out with a private lender and paid less money.
Travis [00:14:49] So, that’s an example for parents of why you would want to take out a private loan. So, a very typical example of who takes out a private loan is a parent trying to pay for their kid’s undergrad. So we have a place on our site — StudentLoanPlanner.com slash private — that you can visit, and you can see and comparison shop a lot of these different options. So you can do this for undergraduate loans or for graduate school private loans that you need.
Travis [00:15:10] As an example of this, let’s say that the parent decided to visit our site, and they shopped LendKey and Credible, which search a whole bunch of different private lenders. And they find, you know, a loan through, you know, Discover or Sallie Mae, something like that. And they get a 5% or 6% interest rate. They’re probably saving 1% or 2% on the interest rate, and they’re getting a lower upfront fee.
Travis [00:15:30] So is that worth it as a parent? You know, if you’re borrowing a small amount that you know you will have to pay back, then that’s a good thing to get a much-lower interest cost. But again, if you borrow over $100,000, this could be crippling to borrow private student loans.
Travis [00:15:45] So it’s kind of this catch 22 where you’d think that the bigger the amount you borrow with the private lender, the bigger the interest rate savings are. But what happens is when you borrow that much, your typical person doesn’t have the economic power and discipline to pay that back.
Travis [00:15:58] That causes retirements to be delayed. It causes a massive amount of stress. It causes family strife when the parents turn over the debt to the kids and say, “Hey, pay this back. Oh, by the way, you’re being, like, a normal 20-something-year-old, and you’re messing around in New York City or something like that without making much money, like, and paying all your money towards rent.”
Travis [00:16:18] That’s a very typical 20-something-year-old thing to do, right? You don’t really get serious about your economic obligations a lot of times until you get married and have kids or you hit your 30s.
Travis [00:16:27] So, is it worth it to borrow private loans as a parent? Yes. If you’re borrowing, you know, I would say less than $100,000, that you have a great job for, you’re going to pay it back in less than five years. If you’re going to borrow more than that, you definitely need to go with Parent PLUS Loans. And make sure, too, that that loan that you take out as a parent is only in the name of one parent so you can file separately for taxes and only include one parent in the monthly payment analysis for, like, an Income-Contingent Repayment amount.
Should private loans be used for graduate school?
Travis [00:16:55] What about for graduate school? Should you use private student loans for grad schools? I know that if you’re listening to this, you’re more likely than not either in a graduate school program or you’re a professional that’s graduated in last few years, and you’re interested in the student loan rigamarole. Let’s say to this, like, the next time somebody asks you around the water cooler, like, “Should you take out private loans? Do you think that’s a good idea?” Like, you want to be informed, right? If you’re in school, you’re probably trying to figure out, “Well, shoot should I take out private loans for my school cost?”
Travis [00:17:28] Here’s an example. I have — One of my favorite readers has battled through this situation where they’re trying to figure out how do they go to the cheapest dental school possible. So I’ll pick on one dental school this person was looking at. So, we’re going to talk about the Dental College of Georgia. This is one of the best deals in dentistry in terms of the total cost of attendance. That said, if you add up all of the tuition, the fees, the potential tuition increases and living expenses, you’re probably going to come out of the Dental College of Georgia with about $300,000 of debt.
Travis [00:18:01] If you come out with $300,000 of debt and you’re planning on practicing and becoming a practice owner in the state of Georgia, you’re probably going to do pretty well. You’re probably going to make more than $200,000 a year, especially if you go somewhere that’s not ultra-saturated in downtown Atlanta or something. So, you pick any reasonable practice and you purchase that, you’re probably going to do well enough to pay the loans back.
Travis [00:18:22] Here’s something that’s real interesting with graduate school programs. So listen up if you’re even not a dentist. For graduate school programs, remember that Stafford Loans for undergrads [are] like $5k to $7k a year. It’s very, very low in terms of what they let you borrow. But for grad school, you can get $20,500 per year. That is way, way more in Stafford Loans than for undergrads.
Travis [00:18:48] Now, for a lot of different medical professions, they will actually let you borrow $40,500 per year. So they’ll let you borrow much, much more of this 6% Stafford Loan that has a very low origination fee. That’s great if your eventual goal is to pay back your debt.
Travis [00:19:04] So, in this case, for this person going to Dental College of Georgia, they’re going to take out $40,000 a year of Stafford Loans — $40,500 a year of Stafford Loans at about a 6% interest rate. And when you start borrowing above that level, you have these Grad PLUS Loans. So remember that parents have Parent PLUS Loans for kids and undergrad. Now for grad school, they take the parents out of the equation.
Travis [00:19:23] And this kind of makes sense. Think about the way our culture talks about grad school. So my parents would always say, “We’ll help you out with undergrad, but grad school, you’re on your own.” Right? And how many times have you heard a parent say, you know, “I got you for undergrad, but after that, you know, I’m done.” Right?
Travis [00:19:37] So, there’s this definitely popular conception that grad school is the individual’s responsibility rather than being a family responsibility. And undergrad is kind of a mixed bag. Some people say it’s the kid’s responsibility. Other people say, well, it’s the parent’s.
Travis [00:19:50] So, if you think about that, you know, graduate school — it’s the kid’s responsibility, and our policy reflects that. OK? So, you’re going to take out $40,500 of Stafford Loans as this dental student going to this in-state university. And then you’re going to take out the rest as Grad PLUS Loans.
Travis [00:20:07] So Grad PLUS Loans have no cap. Remember Parent PLUS Loans have no cap. Grad PLUS Loans for graduate school programs after undergraduate also have no cap. That is a big deal if you think about it. That is really high-interest-cost debt. Parent PLUS Loans and Grad PLUS Loans actually have the same borrowing terms. So, Grad PLUS is 7% with a 4.25% origination fee.
Travis [00:20:30] So that is pretty expensive, pretty costly. And you’re going to take out this balance of about $140,000 — [it’s] either going to [come] from a private loan or a Grad PLUS Loan. So this math is very similar. If you’re a dentist, a veterinarian, a physician if you’re going to any of these medical programs that have a much-higher borrowing limit for Stafford Loans, then this math is going to be the same.
Travis [00:20:52] So as a dentist now, you have an option that has not previously existed. CommonBond is one of our referral partners. They have this loan program that you can take out a loan in your name only, which is very different. Most private student loans require a cosigner that’s currently earning an income that will kind of back you up and say that, “We’ll cover this in case you won’t.” Most private student loans require cosigners when you’re taking it out for school.
Travis [00:21:17] However, some of these programs, like CommonBond — I’ve read recently maybe College Ave is coming out with one of these and some other private lenders — they will let you take out loans in your name alone, which is really, really different. That’s not previously been an option for graduate students, but it’s becoming an option.
Travis [00:21:31] If you can get a loan from CommonBond and let’s say you could get a 5.5% interest rate from CommonBond, which has a 2% origination fee. So your options are 2% origination fee, 5.5% interest rate. Or Grad PLUS, which is 7% interest rate and basically 4% origination fee, give or take.
Travis [00:21:48] So here’s how this would work. You’re going to take out the Stafford amount first, and then you’re going to take out what you need from Grad PLUS or from CommonBond. So in year one, let’s say you take out $35,000. The fee that you would pay that would be financed into your loan with a private loan here would be $700 bucks, and with the government (would be) about $1,500. And the interest that you’re going to pay in year one is about $2,000 versus $2,500. There are some savings there. OK? But it’s not a massive amount.
Travis [00:22:18] Now, each year you borrow, the difference in the interest rates kind of adds up. So, over four years, you’re talking about private loan having much less interest costs in this case than Grad PLUS. So, if you sum up the total differences in the interests savings and the difference in the origination fees, what you come to is, with this marginal borrowing that you could either borrow from Grad PLUS or you could borrow it from the government, the private loan ends up being about $160,000 and the government loan ends up being about $170,000, including all the fees and interest everything. So, in other words, by using the private loan instead of Grad PLUS, you saved about $10,000 in interest over four years’ worth of dental school.
Travis [00:23:05] That sounds like a great thing, right? It makes you kind of wonder, well, should everybody be doing this? Because that’s really a pretty good deal to have $10,000 in interest savings from borrowing at a lower interest rate. But there are a bunch of catches.
A rule of thumb for how much private loans can save you vs. Grad PLUS
Travis [00:23:19] First off, I’ve got a rule of thumb for you. So pay attention. This rule of thumb is basically this: Every $15,000 that you replace Grad PLUS with lower-cost private loans, you’ll save an average of about $1,000 in interest costs over a four-year school period. And of course you’re going to try to refinance that.
Travis [00:23:40] So I would never compare the long-term interest costs of a federal loan versus a private loan because that just doesn’t make sense. So you’re really looking at the four years of school — like, what savings are you going to have from doing that? And that’s a general rule of thumb. So every $15k you’re replacing Grad PLUS with private loans, you’re going to save $1,000 bucks to do this.
Travis [00:24:00] Let’s pretend that you are in this situation where you just are a recent grad, and you just took an associate job. You’re making, like, $120,000 a year as a dental associate in Georgia. The thing that you would want to do is refinance your $300,000 student loan into a 20-year fixed repayment term. You might be able to get around a 5% interest rate, and if you get that, then you get about a $1,900-a-month payment.
Travis [00:24:23] So, $1,900 a month is certainly not that big of a deal. What I would focus on in that case is getting a big emergency fund of six months of expenses. You’re going to have to include your loan payment in the calculation on that. So you probably need, like, $30k to $40k of cash with your refinanced 20-year loan term. You’re also going to need to kill it doing great production, and then you’re going to be able to get a private loan from a bank to buy a practice. So you could replace that with buying a house. Like, starting a family. Like, whatever big financial goal you have.
Travis [00:24:56] If you do take out private loans in school, then what you’d want to do is you would want to basically refinance them as soon as you get out and get a really long-term monthly payment so that that won’t be used against you when you’re trying to qualify for various kinds of loans that you might want or need.
Travis [00:25:13] After you are secure in what you need for borrowing terms, then you’d be able to basically utilize a shorter-term interest rate — or shorter-term refinancing deal, I mean, with a lower interest rate, so you could do a 10-year, seven-year, five-year refinancing option once you get established in whatever you’re trying to get for funding your next big financial goal in life.
Travis [00:25:36] So, to take out a private loan, this person’s borrowing $300k total becoming a dentist in Georgia. They need to be 95% sure or greater than that that they will be paying back all of their loans. So, in other words, you need to be totally sure that you’re going to pay back all your loans instead of utilizing any kind of forgiveness programs at all.
How a private loan payment could affect your financial goals
Travis [00:25:55] And you also need to be sure that your financial goals will not be inhibited from having a high required payment. This could be something serious like starting a dental practice or buying a house or starting a family, where, by definition, a percent of your income is always affordable, so you never have to worry about it stopping you from doing something.
Travis [00:26:13] Or it could be something super silly. An example of this is I traveled the world when I was in my mid-20s for about a year to year and a half. And I would have been able to do that with an income-driven repayment option. I would not have been able to do that with a higher required payment out of my assets that I had to pay to a private lender.
Travis [00:26:32] So, whether or not your, you know, your life goal is a serious one that will result in, you know, adulting, hitting all those big milestones, or if it’s kind of silly, like, you want to join the circus. Or I don’t know. You know, something that’s not super financially sound, but you just want to do it because you only live once.
Travis [00:26:49] Federal loans are much better for these really flexible kinds of paths that people sometimes like to take. The reality is this, you know, if you’re making $200k a year, your payment on REPAYE (Revised Pay As You Earn) would be about $1,500 a month. And that’s true if you have $300k in debt or $600k or anything really. OK. And then if you refinance to a 20-year term, it’s $2k a month. A dental practice lender or a home mortgage lender will not care about that either way.
Travis [00:27:15] Now, this math is applicable across the board, no matter what profession you’re in. So, you know, obviously please listen in if you’re not attendants. This is applicable to everybody. But let’s say you went to a higher-cost program. Just to pick on NYU (New York University), which is one of my favorite schools to talk about — if you got a dental degree from NYU, you’d probably have $600,000 of debt.
Travis [00:27:33] You might think, “Well, OK. Well, I’m going to replace all this Grad PLUS borrowing. Everything above $160k, I’m going to replace it with, this Grad PLUS, I’m going to replace it with private debt.” So if you did that, you’d have to borrow $440,000 in private loans to replace your Grad PLUS Loans.
Travis [00:27:49] So, based on my little rule of thumb that every $15k you borrow saves you about a grand of interest, you’re talking about, like, approximately $30,000 grand of interest that you would save if you took out private loan instead of federal ones, and you paid them all back.
Travis [00:28:04] But if you have $600k of debt coming out of a really high-cost program like that, then your REPAYE payment is going to be the same if you have $400k or $600k of debt. So by adding even $100k of private loans, all you have done is created an additional monthly payment.
Travis [00:28:24] So, for example, your REPAYE payment is the exact same no matter how much debt you have. And then you have an extra $1,000-a-month private loan payment with $100k of debt that you have out. So it’s an additive payment.
Why an additive payment is bad news
Travis [00:28:35] And this is how people get really screwed over. In my experience, this is one of the worst things that can happen to you in student loan borrowing, is when you have a big chunk of debt, and you took out some private loans for a little bit of it. And it’s just an additive payment where, instead of paying, you know, your REPAYE payment or your Pay As You Earn payment and you’re good for figuring out what you want to do in life for the next few years, now you’ve got to make the federal payment, which the federal government doesn’t care at all that the private lender that exists. They’re not going to take that into account at all.
Travis [00:29:03] So you’ve got that, and you also have this private loan payment, so now you’ve got to pay $2,500 a month because you just borrowed $100,000 grand of private loans to cover a portion of your total cost.
Travis [00:29:12] And that’s true even for people, for example, who take out health professions loans. I see these offered a lot by the higher-cost schools, and they think that they’re doing people a favor because they’re getting you these 5% loans that are kind of subsidized and they don’t accrue interest for a while. Everybody thinks it’s a good idea until you realize that a lot of people that treat those as private loans actually create two separate payments for themselves, which is terrible from a cash-flow perspective.
Travis [00:29:38] It’s really hilarious because these financial aid offices really have no clue what they’re doing in most cases when they’re counseling people of what kind of loans to take out. I mean, I even got a message recently from a pretty high-up person in one of these professional programs, and they counsel people to try to make sure they pay down the interest while they’re still in school. No offense but that’s foolish advice when you look at the math because this particular graduate school is probably producing people that 90% of the time are not paying down their student loans. And they’re telling people to pay down loans that are going to eventually be forgiven, which is just awful advice. And this is somebody who’s super smart, that has a Ph.D. Who is, you know, a really senior person of this program who is clearly smart. They just are giving people bad advice.
Travis [00:30:21] So if you think about this, at NYU, 90% plus of the dental students are probably not paying down their loans. If you held a gun to their head and forced people to reveal what’s actually going on, you know, they might claim otherwise. But I feel pretty confident about that — that the vast majority of their graduates are not paying down their loans and are really all going for forgiveness.
Travis [00:30:42] So, if you replace any of that loan that’s going to be forgiven based off of the math, then what you did is you replaced $100,000 of private debt with something that would have been taxed at a 40% rate in 20 years. So, in other words, you’re trading $100,000 now for $40,000 in 20 years — which, holy cow, that is a terrible trade.
Travis [00:31:05] That’s why I said if you do take out private loans while you’re in school and you’re trying to basically take out loans from a private lender while you’re still enrolled because you think it’s going to give you a lower interest cost, that’s why you have to be 95% certain or more that you will be paying back this debt and that it’s going to be pretty affordable compared to what you’re going to be earning.
Travis [00:31:25] So you really shouldn’t be taking out private loans if you’re going to graduate with a debt-to-income ratio above 1.5. So, one point five. So, if you graduate with a debt-to-income ratio above 1.5, that’s telling me that you would be better served with a lower payment. That’s going to come in the form of an income-driven repayment program until you realize whether or not you’re going to make enough money to afford to pay back your debt.
Fields with higher Stafford Loan limits
Travis [00:31:47] OK. So what about other fields? Because I just picked on one particular example looking at a low-cost program versus a high-cost program and only one profession in dentistry. So let me expand the talk here a little bit and tell you about who gets to borrow this much higher Stafford Loan limit. And realistically, if you’re able to only borrow Stafford Loans under any of these professions, you’re going to be sitting pretty. You’re probably going to be able to pay back this debt without having too much of a problem because these are generally fairly low-risk professions with a couple exceptions.
Travis [00:32:19] For example, here’s the list of people that can borrow $40,000 grand per year of Stafford Loans instead of $20,000 grand, which is the normal limit for graduate students. So you got dentists, veterinarians, optometrists, physicians — either osteopathic or allopathic — podiatrists and naturopaths. Those are the people that can pay back the — that can borrow the $40,000 grand of Stafford Loans per year instead of 20.
Travis [00:32:40] The only person that I think if you only touch Stafford Loans that could not afford to pay that back is probably naturopaths because, you know, they don’t make enough money typically to be able to pay that back if you borrow for four years.
Travis [00:32:49] Now, there’s a different limit for pharmacists, psychologists, chiropractors and people in public health. There’s a $33k limit. $33k. Now, for other folks, you can borrow $20k year if you are in law school, occupational therapy, nurse practitioner, PAs (physician assistant), physical therapists, MBAs (Master of Business Administration). A lot of professional degrees that are not on that list, you only get to borrow $20k per year of Stafford Loans.
Travis [00:33:15] So that means if you are in this law school, MBA, you know, nurse practitioner kind of realm or you’re not one of these special medical professions that gets the really high borrowing limit, then you hit that Grad PLUS ugly 7% interest rate loan option way sooner than your dentist or veterinarian or physician peers would.
Travis [00:33:34] That means here’s this situation for people in law school or MBAs or something like that. Say you’re in your second year of your program, and you’re really, really sure that you’re in the top of your class. You’ve got a job lined up — or you know you will be getting one soon — and you’re going to be making a lot of money. And you have to borrow more than $20,000 that year to cover your education.
Travis [00:33:55] Then it makes a lot of sense to use private loans for that because you’re just going to be refinancing the whole thing anyway when you graduate. So you might as well go ahead and take private loans out for the graduate school — or the Grad PLUS part of your graduate school needs.
Travis [00:34:12] So let’s say, for example, that, you know, you’re at Harvard Law School, and, you know, you’re going to get a BigLaw job making $190k. And you’re in New York. Well, you might want to go ahead and make a take out a private loan. Everything you need above $20k, you know — Unless obviously Harvard Law probably has some sort of special low-interest borrowing program. Maybe. I’m not sure. I’m not super familiar with it.
Travis [00:34:30] But let’s say that you’re at a school that’s still in the top kind of realm, like one of my friends went to Boston University, I think, for law school and was in the top of his class. Got a BigLaw job. So, let’s say he’s got the BigLaw job landed. Well, now it makes a lot of sense to just use private loans with a lower interest rate than to take out federal loans because he knows that as soon as he gets his job in BigLaw, he’s going to be refinancing it and paying it down aggressively.
Travis [00:34:56] So, for people who are going to be taking a program that’s going to put their debt-to-income ratio below 1.5 to one right away and they are more comfortable with the sort of traditional corporate path, then I think it makes a lot of sense to go ahead and take out private loans to avoid Grad PLUS.
Travis [00:35:12] So, avoiding Grad PLUS in graduate school is the primary reason why you would borrow from a private lender. That’s really the only reason why you would do it. I would not use it to avoid borrowing Stafford Loans because Stafford Loan terms are really honestly not all that bad.
Travis [00:35:24] So if you, for example, are in a top MBA program, let’s say you’re going to do an investment banking job or a consulting firm job, then getting a private loan with, you know, a Sallie Mae, CommonBond kind of place, you can visit StudentLoanPlanner.com slash private to look at options there. You’ll save some money. Remember, every $15k that you borrow that you’re not borrowing under Grad Plus, that you use private loans instead for will save you about $1,000.
Situations where private loans are the worst option
Travis [00:35:54] OK. Now let’s transition to a different segment. When are private loans the worst no matter what? Here’s a couple examples. You don’t know what jobs you’re going to take in the next few years. For example, you’re in an MBA program. You are unsure about your path, even though you said that you were going to MBA school to go into big tech and then you change your mind. You’re kind of unsure, and you want to take a job at a startup. And then you want to maybe start your own firm. Or maybe you want to try different things or travel.
Travis [00:36:25] Like, say basically you don’t follow a traditional path. Then private loans are the worst because it is a required monthly payment that you cannot get out of for any reason.
Travis [00:36:35] Whereas federal student loans, let’s say you take up with, you know, a British classmate of yours, and you marry. And you move to the U.K. and now you’re living abroad. Well, you can exempt $100,000 of income per year from your income-based repayment number. So, say you’re making $150k and you’re living in the U.K. and you’ve got only federal loans, you know, and you only have $50k of U.S. taxable income, you could be paying, like, $300 a month on$200k or $250k of debt. So. And that’s if you’re, you know, a top MBA grad or something.
Travis [00:37:06] So, if you’re going to have a really weird life, then private loans are really awful. If you’re going to be really straightforward and traditional with your career path, then private loans can make a lot of sense.
Travis [00:37:18] Another issue where people get screwed when they take out private loans for school: I had a case where a physician assistant, she went to, like, this high-cost program in the Northeast Mid-Atlantic kind of place. So, you know, like a Georgetown, like, BU (Boston University) kind of school. Right?
Travis [00:37:34] So she took out — half of her loan, she took out private loans because her parents saw the Grad PLUS interest rate was really high and they could get a cheaper rate at Wells Fargo with, like, 6%. And guess what happened? She ended up taking a job at a big hospital system — a real prestigious one in, like, a big city — and she ended up qualifying for PSLF (Public Service Loan Forgiveness). Holy cow.
Travis [00:37:56] If she had borrowed federal loans, that $100-something-thousand that she had borrowed would have been forgiven tax-free, instead of her having to pay that back. So her parents thought they were helping her out by getting a lower interest rate, and instead, they blew up their finances.
Travis [00:38:12] This is an example of the problem with private loans is this: You can save yourself, you know, $10,000 to $20,000 to $30,000 grand by taking out private loans while you’re still in school. That’s the high-end savings amount for private loans. The downside risk, though, is you could cost yourself $100,000 or more if you make a terrible mistake and borrow private loans when you should have taken out federal loans so you could benefit from forgiveness.
Travis [00:38:41] So, this is a situation where the odds are stacked against you for taking private loans. Because if you take private loans and you know what you’re doing, then you could save some money. But if you don’t know what you’re doing, which is the vast majority people, by the way, in terms of their student loans, then you can really screw yourself over.
Travis [00:38:58] And, you know, no offense to people. Right? But, like, it’s nice when people just admit that they don’t know the intricacies of student loans. I’ve got a lot of people that are like, “I’m on my REPAYE plan. I’m paying my 10%. And I know exactly what I’m doing. I don’t need any help.” And unfortunately, like, my own parents are kind of like that. They would rather hit their heads against a concrete wall than pay money to a lawyer to do something that they need to do.
Travis [00:39:24] No offense, but that’s, like, probably not a smart thing to do. Because what ends up happening is you title something the wrong way or you make a mistake because you didn’t — you weren’t aware of something, and then you cost yourself a ton of money.
Travis [00:39:37] You know, if you have a very simple situation or if you are committed to listening to all these podcasts and reading our blogs, then you definitely don’t need our help because you’re doing your homework. But most people don’t. They read a couple articles, and suddenly they’re an expert. Then they make a decision, and it ends up being a terrible decision.
Travis [00:39:54] So, for example, that person that’s like, “I’m on my REPAYE plan. I’m paying my 10%. I’m good. I don’t need any help at all.” Suddenly, the person, you know, you find out they’re filing taxes the wrong way. They live in a community property state. They haven’t considered the proportional distribution of payments across spouses. They haven’t looked at the interest rate, basically equivalent savings from refinancing a spouse alone versus both going for loans and getting PSLF and using the spouse’s payment for absorption of payments.
Travis [00:40:21] So, there’s all kinds of complicated stuff going on for private school loans. I do want to try to boil it down a little bit. Again, if you’re certain you’re going to pay back your debt, then take out private loans. If you’re not sure, if you have any doubt at all, do not take out private loans.
Travis [00:40:34] Now, private loans are good for these traditional career paths, but they are really bad for people who want to do a startup or take some job that’s a little different. So even a dentist that wants to buy a dental practice, you want to have a low required payment that’s a percentage of your income. You don’t want a big, high required payment that you’re definitely going to have to pay because, you know, you might find out that you can’t do the startup that you wanted to do. Dental startups, you need — you want to have a ton of cash. You want to do an acquisition; you need at least $30,000 to $40,000 in the bank.
Travis [00:41:04] You know, if you have this big required student loan payment, what if the lender that’s looking at you decides to decline your practice loan for a year because you have a high required student loan payment? These are the big risks that exist with private student loans. It’s not being able to get a loan for something that can make you make more money. And it’s preventing you from taking entrepreneurial risks that could pay off big time in the long run and save you far more money than $10,000 of interest savings.
Travis [00:41:33] So, I don’t want to say that the private loans don’t have a place, but I want people to be adequately prepared for understanding what they’re getting themselves into.
Why overestimating your potential earnings can hurt you
Travis [00:41:39] Just a little aside here, while I’m in my ranting mode, most people overestimate what they’re actually going to earn. For example, my wife thought she was going to earn a certain amount of money as a surgeon, and then she actually got the offers from the academic hospital she wanted to work at. And she’s looking at offers that are like 50% less than what she thought she was going to make. What she did is she just took the mid-career, private-practice number that she heard from some friend. She thought that was what she’s going to earn. And it wasn’t accurate. Right?
Travis [00:42:08] So everybody, like Lake Wobegon. There’s this, like, story where everybody in Lake Wobegon is above average, you know, and everybody believes they’re above average. Well, obviously that’s not possible.
Travis [00:42:21] So, when you look at these reports, it shows average earnings. If somebody is going to be an occupational therapist in a very saturated area, you’re going to make $60,000 to $80,000 most likely. If you are going to be a lawyer in a town without a big law firm, you know, you’re probably going to make $100,000 grand. Probably not much more than that, unless you become really successful and have your own shop. You know if you are a physician at an academic facility, you’re not going to get giant raises. You know if you are a dentist in a saturated area in the San Francisco metro area, you’re probably to make $150k to $180k, and that’s pretty much it. I mean, that’s the average.
Travis [00:43:02] So people oftentimes, like, they will drastically overestimate their earnings. And when you do that, it makes your assumptions about what income you were going to get totally wrong because it makes that debt-to-income ratio number a lot higher than you thought it was going to be. And then the math supports going for forgiveness instead of paying it back.
Travis [00:43:19] So, you do want to be a little conservative. Like I would just be conservative with what you think you’re going to earn. And if you still are hitting that 1.5 debt-to-income ratio that you need to take out private loans, then do it. Don’t feel bad about it. I don’t want everybody not doing private loans.
Travis [00:43:34] Full disclosure, you know, when you visit StudentLoanPlanner.com slash private, you know, we get paid if you decide to click on those links and shop through those lenders and take out a private loan for school. And I’m actively trying to make sure that you’d make the right decision. Because that’s what it’s all about, is giving you the accurate information that you need to make a decision so you trust Student Loan Planner, and you want to tell your friends that we’re a reliable source of information — and also just because it’s the right thing to do.
Travis [00:44:00] So, if you want to take a career risk or a family risk and not follow a linear path, federal loans are the right decision for 80%-plus people. The other 20%, one in five people, should definitely consider getting the same educational product for a cheaper price but financing it with private debt.
Why private loans might make a big comeback
Travis [00:44:18] And I think that, you know, you’re going to see a lot of private loans make a big comeback, especially if Republicans win and take control. I think there’s a huge movement to cap borrowing for federal loans. And if that happened, you would need a massive amount of loans to help people get through their education.
Travis [00:44:37] The reality is I feel like student loans and unlimited student loans are a lot like heroin addiction for these universities. The universities are just addicted to it. I mean, that’s why you have such big budgets. That’s why you haven’t seen, you know, any effort to cap costs at these schools because they don’t have to. Because they can literally just say, “Well, I’m going to raise the cost of tuition another 10% because we can.”
Travis [00:44:59] There’s even a case with the University of Washington that I think is really fascinating. Their dental school basically, you know, a couple deans ago — and again, this is my opinion — but the dental school dean was an absolute moron and made all these terrible business decisions. And the only way that the dental school could bail themselves out financially was basically to jack the cost of attendance up by, like, double or triple.
Travis [00:45:23] And so, over a very short time period, you saw these massive increases in the cost of the program — all because the dental school tried to make all these, you know, extra satellite campuses. And it didn’t work out well, and they kind of blamed it on the legislature for cutting their funding.
Travis [00:45:38] And then it wasn’t really that. It was because they made a bunch of stupid decisions. Again, this is all just my opinion, but I think you have a lot of these private and public universities with these really expensive graduate programs that, if you did have capped borrowing, it would take them a while to right-size their program sizes.
Travis [00:45:55] So, I think you would see private loans enter the market to try to help soften the blow of people who still want to go to these programs and borrow to cover the cost. But the tuition would absolutely collapse on a lot of these programs if you had capped federal borrowing.
Travis [00:46:10] Of course, you would you would see a lot fewer graduates, so, in a lot of these programs. And that could potentially limit access to people from more-needy families. I mean, that’s a concern.
Travis [00:46:19] And frankly, too, I mean the system that we currently have, if you’re only option in life is to work a desk job or, you know, be a dentist and go to any place that will have you, it’s still a good job — a good idea to be a dentist. Because you can go to Midwestern or NYU or USC kind of place and borrow $600,000 grand, and you’re not really borrowing $600,000 grand. You’re borrowing 10% of whatever earnings you’re going to make because that’s the way the income-driven programs work. And you pay 10% of your income for 20 years, and it’s wiped away. Yeah, you probably have to pay a tax bomb. But realistically, the politicians are probably not going to let that happen to people, even though you should prepare for it.
Travis [00:46:56] So, would you rather make $120k working 40 hours a week being a dentist with losing 10% of it to taxes? Or would you rather work a desk job at a corporate place somewhere with no debt and make $60k, $70k, $80k a year. It’s still the decent idea to make what’s on paper a terrible financial decision and go get these professional degrees.
Travis [00:47:16] So, it’s really fascinating. It’s just real interesting to think through this stuff and all the implications. And, you know, just for letting you know, I mean, a lot of the cases where I’ve seen people really be screwed over, they had private student loans and a lot of them with federal student loans.
How an interest rate offer shows whether a degree choice is sound
Travis [00:47:30] So, just be careful that — a couple more notes — if you are getting only offered private student loans at a high interest rate, I don’t want to be mean or anything, but that’s basically the private lender telling you that you’re probably making a stupid decision going and getting that degree program. If they’re coming back and they’re telling you your only interest rate that you have offered is, like, a 12% or 13% interest rate, they’re saying that the quality of the education you’re getting is probably pretty bad, and you probably shouldn’t pursue it.
Travis [00:48:01] So, there’s some exceptions. You know, maybe you’re like — you got a green card or something, or you’re not technically a citizen or permanent resident. So you have — that’s your only option for borrowing and completing school and getting the degree that’s going to allow you to earn money.
Travis [00:48:13] There’s obviously exceptions to every rule, but as a general rule of thumb, you know, if you’re looking at private student loan options, that might be a great proxy. Even honestly, if you just wanted to apply just to see what you could get offered and see what interest rate you’re going to get, that’s a good proxy for what the private market thinks of your degree.
Travis [00:48:31] So, that’s kind of an interesting thing to do when you’re considering going to school or continuing a program. Like, see what interest rate the private sector would offer you, and if it’s a decent one, then you’re probably making a decent decision. And if it’s not a decent one, you’re probably getting had by, you know, a sales department in the admissions department masquerading as trying to help people out.
Travis [00:48:52] So, for top students going to the private sector trying to avoid Grad PLUS, private loans — StudentLoanPlanner.com slash private — definitely a decent thing to do. But for other people — people that could potentially end up [with] not-for-profit employers, people who are free spirits that might travel Europe instead of getting a job right away, people who might want to do entrepreneurial stuff like start their own business or own their own business, people who want to eventually work part time at some point, maybe have a big family — these are all people who should prefer federal loans over private loans.
Travis [00:49:26] But private loans do have a place. And if you do have any comments or questions, please leave a comment on the show notes. You can find the show notes here by going to StudentLoanPlanner.com slash 34, and you can leave a comment if you have a question about the show.
Travis [00:49:41] Also, we love hearing from you — Podcast@studentloanplanner.com. We’re going to have a SpeakPipe coming down the road soon where you can actually leave a comment or a question with your actual voice, and we’ll actually record some of those and show some of those on the show, so you can get kind of a source of free help via the podcast. So I’m excited about that.
Travis [00:50:00] Obviously, if you have any questions about your private loans, you know, you can go visit that StudentLoanPlanner.com slash private and leave a comment, and I’ll answer it personally.
Travis [00:50:08] If you have a specific example that you’re trying to work through about whether or not you should take private loans, we would love to help you out with that. So thanks so much for listening to our show. And you have a wonderful week.