Imagine you have just finished residency and are starting your medical career. You may feel relieved to finally have those years of schooling and training behind you. But then reality sets in, and you wonder how you are going to deal with the medical school debt that you’ve accrued. According to the American Medical School Association1, 86 percent of medical school graduates carry educational debt, with the median debt burden $155,000 for public school graduates and nearly $185,000 for private school graduates.
How can a young physician balance the financial stresses of overwhelming medical school debt with buying a first home, saving for retirement, buying a new car and, at the same time, enjoying life? Let’s approach this question with a specific plan of action and some principles that can help any young physician.
Below is a case study with a basic guideline of how a young ophthalmologist’s finances could be spread among these above-mentioned priorities. To develop a plan, you will need to take some time to ponder and reflect upon your situation. The best time to do that is now, early in your career. Here are some things to consider as you do that.
|Case Study: Young Ophthalmologist
|Rainy Day/Further Debt Paydown
|Save for First Home
Strategies for Student/Consumer Debt and the ‘Rainy Day’ Fund
In my opinion, one of the most important things you need to do is to lower and eliminate consumer and educational debts as well as establish your “rainy day” fund. Now that you have your first job as a physician, make sure that, during the first few months, you set aside money for the “stuff happens” factor in life, such as the car breaking down or the furnace going out. I call this the “rainy day” fund.
For any physician, I suggest saving a minimum of $12,000 within the first few months. If you make more than $250,000, double that. Continue to save that amount annually to keep building up for the rainy day. Keep these funds in a money market or checking account until you have more than $20,000. Then, consider a low-risk investment account where you can pull out all of your money without any penalty, if necessary.
Beyond the Cash Cushion, Focus on Reducing Your Debt
First, make sure that you consolidate and lock in the interest rates for your student and consumer debt. We are at all-time interest rate lows, and they are not likely to get any lower. In fact, interest rates are likely to rise within the next two to three years. Consider signing up for automatic payments to knock off 0.25 percent or more of your debts.
Secondly, while in residency or fellowship, consider either deferring your loan (where interest will compound) or seeking forbearance through an income-sensitive or earnings-based repayment plan. Note that earnings-based repayment requires a lower monthly commitment than an income-based version but extends the life of the loan.
Next, consider debt-forgiveness programs that are available through federal or state sources. Visit the Association of American Medical Colleges and the National Health Service Corps for more information.
Also, find out what it would take to pay back your student loan in 10 or 15 years instead of 30 years. Consider that 30 years of interest on a 5 percent $150,000 student loan amounts to nearly $140,000 worth of interest! If you pay back the loan over 30 years, you’ve just nearly doubled the total amount that you’ll have to pay; whereas using only 15 years reduces the total interest to nearly $64,000. That $76,000 interest savings could buy you the cabin or RV (or five European vacations!) you want in retirement. At a minimum, consider putting at least an extra $500 to $1,000 per month or more towards your debts.
Lastly, your student loans are not likely to be tax deductible (because you will be making more than $90,000); as such, pay them down before you pay down a mortgage. However, other consumer debt, such as credit cards and car loans, typically carries higher interest rates. Pay off this debt (or even better, don’t have consumer debt in the first place!) before paying down student loans.
Focus on paying off one debt or another by balancing interest rates versus your cash flow. If you have a huge interest-rate difference between debts — say 4 percent or more — pay off the higher interest rate debt. Also, if you only have $5,000 or more left for a debt, consider focusing on that debt: pay it off and increase your monthly cash flow.
Enjoy a Reasonable Lifestyle and Save for Retirement
What is a reasonable lifestyle? Although this means different things to different people, I consider it to mean that you aren’t just squeaking by. Perhaps you are able to eat out frequently, go on a vacation or do things you enjoy, while still being committed to keeping your expenses within limits. To help keep an eye on your living expenses, use free budgeting and wealth management tools such as Mint.com, Emoneyadvisor.com and Creditkarma.com.
Next, how do you balance all of this with saving for retirement? First, contribute to your 401(k) (or 403(b)/457(b) defined-contribution plans). This not only counts towards retirement, but it lowers your income taxes. Secondly, make sure to contribute at least up to the maximum match that your employer provides. If your employer matches dollar for dollar, this is equivalent to an automatic 100 percent return. Even if your employer matches 25 or 50 cents on the dollar, that is still equivalent to a 25 or 50 percent return just for contributing. Lastly, if your debt load is reasonable and you have the ability, try to get as close as possible to maxing out your maximum contribution in your 401(k) (or other plan) to lower both your federal and state income taxes. If you are under 50 years old, the maximum you can place in the 401(k) is $17,500 in 2013.
Be Smart About Big-Ticket Items
After years of living in small houses or apartments or driving older vehicles, many young physicians feel they’re more than ready to purchase a new home or car when they finally get their first “real” job. Instead of rushing out to buy such big-ticket items, however, take a moment to think about how those purchases might affect your ability to achieve your long-term financial goals. What happens if your first job doesn’t work out and you have to relocate? Bear in mind, too, that your lifestyle can change as you pay off your debt.
Once you are finally ready to make those purchases, here are a few things to consider.
When buying a home, make sure you can put at least 20 percent down on the property. If you put only 5 or 10 percent down, you may be required to have private mortgage insurance, the cost of which could raise your monthly payment by a couple hundred dollars. (Note that there are some physician-specific loan programs that may not require private mortgage insurance. However, getting in the practice of saving towards a goal is a wonderful form of financial discipline.)
Remember that cars are depreciating assets. The second you drive a new car off the lot, you typically lose $5,000 to $10,000 of the value. Why put a significant chunk of your hard-earned income into something that you know you will lose money on? Instead of buying a new car, consider buying a used one and holding onto it as long as possible. Financially speaking, buying a low-mileage used car (say with 20,000 to 50,000 miles on it) and holding it for five years or more makes much more sense than leasing or buying new.
I also strongly suggest paying cash for a car. If you already have a high-interest car loan, consider paying it off as soon as possible. If you do decide to get a new car, remember that buying can be a better deal than leasing, especially if you hold on to the car for five years or more. If you lease a $20,000 car over three years at 6 percent interest and pay $1,000 down, the total cost over three years will be $12,600 plus the down payment. At the end of the lease, you will have paid $4,200 toward the principal of the loan and can either purchase the car or return it to the dealer.
If you purchased the same $20,000 vehicle with the same down payment and financed it at 6 percent interest, you would pay $7,500 per year ($22,500 plus the down payment over three years). At the end of the loan period, you will own the car.3 And if you look at the cost of leasing over 10 years (let’s say that you renew your lease every three years) and get the latest model car, the costs for leasing will be at least $42,000 plus down payments. (Whereas if you bought the car and held on to it, the cost would have been $22,500 plus regular maintenance.) Buying rather than leasing would save you nearly $20,000.
Physicians have big hearts and big dreams. They may want to pay for their kids’ college education, buy the cabin or second home, buy a boat or RV or give lots of money to worthwhile charities. Here’s my advice: hold off on these things until you are debt free. Remember that once your debts are paid, you’ll have the cash to fund these other projects.
As a physician, you’ve made a commitment to helping others and your community. Now, you need to make a similar commitment to your finances. If, as a young physician, you focus on paying off your debts, saving for a rainy day, living within your means and putting money away for retirement, you can then do the things you’ve long dreamed of doing and be well down the road toward financial independence.
2 Assumes married and filing jointly, effective tax bracket based on 2012 tax brackets with standard deduction of $11,600 and payroll taxes of 7.5 percent up to $110,000 of compensation.
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About the author: Dave Denniston, CFA, is a professional wealth manager and financial advisor located in Bloomington, Minn. He is also the author of 5 Steps to Get out of Debt for Physicians and 45 Secrets to Financing a College Education. You can contact him at www.daviddenniston.com/young-physicians.