By Dr. James M. Dahle, WCI Founder
Those of you who have been hanging around this website for a while know I think most doctors should pay off their student loans within 2-5 years of completion of their training. This task is becoming more and more difficult with the downward pressures on physician incomes and the upward pressures on student loan burdens.
However, accepting the reality of massive student loan burdens, inviting your loan into your house like a family member to stay for the long-term is still a mistake. A student loan is not a mortgage, even if you can get it to a very low interest rate (and most cannot.) Here are 10 reasons you should pay off student loans as quickly as possible:
#1 Greater Asset Protection
One aspect that few people pay much attention to with regards to the investing vs student loan question is the asset protection angle. If you are sued for everything you own and have to declare bankruptcy, those student loans are still there. It would have been much better to pay them off than to have invested or even bought a home (in many states with low homestead limits).
However, the truth is that you are far more likely to lose money in a divorce than you are to a lawsuit, especially if you carry adequate malpractice and umbrella insurance. But even here, paying off the loans is a better idea. Consider a divorce — your ex-spouse gets half of what you've saved and invested plus alimony. But he isn't going to take half of your student loan burden. That's all yours.
#2 Paying Down Debt Is a Guaranteed Return
Paying down debt can be a fantastic investment but one of the best parts about it is the rate of return is guaranteed and knowable up-front. It's the interest rate of the debt! 5% loan = 5% investment. Guarantees are worth something, just look at how much all those permanent life insurance and annuity purchasers are willing (although admittedly, perhaps unwittingly) to pay in fees in order to have some sort of guarantee.
#3 Paying Down Debt Is a Solid Return
Not only is the return guaranteed, but it can be quite good. Student loans these days are generally 5-10% (most often 6%-8%). Even if you refinance them down to 3%-4% variable or 4%-5% fixed, that's probably still an attractive return, especially when compared to what other equally safe investments are paying (i.e., 1%-3%).
#4 Student Loans Are Not a Mortgage
Too many people equate student loans with a mortgage. Somehow both of them get thrown into the same category of “good debt.” I don't buy it. There are several reasons why student loans are inferior to a mortgage.
Not Backed by an Asset
Student loans aren't backed by an asset. I mean, if you decide you no longer want to have a mortgage, you can just sell the property it is attached to, pay off the loan, and walk away with whatever is left. (Yes, I know you can be underwater.)
However, a student loan doesn't come with an asset. In fact, in a post a few months ago we learned that sometimes they don't even come with the ability to earn a living. One guest poster I've had felt like his student loans were a mortgage he took out on his brain, and he just hoped no one would foreclose.
Unlike a mortgage, student loans don't go away in bankruptcy as we've already discussed.
Higher Interest Rate
Mortgage rates are lower than student loan rates. Mortgage rates are currently around 4%, but medical school student loans start at 6%.
Dave Ramsey, perhaps our nation's leading expert at getting people out of debt, makes a special exemption in his baby steps for a mortgage. The student loans get thrown in with the credit card loans and payday loans — to be paid off completely before you ever do anything with money except a $1000 emergency fund.
Interest Is Often Non-Deductible
Student loan interest isn't deductible to most practicing doctors—they make too much money. Even below the phaseout, your deductible interest is capped at just $2500/year. At 6%, that means your maximum deductible loan is just $42K. That's a rare doc getting out of medical school with such a tiny loan.
#5 Pay for Your Education While You Still Appreciate It
When you first get out of training, you're very grateful for all the time and money you invested. You are enjoying this awesome new income. It feels like money is coming out of your ears. Guess what? That feeling goes away after a while. And then that student loan burden just feels like a huge weight hanging over your head.
Get rid of it before the novelty of being an attending wears off. I frequently recommend living like a resident for 2-5 years out of residency. That allows you to get a jump start on retirement savings, pay off all your student loans, and even save up a down payment on your dream house.
#6 Paying Down Loans Builds Wealth Too
A typical doc may come out of residency with a net worth of -$250K. Net worth is your assets minus your debts, everything you own minus everything you owe. Getting rid of debt boosts your assets just as much as acquiring assets. A dollar of debt paid down is exactly as good as a dollar invested. The investing vs paying down loans discussion can be complicated, but just realize that both paying off debt and investing are good things to do with your money. If you live like a resident, you can probably do both just fine.
#7 Allows You to Carry Less Disability Insurance
Consider a doc with a $4000 per month student loan payment. In order to be able to cover that, as well as support her lifestyle, she needs a disability benefit that is $4,000 higher than it would otherwise have to be. That costs ~ 5% * $4,000, or $200 per month. That's $2400 a year she could be investing or even spending. That effectively boosts the return on that “investment.” I'd say the same thing about life insurance, but most student loans go away at death. If yours don't, add that benefit in too.
#8 Lower Interest Rate Risk on Variable Loans
Anyone investing in fixed income investments is running interest rate risk. If rates rise, your bonds will be worth less money (because a bond purchaser would prefer to buy a new bond at a higher rate if you don't discount yours sufficiently.) Likewise, if you have a variable rate student loan, you are also running interest rate risk. If rates go up, you will pay more interest each month on your debt. That doesn't mean a variable rate student loan is necessarily a bad idea, but paying it off quickly certainly lowers your interest rate risk.
#9 Improves Your Cash Flow
Overall returns are important, but cash flow is also important. Many companies have gone out of business not because they weren't making money, but simply because they weren't managing their cash well. Most real estate investors have known the pain of a negative cash flow investment.
Your personal cash flow is improved when you minimize your fixed expenses, even if your overall expense is the same. That's because if something happens, you can simply cut back on your variable expenses and redirect that money to the emergency need.
However, a big student loan payment is a fixed expense. If something happens to your income, that payment doesn't change. As one Boglehead said recently about paying off his mortgage, “I don't know if it was a good deal or not, but I do know that I only need $6,000 a month now where I used to need $8,000.”
#10 Increases Happiness
There's a proverb: the borrower is slave to the lender. Who wants to be a slave? Paying off debt helps you to be financially free. You're free to use that money for another need, or cut back at work and not make the money at all. The more financially independent I become, the more I enjoy my job(s).
Lots of people pay off their mortgages early mostly for the psychological benefit. Very few of them, despite understanding the math behind borrowing at a low rate and investing at a higher one, then go take out a home equity loan in order to invest. I don't think those people are ignorant; I think they've honestly stumbled on to something that makes them happier. You simply make different decisions in your life when you don't owe a ton of money. You have more choices, and that's worth a lot.
What do you think? Do you think student loans should be drug out for decades? Why or why not? Does the interest rate matter? Do your alternative uses for the cash matter? How long do you think a doctor making $200K should take to pay off $200K in student loans? Comment below!
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