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
Bankruptcy
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).
Divorce
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.
Bankruptcy Exposure
You're in a tight horserace to pay off your debt and build a nest egg before you can no longer earn a high income.
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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I think that the amount of interest matters. At current rates I’d definitely pay it off very aggressively. However, mine are thankfully at 1.65%. Any extra money that I’m contemplating putting toward the loan goes into my taxable investment account. This way it’s there if I need to pay off the loan to improve cash flow, but I expect a better return on the investment than from paying off the loan.
I agree with above comment. My student loan debt still sits at about $170,000 and I am about 8 years out of residency. However, my interest rate is 1.625% and therefore it is very hard for me to put extra money towards loan rather than into taxable investment account, etc.
I would indulge my latent market timing tendencies. When the market is down 10% ( like now ) I’d funnel money into the taxable accounts. When the market is up 20% ( when the S&P reaches 2300)I’d funnel discretionary money into the student debt.
I think interest rate is key to this discussion for the individual. My comparatively modest $100k debt is locked in around 2.7%. After subtracting 2% annual inflation that’s 0.7%. I would rather aggressively pay off my mortgage of 3.5% because I make enough that the mortgage interest deduction isn’t all that great for me, and being free of a mortgage payment would make a much bigger difference to my monthly finances. Plus, as you point out, student loan debt (unlike my mortgage) vanishes if I die so I would rather put money into assets that would help my family like the mortgage or investment accounts. So I’m not in a hurry to pay these off – maybe after the mortgage is gone.
Obviously if I were at a 5% or 8% interest rate I would have a completely different response to this subject.
I guess we all graduated at the same great interest rate time. My interest rates are also 1.65% and I cant see any reason to pay that off early. Almost any investment of money geared to that principle can at lease make 1.65%
The five year high yield CD at Ally yields 2% so even if you just use that crappy investment youre better off than paying off 1.625% student loans.
Probably not after-tax.
The same discounting for tax applies to paying down a loan since its after tax money. Even a vanguard s&p500 fund is at 2.16% div yield, not smart to have dividends in a taxable of course (depends more on your state tax laws though).
Hi,
Who is giving loans at 1.65%? I’d love to refinance to that. TIA.
I also have the 1.6% interest rate. I think we all consolidated at the bottom at the same time. I have no intention of paying this off before my last payment is due in 2040. Besides the lowest interest loan you can get another advantage is I consider it a life insurance policy of sorts. The government forgives the debt in case of death or disability. For me that’s 90k left that if I paid off would just be gone. Instead, I keep investing according to my written plan and that’s 90k extra in there.
Excellent point that it also functions as a bit of life insurance.
Would love you opinion on my situation. I have an equal mortgage and student loan amounts and very similar interest. The interest for both is around 3.1%. My mortgage is a 30y mortgage with only fixed for 7 years. The student loans through Laurel Road, thanks to you, is fixed for 10 years at 3.1%. After maxing out IRA and 401K would you suggest I pay into my mortgage or student loans or invest into stocks?
Thanks!
I’d refinance mortgage to a fixed 15 year if you can afford it. Can get at 3.1% currently. Then make those payments on time and if you have extra pay the student loan.
I’d have a plan to pay off the student loans in less than 5 years. I’d also try to max out all available retirement accounts. Once you’re doing both those things, it’s up to you whether you put the extra money toward the student loans or invest it in a taxable account in stock index funds. I wouldn’t bother with the mortgage until the student loans are gone, even though it is a 7/1 ARM. You may not have that house in 7 years, you may pay off the mortgage, interest rates may go down etc. No reason to panic about it. You’ll likely be in a much better financial position in 7 years anyway and besides, that mortgage interest may be deductible to you already or maybe later and if you’re an attending, the student loan interest certainly is not.
What is the advantage of paying off student loans when the interest is 3% which is the same as my mortgage? I have term life insurance, if I have the house paid of and I happen to die the student loans would be forgiven however the mortgage wouldn’t be? Outside of IRA and 401K what other ways would you suggest investing? Thank you so much!
The advantage is a guaranteed 3% return.
You can always invest more in a taxable account.
I’m looking at about 8 years. It’s funny (in a dark way) that when I see 200k student loans I think “that’ would be easy!” When I finished residency my balance was 344k and DW had 55k from grad school. We have 2 young ones both in daycare. Started primary care job last year. DW is in a much lower paying field of work and from a dollars and cents perspective it would make more sense for her to stay at home, but not all family finances are all about the $.
I saw a colleague last week who was thinking about 25yr repayment; I bought her a copy of WCI 🙂
This is also my response.
I paid off my school loan 8 years after residency. Because I delayed paying it off, I was able to have a little extra cash on hand to use as a down payment for my first (starter) house and put extra money toward that…which I paid off 2 years after the school loan…and am now aggressively paying down my (attending) home. The assets number goes up either way, but it is unexpectedly thrilling to see the debt number go down each month!
While it should be obvious that one should immediately pay off loans upon getting an income, the problem is that most who end up with the biggest loans got there in the first place because they weren’t tightly controlling their spending throughout med school. I seem to be finding that those same people aren’t terribly interested in limiting their spending (in order to pay down loans) once making serious money if they couldn’t do it while making negative money. All the more reason for pointing people towards this and other similar sites, I suppose.
Bonus points: El Cap (and yes, I’m jealous). I’d totally be in favor of a post highlighting your various climbing pursuits, whether or not it related to finances.
The route is not on El Cap, but you’re in the right neighborhood.
While some may struggle with student loan payoff vs taxable investing if you have loan rates at or below 3%, you should still preferentially pay off loans rather than hold any bonds/fixed income in taxable accounts which can’t measure up to a guaranteed 3% ROR. This point convinced me to accelerate loan payoff.
Great article, totally agree. Even if your interest rate is rather low, you’ll still want to pay out your debt. By the way, I would not define mortgage or any other loans on depreciating assets as good debt. Good debt is something that can potentially bring much higher return, such as investing in your practice growth. So while I highly recommend paying down all debt, and not taking any on once you pay it all out, the exception goes for borrowing money to grow your practice (and occasional 0 interest debt used for car purchase, for example).
Here’s my Dentaltown article on debt repayment basics that echoes WCI’s post:
http://www.dentaltown.com/Dentaltown/Article.aspx?i=396&aid=5466
I really disagree with this entire line of thought when it comes to debt. If I have 50K in debt at 1.6%, why would i pay it off if I can invest that 50K to get a higher return even taking tax into account. Other than the psychological feelings of being debt free, it doesn’t make any financal sense to do this. In fact if you believe that inflation is higher that 1.6% which it is, you are making money in real dollars by not paying it off.
Assuming you can get a better ROR on that interest after-tax and after accounting for inflation. Then what? For me, the feeling of being debt free is worth much more than assuming I can get a better return on my money vs paying off a low interest debt.
I guess it’s fine if you can detach the psychological feeling of being under a debt burden from the pure numbers.
Also this assumes that one has the confidence/ability to make a greater return on that 50k in the next #x of years vs the interest. Sure I guess we’re still in a bull market but for me I’d rather pay off debt aggressively then more money is freed up to invest.
I think everyone is different in their tolerance for debt. Im just saying that its unlikely you will ever in your life be able to borrow 50K at 1.6% and unless you’re are an extremely uneducated investor there are plenty of things you can do that will get you more than 1.6%. If you just review this website you can find them.
I also don’t understand your logic in the argument that by paying off your debt you will have more money freed up to invest. If you have 50K in debt and 50K in cash, you can pay the loan monthly at 1.6% and invest the 50K. As I mentioned in a previous post you can find CDs to pay you above 2%. If instead you use that 50K to pay off the debt, you have no money to invest, you haven’t freed up money, you’ve taken it away. Having said this, I get that there is a psychological issue with holding debt and for many they just want to get rid of it. My point is that this is not the most prudent investment
I totally agree DD. I’ve been tempted to pay off my 90k remaining at 1.6% , but it’s just throwing away money. Seems like bad use of resource when you can easily make make more with very little risk over the course of 20 years. Also, asset protection was mentioned as a reason to pay it off. The counterpoint is the government forgives the debt in case of death or disability. It’s a disability and life insurance plan!
At a certain point, the $90K will no longer be a meaningful part of your financial life and you might pay it off just to simplify things. I mean, even if you made 8% on that money, that’s only $90K*(8%-1.6%)=$5,760 per year, before tax. Once you adjust for tax and risk, it doesn’t move the needle of someone with a $5M net worth.
Why do you still bother with Backdoor Roth contributions at 5-10k? I realize it’s not exactly the same since you get tax free gain over time when you do it year after year but at some point is it worth your time to go through the Backdoor Roth process if you have a net worth 5 or 10M? This may not be the best example, but a lot of the tips you recommend and do yourself are for 5-10k benefit. Why is this different? I definitely don’t need the extra 5k but it’s the principle (principal?) of it. It’s just bad use of money to pay off a 1.6% loan unless you don’t have the discipline to use it more wisely.
Great questions.
As I said, I don’t think it’s crazy to carry that kind of debt. I just said I wouldn’t be surprised if you got sick of it and paid it off.
I couldn’t agree less. I paid off $230 k worth of loans in my first 3 years post residency. This While I was an employee, with a predictible paycheck. Then I went to work on building my own practice. Sooner or later, you may want to take on calculated risk to build a practice, buy into a practice, buy into a surgery/dialysis/infusion center etc. etc.
Making such investments, particularly if you are seeking bank financing, is A LOT harder if you are sitting on a pile of unsecured debt. – Banks hate unsecured debt. -and they know oyu’ll default on your business loan before you default on a student loan.
So, I only offer my perspective as a form of advice. Don’t rationalize away your debt. just because it has a low interest rate, which you believe your investments could beat.
Live like a resident and pay it off !
Peace
Of course it depends, and even more importantly you can most likely do at least a little of both so the binary decision isnt a great reflection of reality. Rates are low, and it isnt that hard to refinance, was painless for me.
For me, I think the most important thing is to first maximize your tax deferred investment space as the long term compounding and marginal tax rate cut are a difficult combo to overcome and its not as simple as your return being just the loan rate or the market return. Time in the market is going to be (hopefully) much much longer. Again, im not advocating a 30 year loan payback, just weighing your options mathematically and probabilistically.
You also have the present value of whatever dollars you’re using, and they are almost always (barring a long term deflationary environment) the most valuable dollars you will ever make and the earlier theyre exposed to compounding the better, a dollar in your 30s is worth a lot more than one in your 50s.
Compared to the likely long term return on the market, a lot of the concerns in the post are very low probability in nature. Your actions, insurance, etc…should match your level of concern with the probability of that outcome. We dont think every fever is ebola right? Likewise choosing long term expensive in opportunity cost options doesnt make a lot of sense.
Again, not an endorsement of student debt as its terrible. However, we arent contractually locked into continuing how we started out and can switch gears at any time. One can build up a decent start to a nest egg and attack the debt or vice versa. You could be creative and invest in the market or RE and use the cash flow to pay down the debt. Its your call. You could even swap non bankruptcy/dischargeable debt for its more useful types.
A huge upside to the debt payoff is flexibility. This almost cant be overstated. Most points that are extreme to either side dont reflect that you really can do both and dont have to choose. When starting I think you should take into account the tax implications and maximize any deferred space first since youd rather not pay down loans with your marginal dollar costing another 25-40% on top of the payment.
I guess if really got pinned down, I wouldn’t say this is a pay off debt vs invest issue. It’s more a pay off debt vs spend issue for most people.
I would agree, and even people making great plans to “invest” their money they otherwise might put towards loans tend to nickel and dime it away instead. So there is a behavioral aspect to it that is reinforcing.
Either way, you have to be disciplined, and if choosing to invest instead of maximizing loan payments…you better check on progress quarterly or so and if you find youre spending instead its time to switch back.
I have a convoluted plan of RE/investing/paydown I hope to get off the ground by mid next year where I accumulate assets and cash flow over time and instead of paying any profit towards a mortgage I first pay down the student loans with that (given their differential discharge and tax implications). This way I try to maximize my portfolio of assets while still addressing the loans in short order. Cap rates are kinda crap right now though.
Would you agree that if I have 90k I could invest in the market according to my written plan vs paying off a loan at 1.6% the wise thing to do (which I’ve done multiple times) is to invest it rather than taking the guaranteed 1.6% return?
Depends. There are times in my life when I have done both. More details here:
https://www.whitecoatinvestor.com/pay-off-debt-or-invest/
If the interest rate is low like 1-2 it’s a no brainer not to pay it off more rapidly
No matter the interest rate, fund your ret plan to the max
That’s much more important than paying down any loan
At age 30-35 you start way behind most of us so you gotta jumpstart those ret plans
If need be do non deductible iras as well
No reason to do non-deductible IRAs unless you’re going to backdoor Roth them.
I agree with paying off loans quickly – after you have a substantial emergency fund saved up. If you don’t have an emergency fund and you are aggressively paying off your debt when you have a large, unexpected expense, you have no way of covering that cost unless you take out another – generally more expensive – loan. I have over 300k in student loans and will pay the minimum until I have 25-30k in a fund before going on to pay extra on the debt. I don’t say this to detract from what is written above, as there are many great points on that list, and I agree with all that is written.
Interesting. Definitely not the way I just did it.
Who gets the student loans in a divorce is a little more complicated than that. In most community property states, if the debt was incurred prior to the marriage, it’s likely a separate debt, which stays with the borrower in divorce. However, paying off that separate debt during the marriage isn’t going to make you better off in the divorce, as the spouse is likely owed a reimbursement for use of community funds to pay a separate debt. If your spouse hires a decent attorney (and she will, because she is married to a doctor and has the money), how those loans were paid off will undoubtedly come up in the community property settlement, and will not be forgotten.
Likewise, if the debt was incurred during the marriage, it will typically be considered a community debt, and thus shared by both spouses in divorce.
When you get to non-community states, you have to deal with whatever “equitable” solution your state has come up with, or however a judge might feel that day.
Here’s a good article:
http://www.wsj.com/articles/SB10001424052702304626804579363253873904162
Disability is another issue too, but more nebulous. There have been cases of student loans being discharged in bankruptcy in cases of total and permanent disability. Still, these cases are quite unique and few and far between. Chances are, you’re stuck with your loans no matter how bankrupt you are.
Needless to say, if you’re thinking about divorce or bankruptcy, you must consult a qualified attorney in your area.
I have made this comment on other posts, but continue to believe it to be true. There is nothing like the feeling of having $100,000 in the bank (or brokerage accounts). My wife and I maximized our ROTHs during her residency and when she started to practice (EM), we both maximized our 401ks. I also maximize an HSA (her employer insurance is very good, so good it will get the “Cadillac tax”, but does not offer a HSA).
When she first started earning her attending salary, we struggled with the loan vs taxable investment question. Ultimately, investing won out and we saved up $50,000 in the first year in a taxable Vanguard account. Our reasoning was that the $50,000 would be available if she wanted to make a large student loan payment, but it would also be available if she wanted to take 3-extra months off after having our first kid.
I received a $50,000 inheritance so our total “safety net” was now $100,000 (yes, there is market risk, but even a 20% downturn leaves us with a large safety net). There is more freedom in this asset than a student loan balance that was $100,000 lower (make a $100,000 payment to your student loan in June, they still want the same July payment – the cash flow impact comes only when you fully pay off the loan).
Now, I am returning to school (MBA while still working) and will use the inheritance to fund the first 10 classes. Savings allow you to avoid future debt too.
Overall, this is a deeply individual decision. For female attendings who want to start a family after residency, there is a high probability that they will take 3 to 6-months off within 2 years of starting their first job. Think about all of your future commitments to determine the best decision for you and your family.
High probability of 6 months off? Ummm, really? Do you have any statistics to support that kind of claim? I highly disagree. Didn’t do it for the first child, or the second, or the third, or the fourth…
While my wife is residency, we are putting a ton of money into our Roth accounts instead of paying off student loans. I do not have to worry about cash flow issues which are my biggest concern because of LinkCapital/DRB residency deferment and PAYE loan payments. My thinking is that we are most likely to be classified as super savers and we should build up our Roth accounts while we can. Once my wife is out of residency, we will fill up our Traditional retirement accounts while using extra money to payoff the student loans in 1-3 years. I would pay off the student loans earlier, but the government gives us weird incentives…
All that being said, I do not agree with people investing in taxable instead of paying off loans.
1. You don’t improve your cash flow
2. When a recession hits you will want access to extra money which you cannot take from taxable without taking a cut on it. If the loans are already paid off, you can shift cash flow around.
3. Really should not have bonds if you have large amounts of student loans. Rate differential is much when you take into account taxes and risk.
4. Reduces insurance needs like WCI mentioned above.
1. You do, but its more over time. Your change in net worth is the same either way but has more upside.
2. Why would a recession cause a physician to want more money? Are you assuming lower pay, this is not a usual issue for most physicians.
3. You should have minimal to no bonds if you’re young, especially considering their long term potential to destroy your return from where they are starting (even though rates might be low for a while). This should have no part in the discussion because it isnt and either or kind of thing. One can put their money to work anywhere. Just a non sequitur.
4. Self insurance is great, but realistically it will be a long time before most new grads are in that position.
Ok, this topic again. It was the hook that first brought to me this website when I posed the question on Bogleheads last year. Thank you, Jim, for changing our lives forever by simply inviting us to take a look here.
I was going to argue point #3 –a solid return–but I see that many people have already pounded it pretty hard. 1.65% or 2% (what we had) or whatever really doesn’t matter. It became a behavioral choice, no longer about money but the burden.
Here is what we concluded: We spend a lot of money. We didn’t want to budget for the debt over 10 more years when we could pay it off in one. We wanted the freedom to choose when we stop working. Preferably, as soon as possible in addition to doing some light locum tenens work and humanitarian service.
Student loan debt ($200k+) is now gone and we are going on a two month cruise around the world this winter (with some paid work in Antarctica). YOLO.
+ 1
I’m a 45 y.o. FP in NJ, have struggled with this question for years. I finished med school with 186K in loans that accrued to 197K by the time I stop deferring and started paying it back. I consolidated everything under Sallie Mae (this was back in the late 90s) and we bought a cheap house in 1999. We were lucky that the real estate market appreciated so much after we bought our house because, when the Sallie Mae interest rate hit 8.5% a few years later, we paid off most of the student loan debt with a HELOC at a variable 2.89% (and that rate has not budged in the years I have held the loan). Unfortunately, I did not have an IRA until age 40 and was only contributing the minimum required for years, fortunately an 8% match from my employer has helped it build. I am now divorced, still carrying the HELOC which has 163K left on it, have 158K in the IRA and recently decided to max out that contribution so I will be putting 18K a year into it. I decided to do this rather than pay down the HELOC since 1. the HELOC interest rate is so low 2. I was really late in starting to save for retirement and feel very behind my peers in this area and 3. I get a tax deduction on the HELOC interest. I am actually looking for a rental property now because I would like to diversify my investments, it is all in mutual funds and since I am now able to max out my IRA contribution, I would like to “make money while I sleep” by having a renter pay a mortgage and eventually buy an asset for me. I am happy/relieved to see that others have chosen retirement contribution over paying down low interest debt and I agree that it has to be a personal decision based on a number of factors specific only to each individual situation!
IRA contribution limits are $5500 a year for 45 year olds and have no match. You almost surely mean 401(k).
I’m trying to make this decision now, I have $150 K in student loans at 2%. I have used the conventional wisdom and invested in a taxable account and have a large bond allocation in that account due to having a conservative asset allocation. It only recently occurred to me that I am essentially using those loans as leverage to buy bonds (which are making about the same as the amount I’m paying on the loan). This is essentially increasing my overall investment risk by using leverage. I’m starting to come around to thinking about the $150 K loan as part of my fixed income portion of my asset allocation and thus selling my bonds to pay it down and thus increasing my stock allocation. My bonds are munis, so no tax hit and I don’t have cash flow issues. However, I keep that bond allocation to avoid volatility, as it keeps me up at night.
Why do you have bonds in your taxable account? Really tough tax wise. Even a dividend producing instrument would be better, but not as good as a fund/stock/etf without one.
While you could describe that as leverage, it in no way makes the asset more risky, nor are you going to experience the usual risk of leverage and have a margin call. The asset has an inherent risk, and by applying leverage you are increasing your exposure to that risk by the factor of your leverage, it does not make the asset any more risky. This is basically the strategy behind risk parity and such portfolio styles.
Sorry I somehow missed the Muni part. You do have to sleep at night. Are you watching it to closely? Maybe check less frequently and let the long term take care of it.
I agree that it is an individual decision. It is interesting to me that I see a lot of “all in” on paying student loans or pay a minimum of some sort (maybe not the absolute “25 years to pay this off” minimum, but only a little more) and invest the rest. I think it can be a much more fluid situation than that. Again, saying what an individual decision this is, I have decided to more or less split the difference. I have a very high debt burden (~350k) and am now about 2 years out of fellowship and on the verge of making partner at my private practice.
I have about 120k at 5.75% and the remainder at different fixed rates between 2-3.5%. I currently pay about 2600 a month which would allow me to have the majority of my loans paid off in 15 years (with about 100k left at 2% that are on a 25 year repayment plan). I should also say that even paying 2600 a month I am maxing out my 401k, my backdoor Roth, my HSA, and have an emergency fund. Shockingly I actually have some money left over to have some fun too.
As partner, I plan to increase my overall payments to about 4k per month (all of the extra going to the 120k of high interest loan). This will allow me to pay off these in about 6 years. I will then “roll the difference” into my next highest interest loan and keep doing this until they are gone. As partner, I will also use profit sharing to max out my 401k at 50,000 a year and continue to fund my IRA and HSA funds. Although I could go significantly higher and pay my loans off in 5 years, I would spend these years living as a resident and not get to enjoy have a little money to spend. While some would say that I should do this until my loans are paid off, I disagree. I think there is a line to this and for me personally, I would be absolutely miserable continuing to live like a resident for another 7 years after residency. I think 10 years is a more reasonable time frame, which will still give me 22 years (my loans will be paid off when I am 43) to work student loan free. I can decide whether I need to ramp up my savings at that point and roll my 4000 from student loan payments into taxable investments, spend it on fun stuff like vacations and toys, or some hybrid of the two. I should point out though that 55000 compounded annually for 30 years is close to 4mil, which many would say is plenty to retire on at age 65.
Sorry if that was long winded, just was seeing a lot of all or none posts, and wanted to point out that you can do a hybrid of these and still pay off your loans in a reasonable amount of time, save enough for retirement, and still have some money for fun while you are young.
Spend your money on what will make you the happiest, but I can tell you this- still having student loans hanging over my head 15 years out of residency would make me very unhappy. I’m not sure I want a mortgage hanging over my head at that point. Front-loading this sort of stuff before you get used to the money seems very prudent to me. I found that I had money for retirement, debt reduction, and fun and still felt like there was more coming out of my ears when I left residency. Now that $120K military salary seems very inadequate to me given our current spending levels.
Hey WC, I read that book you recommended about debt in retirement and though I disagreed with the vast majority of it, I have to say it got me to look at the benefit of having a mortgage still in retirement. I used to think I wanted to pay it off asap, but with rates as low as they are i think it might make sense to keep a mortgage and save more cash when closer to retirement for all the reasons mentioned in the book.
I would like to echo that this seems to be a very individualized decision. I wrestled very much with this question…
My scientific logical mind said: My $386K of student loans is at an average interest rate of 3.5%, in the long run investing aggressively should yield me 6-8% return and I’ll be better off allowing my interest to compound. If I make minimum payments on my student loans, it will truly be a long-run payoff.
The rest of my mind said: How in the world can you sleep at night with $386K of student loans?!?!? Pay it off, free up cash flow, get several of the other bonuses listed in this article and get rid of those loans!!!
Thanks a million to this website, seeing others in my situation work through options/choices really helped my wife and I come up with a plan!
I’m now 14 months out of fellowship, and 6 months into serious debt repayment plan – goal to put $4700 towards principal each month for a payoff in 7 years. 6 months in, we are doing better than that and currently on pace to pay it off in just under 5 years!!
I can’t wait to have this weight off my shoulders and decide how much of that $4700+ (plus the GONE interest payments) to put towards retirement vs paying of the mortgage…
I’m not ignoring retirement at this point, but wish I was funding a little more in my optimal compounding years (getting all of my matched dollars and adding a little more – ~12% of gross income in 403B/457/401K accounts), but I think it will be worth it/the best choice FOR US in the long run!
THANKS WCI – I’ve become a regular reader and am working my way through the archives!
Is the climb El Capitan?
Nope, not even the right piece of rock, much less the right route. As a hint, this piece of rock is near El Cap, but not as tall as El Cap.
i have these convos alot with other docs and residents. I think it’s worth pointing out that forward progress is always good. If you are throwing around a few extra thousand every month and trying to decide whether or not to save for retirement or more rapidly payoff student loans you are in a good place financially. There are a dozen variables that could push people in one direction or the other but I always point out to people struggling with this decision that this is a good problem to have! You are basically saying “i have a chunk of money i’m going to do something very responsible with, i’m just trying to decide what that will be.”
Absolutely. Great perspective.
As usual, when this discussion pops up, I look for the Public Service Loan Forgiveness footnote. Just to comfort myself, to see that it’s still recommended in the right situation.
We have $396k in loans, all federal.
My wife is a Family Practice doc at a large non-profit insurance slash hospital behemoth. Makes $160k annually, 1 year out of residency. She is currently eligible for PSLF and we pay the $2,600 minimum.
6 more years, our loans will be forgiven without ever paying more than minimum payments.
Right?
Be careful mark in assuming the PSLF program will stay the same in the future. There have been reports of changing the program to limit the amount of debt being forgiven and just now I think we are starting to have the program start benefiting people.
So just a heads up. But it is interesting dilemma to see if you should gamble on the PSLF staying the same OR pony up more money each month to pay down the debt.
Sounds right to me.
Seems like a common sense topic but surprisingly lot of people are not aware of this concept, especially if med students come from wealthier families and are used to lavish/high-spending lifestyles (though they may also be very lucky in that they do not have any debt coming out of med school!)
I’m in the hole for about 290k or so and after residency my goal is to hopefully eliminate that in <5 years if possible.
Brief plan of attack:
25-35k budget for living expense annual.
50k for taxes (assuming rough 25% effective rate on a 200k income, plus state/local)
24k for maxing out IRA and 401k/403b (preferably Roth in both)
91K left over (assuming 200k gross) = All in to tackle debt
If above goes well hopefully can eliminate debt in about 4-5 years.
Remember not to make yourself feel too deprived or you won’t be able to stick with the plan. $30K in living expenses isn’t much.
One thing Dave Ramsey hits hard that made sense to me is if your mortgage is paid off, or in this case your student loan, would you take out $350,000 at 3.5% to invest in stocks? If so how about $3,500,000? We all have a certain amount of risk we can tolerate, but I will sleep better knowing that my loans are paid off. It’s easier to watch a portfolio drop 100K in a month, and leave it alone, when you don’t have any bills to be paid.
Unfamiliar with his question or the terms of said loan, but the obvious mathematical answer is yes and where do I sign. You’d be taking a lump sum at present day value and instead of dollar cost averaging you do it in lump sum and pay down the loan, which might even be tax deductible. WCI made this point a while ago and of course we all have our interest rate breaking point where we’d either pay all loans asap or take out as much money as someone allowed. As usual, it depends.
If a loan of this nature were available I’d be all over it. This is entirely different than margin and cannot be compared with a straight face.
You’d have to do a present value, discounted cash flow analysis, etc…but after doing so you’d likely come to a similar conclusion. You always have to do what allows you to sleep at night, and different situations call for different approaches.
You are right, it’s a totally individual thing, and for me it changes with time. WHen I was in school I would have taken out a chunk at low rates if I could have. Now, it’s not worth worry about it. a 3.5M loan is more than I’m worth so putting it all on the line seems silly at this point. When I had a negative net worth, I would have done it in a heartbeat. Same thing as we get closer to retirement. Not to many are still 100% stocks when they go to retire, it may make sense on paper, but there is more to finance than numbers.
I think we would agree on everything number-wise, but our emotional risk tolerance may be different.
We may be on different timelines as well, as you said that changes things as well. 30 years compounding a large initial sum is awesome, less than 10 years would be different.
You are definitely worth 3.5 million! It may be cumulative, but its there, dont discount yourself.
Haha, yes I guess I was talking net worth right now. Worth more than that with life insurance, but I plan on staying around a while.
If you have enough cash flow already to keep up with the minimum monthly payments on that 350k/3.5mil loan.
Easy to calculate that at the end of a 30-year value after that initial lump sum investment (low cost index fund or maybe some other investment that can guarantee a >3.5% ROR after tax and fees) but of course as we all know loans comes with monthly payments after you get the money and aside from the fact that those loans at those amounts and rates do not exist (easily) to the regular ol Joe Schmoe…one needs to make sure to have cash flow to keep up with any emergencies in life and to keep up with the monthly payback of that loan I would think….
I can’t even imagine what a monthly payment for a 3.5MIL loan at 3.5% would be. Likely too much for anyone to keep up with unless you somehow can invest that 3.5MIL lump sum into an investment that provides a steady stream of cash flow each month AND over 30-years can beat the interest rate on its returns after taxes and fees….
For me? The rhetorical question by Ramsey is to answer a big NO.
Any of these scenarios are totally hypothetical of course as you cant get a big upfront loan like this. Of course you’d have to take into consideration how much you could afford monthly. However, that amount would be drastically different than your current budget likely since you would never have to contribute to your retirement account ever again as you just swapped lifetime payments for a lump sum. Since this is all a mind experiment you can think of it as either starting your final sum of payments compounding today and paying down the loan, or pay down the final sum over time.
Obviously the lump sum is the better math way to go, but of course we have ridiculous assumptions. No one is going to give us a 7 figure loan at a rate that the SWR could be higher than and still grow to a huge sum, they could probably put it to better use. If at a flat ridiculously low rate of 3.5% for a term of 30 years (unlikely long term) it would be $15,716/month. Thats a lot but certainly doable for many (I assume you’d pay your student loans off as well). 3.5 million is likely way too much though as you’d have a massive sum in the end and something smaller would achieve a similar goal without near as much risk. 1 million would be an easy debt service and have a huge impact on your ability to get far ahead in the retirement game.
All fantasy I’m afraid.
I actually ran some rough numbers last night with S&P 500 annual percentages, taking out 190k at the beginning of each year to pay the annual debt service. Like was said above, the 30 years is key as you always came out ahead. Most of the time after 10 years you did also, but it wasn’t guaranteed.
But as you allude to, the stress of having a loan like that would keep me up so it’s not worth it. Even my million dollar practice loan which is about 3% after tax, I want to pay off ASAP. Not at the expense of retirement, or even contributing to my taxable accounts, but if there is any extra, that is where it goes.
Interestingly, I did get my second practice loan as a line of credit type, with a fixed rate and a balloon payment for everything at the end of the loan. Rather than have my money sit in checking, I have it sit in there, thus decreasing the principle and interest due on it.
How do you have extra after contributing to taxable accounts? They have no contribution limit.
True, no legal limit, just my limit. I try to not put more into taxable accounts than 1/2 my income. My wife and I are both savers, so the limit I enforce allows us to hit early retirement goals, and then use the rest to travel. If I didn’t have it, I think we would be to far on the savers side and not take the time to enjoy the spending side of the equation.
That cracks me up. Your limit is half your income? Why keep it so low? 🙂
I agree that if you’re maxing out all your retirement accounts AND putting half of your income into taxable, then you can definitely stop there. I have no idea what you’re living on, but that’s okay.
Well you already have a million dollar loan so that doesnt count…You’re talking about adding a couple million to that which definitely might cause all your hair to fall out precipitously and age you overnight.
If I could I would try to keep as much principle in the market as possible and let the dividends just churn out and reinvest, and only sell some shares to make up for slower months.
You were able to get a practice loan for a million at a flat 3%? From a bank or the other members? If a bank I’d be tempted to look into that myself.
Practice loan from the members, but the bank would have done the same thing,but with a small origination fee. The members have run the business without debt, so they didn’t want a bank involved. I personally would rather have a third party, but there were other things I wanted more so it was a small concession.
And the rate is 4.25%.
I see half dome in the background…Munginella?
Great climb, but that’s not it. El Cap on one side, Munginella on the other. We’re getting closer.
Editing note (is that annoying): Under #8, “If interest rates rise your money will be worse less” instead of the intended “worth less”.
Though is it possibe for things to be less worse. For example, which is less worse: Whole life or Universal life?
Lol. Thanks. Amazingly hard to be your own editor some times.
You wrote “possibe” instead of the intended “possible.”
That’s the French way to do it, it’s very hard to say… 😉
Wonderful discussion BUT the pic has me intrigued. With Clouds Rest and Half Dome in the background this is definitely Yosemite. Its not El Cap- a bit too low. I think I can see the Awahnee hotel below you so since you have not written about climbing in Yosemite before and a wonderful first climb with challenges and variety I will say this is Sunnyside bench
Not the sunnyside bench, much closer to El Cap.
This is an ultraclassic route. If you’ve spent a week in Yosemite climbing, you’ve probably done this route.
Cathedral.
Nope. That’s on the opposite side. Surprised nobody has nailed this one yet.
Nutcracker?
Bingo! Winner winner chicken dinner!
http://www.mountainproject.com/v/nutcracker/105833505
http://www.mountainproject.com/images/52/39/107325239_large_7b40d6.jpg
One of my favorites and a beautiful flat summmit to hang out on. It might be called “manure pile buttress” in Yosemite, but anywhere else in the country it would be an attraction people would drive for days to climb.
Full disclosure: I have never been there. However I posted this article on my facebook (to encourage fellow residents and fellows) and one of my friends, also an EM physician, responded that the picture was the Nutcracker…