You have bet on yourself time and time again. This required putting in hours of studying, honing your expertise, and taking on a large financial obligation. You have done all this for a chance to practice a profession that demands the very best of you each and every day. To many residents, the end is in sight! Doubling down and going for broke is about to pay off. As residents work to complete their training, they are faced with many decisions that can have a long term impact on both their personal and professional lives. This shift requires a change in thought. Instead of going for broke, now it is time to go from broke.
Today’s residents report higher than ever student loan debt as they finish medical school. Medical student loans typically start requiring payments six months after graduation from medical school. It is possible to defer student loan payments during residency but the interest will normally accrue during this time with the exception of undergraduate subsidized federal student loans. According to the Association of American Medical College, the average medical school debt for graduates in 2019 is $196,520. Based on this amount of debt the normal ten-year amortization would come out to roughly $2,206 per month if we presume a 6.25% interest rate. This does not include the costs of additional loan payments from undergraduate degrees.
Getting financially started on building wealth can be a daunting task to overcome. At the same time, you must be focused on learning, career opportunities, and where you will be living and working once you have completed your residency. As this transition occurs, preparing yourself for important financial decisions beforehand will result in a much better outcome. Below I have outlined 5 questions residents have asked me during consultations as they try to navigate their life and career to get to the right answers.
The Student Loan Debate: Do I Pay or Do I Go…for Forgiveness?
The answer is different for each person because it often depends on their individual situation. To better understand your options, let’s first explore the three main types of student loan forgiveness programs.
Income-Based Repayment Plans
Income-Based Repayment Plans are only for federal loans and they require payments to be made for 20-25 years, depending on the type of student loan, before the debt is forgiven. This monthly payment is based on one’s income which is recalculated annually and must be applied for each year. There are 4 types of repayment plans. These are REPAYE, PAYE, IBR, and ICR. Often residents choose one of these options to get help through their residency in order to keep their initial payments low. You can get estimates online at Federal Student Aid, an office of the U.S. Department of Education. This will provide information on payment options and the total interest paid throughout the lifetime of your federal loans.
A common aspect of these repayment plans is that as your income increases, the monthly payments increase. Whatever amount is still owed at the end of the 20-25 years is forgiven and is taxed as ordinary income. Unfortunately, this event often results in a large tax bill that year. When running an analysis, this is often the most expensive option. Normally, residents use this as a short term option to clean up other financial issues such as credit card debt and personal loans. This is the best option if you have the ability to increase your income in the future to pay down total debt later or as discussed below, using these repayment options as part of a bigger strategy.
Public Student Loan Forgiveness
The Public Student Loan Forgiveness (PSLF) Program allows all federal student debt to be forgiven after ten years of payments made while working for a qualified non-profit organization. The strategy is to apply for one of the four Income-Based Repayment Plans and pay the least amount over those ten years. One of the great advantages of PSLF is that any amount forgiven is not counted as taxable income!
This can be a great option for those that are already drawn towards working for a non-profit organization. Unfortunately, there are two disadvantages to this method. The first is that it holds you captive in that non-profit field for ten years. This could make you pass on career opportunities. The second disadvantage is that there has also been recent speculation that this program may be terminated in the future. Part of the speculation regarding this program is that it has been attacked in the news for incorrectly not forgiving these student loan debts. If this strategy is implemented, it is very important to follow all guidelines, reporting, and tracking to ensure the highest probability that this strategy will work. Also remember, this strategy only works for public loans. Many loans you take along the way may be private loans. Make sure to do your research about your loans before considering this option.
Special Medical Student Loan Forgiveness Programs
There are also specific medical loan forgiveness options if you go to work for designated underserved communities or positions. These opportunities require some research to track down. The Association of American Medical Colleges has a database that you can review. Below I have listed out some of the more familiar programs available. Typically, these forgiveness programs require a 2 or 3-year time commitment and have limits on how much they will pay towards your student loans.
Each of these has strict requirements. However, these can be great options for some individuals who want to give back to underserved communities while paying down their loans. Typically, these programs are a great fit if community service already lines up with one’s career aspirations and goals.
Bite The Bullet
As you finish your residency and your income increases, your cash flow will often improve enough to help you pay down student loan debt. However, this opportunity can be difficult to execute because you may be tempted to have a major increase in your standard of living. You may want to follow your peers and move to a high cost of living area, purchase an expensive home, and buy a luxury vehicle. Often these things have been put off for over a decade and it is normal to feel like one is missing out.
A good long term strategy is to strive to initially maintain a similar spending lifestyle as though you were still in residency and then slowly increase your personal lifestyle as you make progress on your goals and pay down your student loans. Keep in mind, some things are going to come up that you must spend on. However, you should strive to focus on putting this new windfall towards your financial milestones. This will result in increased flexibility for personal spending without stress or worry now and going into the future.
Should I Take Advantage of My Employer’s 401(k) Match While I Owe Debt?
Do you like free money? According to a research paper by Financial Engines, on average, employees miss out on $1,333 per year from their employer’s retirement plan by not taking advantage of their retirement match. For those with higher incomes, missing out on a match has a much bigger impact as contributions are made as a percentage of income.
Mary and Bob both have a 4% match, Mary makes $150,000 and Bob makes $50,000. Here is their total match:
Mary: $150,000 * .04 = $6,000
Bob: $50,000 *.04 = $2,000
Compounding $6,000 over 20 years at a 6% growth rate = $233,956 in free money.
Compounding $2,000 over 20 years at a 6% growth rate = $77,985 in free money.
Taking advantage of your match should be a top priority. The major exception to this rule is if your cash flow is so tight that it would result in not making payments and going deeper into debt and hurting your credit. If you find yourself in this situation, you should hold off on the match until these higher priorities have been addressed.
Also, you should analyze and understand your employer’s other benefits. Based on research from the Society for Human Resource Management, employees that fail to review their options during open enrollment miss out on $500-$2,500 per year by not properly selecting or utilizing their benefits. Often these are benefits like group insurance policies, HSA, FAS, tuition reimbursement, child care help, etc. While you want to review each benefit in the context of what makes sense for your personal situation, group benefits often have pricing advantages that you can’t get in the individual marketplace.
Should I Refinance From Federal to Private Student Loans?
There are pros and cons to consider when refinancing from federal to private student loans. The positive is that you may get a lower interest rate if you have good credit. However, you are also giving up some of the flexibility that comes with federal student loans. Many repayment options, such as loan forgiveness, deferment, forbearance, and income repayment options are typically not available in private loans. Of course, some companies, like SoFi, have private student loans that offer some flexibility for an unexpected job loss.
If the game plan is to pay off the debt, then exploring refinancing is a good thing to consider. Going from a 6% interest rate to a 4% interest rate can save a lot in interest payments over the lifetime of your loan. Just be aware that some of the flexibility associated with federals loans is being given up. Sometimes a good strategy is to focus on getting settled into your career and new living situation while making some initial payments on the federal student loan debt. Then as you transition more fully into your work, look at refinancing based on what the next few years of income may look like for you.
Why Should I Save For an Emergency Fund and Get Insurance in Place?
Movies and books glamorize building wealth by showing how someone outsmarted others and made some risky investments that paid off. In real life, building wealth in a highly predictable and achievable manner is significantly less sensational. Authors, Thomas J. Stanley and William D. Danko, who wrote the classic The Millionaire Next Door bestseller, point out the common traits of those who build wealth. Most wealth-building starts with personal behaviors that focus on living within one’s income and saving at a constant level.
As pointed out in the book, with all the ups and downs of life, if you do not have a foundation in place to ride out unexpected health issues, job loss, family situations, etc., then even just one of these events could result in a major struggle to get back on track. For example, often the impact of having a major health issue at a young age without a financial foundation in place requires years of income to get back on track. In contrast, those that build a base are often easily able to overcome these obstacles and then move their financial picture forward in a short period of time.
The foundation of your finances should be an emergency fund, health insurance, auto insurance (if needed), homeowner’s or renters insurance, long term disability, life insurance (if needed), and liability insurance. Your foundation needs to fit in a budget that works for you and still allows you to save. Unfortunately, this means that sometimes you are forced to prioritize your foundation. As you check your foundational items off, you can move your focus on growing your assets, paying off debt and reaching your personal goals.
Is it better to put extra funds towards paying off debt or investing?
Unlike saving for an emergency fund which is a precautionary measure, investing is an important financial right-of-passage. In fact, it is one that should only be approached after other priorities are met. For many individuals, the excitement of starting to invest can come to a screeching halt when faced with their debt. The financial industry has long debated if it is better to contribute after expense dollars to pay off debt or put funds into something that invests to grow for the future.
There are a few important things to consider. First, what is the interest rate on your debt? Many student loans are now around a 6% interest rate. Auto and home loans, with good credit, can be much less. Credit card debt tends to be 18%-30%. Depending on the debt, the answer of what to do with your extra income depends on what you need to prioritize.
Investing in something to get a 6-10% rate of return when you have a credit card debt that charges 20% interest rate does not make sense. For student loan debt around 6%, it becomes a bit more tricky. Paying off the student loan gives you a guaranteed rate of return of 6%. If you are investing, there is a risk associated with your return. However, if you have a student loan at 3%, investing in something with some likelihood to average 6-10% over a long period of time could be worth it. If the numbers are even, sometimes it just comes down to personal preference and goals. If you are trying to be aggressive in growing your assets, then investing could be your course of action. Or if you are striving to build more security and open cash-flow, you could put more towards paying off debt.
Betting On Your Future
You have beaten the odds and have set yourself up to pursue a career that motivates and inspires you. Those that continue to bet on their future by preparing and becoming knowledgeable in financial topics are able to make decisions that will provide more personal flexibility as you build wealth. An important aspect of your financial journey is to understand your strengths and weaknesses. As you begin to identify your weaknesses on specific financial topics you may want to consider building a team of experts to help fill in these gaps. I hope this article helps you begin to think about your own personal finances and helps you take action to move yourself forward.
James Hargrave, MBA, CFPⓇ, CLUⓇ
Director of Financial Planning
My Financial Coach