The Key to Financial Success: Debt Management
Debt is a reality of modern life for most physicians. While debt is a tool that allows most graduates to earn a degree, it can quickly become a source of stress if managed improperly. Mastering your debt requires a candid review of your current debt and a repayment strategy that accounts for your other financial goals. The most common types of debt and strategic approaches to managing each are explored below.
Most young doctors have student loans. While student loans paid for the education that created an opportunity to earn a comfortable income, they can also feel like a heavy burden. In fact, the average medical student from the graduating class of 2010 had $160,000 in student loans. While it never hurts to discuss your loans with a private banker or financial advisor, here are some basics:
- Pay, at a minimum, the interest on loans with a rate higher than 6% while they are in forbearance or deferment to prevent interest from accumulating. Make sure you have adequate emergency cash reserves first.
- Elect the longest repayment period available to give yourself maximum financial flexibility. This will not increase your interest rate and you can always repay the loan sooner than required.
- Repay private student loans first. Many private loans have variable interest rates that will cost you a bundle in the long run. If you have variable rate loans, pay them off first.
- Consolidate your student loans to lock in a lower interest rate, but be sure not to mix them with non-student loans. Doing so may preclude you from taking a tax deduction on student loan interest payments.
Credit cards are a common and often problematic source of debt. People with multiple credit cards often pay the balance on cards with the highest interest rate first. Consider another approach. Focus on the balances that can be paid down most quickly. This approach can have a “snowball effect”, which generates psychological momentum by reducing the number of cards to worry about and can actually reduce the total amount of interest you pay in the long run. It is important to save the funds no longer required for debt repayment along the way. If you have maintained a clean credit report, a better approach may be to eliminate your credit card debt altogether by taking out a consolidation loan at lower interest rate. One monthly payment is more manageable and can be the best way to reduce debt related stress.
A mortgage is often the key to realizing the dream of owning a home. It is also a serious financial commitment that should not be entered into lightly. Make sure to have your lender coordinate with your financial advisor to ensure your mortgage fits your overall financial plan. Here are a few guideposts to help you along the way:
- Affordability – Choose an affordable home. If you are just starting out, your mortgage should not be larger than 1-2 times your annual income.
- Down Payment – If you have chosen an affordable house, the size of your down payment is less important. If, however, you maximize your down payment (without sacrificing your other financial objectives, of course) you may receive a lower interest rate. Exploring all available loan options, including banks and brokers, will help guarantee you get the best deal out there.
- Mortgage Structure – You should structure your mortgage such that you can pay it off by your desired age of financial independence or sooner. Make sure your mortgage has a fixed interest rate for 7- 10 years or the length of time you plan to stay in the house, whichever is greater. Maintain your financial flexibility by structuring your mortgage to require small cash payments.
- Repayment – If you are in a position to pay down your mortgage but are considering leaving your cash invested elsewhere, three factors should weigh into your decision: Economics, psychology, and asset protection. If you earn a higher rate on your investments than your mortgage costs, maintain the status quo. Also be aware of the mortgage related federal tax deductions available to you. If having debt keeps you up at night, consider paying down your mortgage even if you are earning more by investing. Finally, it is important to understand how the laws of your state treat home equity in terms of asset protection. Some states, like Florida and Iowa, have strong home equity protections in place. In states with weaker protection, a mortgage can actually protect your home in the event of a lawsuit. After considering these factors, decide what works best for you.
While economics are important, you should not lose sight of the psychological aspect of debt. Your piece of mind and well-being is invaluable. Consider seeking the advice of a professional to help you develop your plan regardless of your situation. It can’t hurt.