Calculating Your Debt to Income Ratio

Sometimes it is fun to calculate a financial ratio to determine how well you're doing compared to your goals or even to other people. One ratio that I think most physicians ought to be very aware of is their debt to income ratio (DTI).  It sometimes seems that the only time anyone ever really talks about debt to income ratios is when you're trying to take on new debt, like a mortgage.  Mortgage guidelines change frequently, especially after major economic and real estate meltdowns partially brought on by lax lending standards. However, a typical mortgage lender likes to see a DTI of 33/38 or so. That means that your housing expenses, including principal, interest, taxes, insurance, and HOA fees should consume a maximum of 33% of your income. If you also include other debt (like student loans, auto loans, or credit cards), then the maximum should be 38% of your income.

Let's Call Your Debt to Income Ratio what it Really is: Your Debt Slave Ratio

Longtime readers know that I generally recommend that housing expenses, including utilities, should not consume more than 20% of your gross income and that I really think you should take on consumer debt pretty much…never. However, I think it would be instructive for a physician to really consider his overall debt to income ratio, including mortgages, buy-ins, student loans, auto loans, and consumer debt. I think it would be even more interesting to adjust it first for taxes. Instead of calling it the rather benign debt to income ratio, let's call it the debt slave ratio. That's really what debt is since the borrower is slave to the lender. A debt is simply spending life energy (time or money, since they're fairly interchangeable in most situations) before you've acquired it.

Calculating Your Debt Slave Ratio

How much of your life energy is going to servicing your debt? What percentage of the time are you actually working for yourself, rather than someone else? You don't want to be someone else's best investment.

Consider an emergency doctor who works 16 shifts a month.  Let's say he makes $1500 a shift, or $24,000 per month. At this income level, it wouldn't be unusual to pay 25% of that income toward payroll, federal income, and state income taxes.  So his first four shifts pay taxes.

Next, he has $300K in student loans on a 10-year plan. The loans are at an average rate of 7.5%, so that works out to a monthly payment in the neighborhood of $3750. That's another 2.5 shifts a month.

Now, he lives in a place with a high cost of living, and although he limited himself to a modest 2000 foot 3 bedroom house, he ended up taking out a 4.5% $900,000 30 year physician mortgage on this property. That's another $4500 a month, or 3 more shifts.

He and his spouse drive two nice cars, with $400 monthly payments on each of them.  That's another 1/2 shift.

They actually carry a little credit card debt, left over from residency, but which they haven't yet paid off.  The minimum payments on this $40,000 debt are $200 a month, but they want to get rid of them eventually and calculated that they need to pay $600 a month just to cover the interest.  So they pay $1500 a month, another shift.

He now gets to work the last 5 shifts a month for himself, including any retirement and college savings.  But since his income is relatively high, he finds that to be doable and his family settles into that lifestyle. Now, however, he decides he is sick of working nights, and really doesn't like working 16 shifts a month.  He'd like to cut back to fewer shifts, work fewer nights, or take on a job in a less busy department that doesn't pay as well. But he can't. He is a slave to the money he has already spent on education, his home, his cars, and his lifestyle. Not only must he keep his job, but he has to keep running at it as fast as he can. His debt slave ratio (not counting taxes ) is 7/12, or 58%. Counting taxes (using his net income), it is 11/16, or 69%. That seems pretty terrible to me.  Truly he is a slave to his debt.

My Debt Slave Ratio

I thought I'd calculate my own debt service ratio. For the most part, I try to practice what I preach. Not only is my mortgage less than 2X my gross income (my general recommendation) but now that my income has grown and the mortgage has been paid down a little, it is less than 1X my gross income. I lived like a resident for 4 years after residency (partially voluntarily and partially due to the fact that the military only wanted to pay me 1/4-1/3 what a private emergency doctor could make) and so have no student loans.  There are no payments on the vehicles we bought used and we don't carry credit card balances. We do have a rental property, but its expenses are almost covered by the rent, and what is not is trivial compared to my overall income. So essentially, my only debt is my mortgage, a 15-year loan fixed at 2.75%. It requires about 9% of my income to service that debt. Maybe 10% if you add in property taxes and insurance. Not too bad, and certainly much less than the 69% used in the example. But you know what, if I didn't have that debt at all I could work two fewer days a month, or quit working nights altogether, and sometimes, after a rough shift, that looks pretty appealing. [2017 Editor's Update: We paid off our mortgage and became debt-free in July this year! Still no car debt. Still no credit card balance. Did the “we're debt-free” yell. I don't feel  too much different but it mostly feels great to accomplish a goal.]

What's A Good Ratio for a Doctor?

I'm not sure there is a good ratio.  Zero is the ideal for the anti-debt, Dave Ramsey types, although even Dave is always quick to point out you should only throw extra money at your mortgage AFTER you're putting 15% of your gross income toward retirement. Certainly, 69% is not a good ratio. 20-30% is probably okay for a young attending who still has student loans to pay off, but I would feel uncomfortable with a ratio that high.  I get uncomfortable just looking at my mortgage statement each month and seeing how many days of my life, after-tax, I've already spent on this stack of twigs I'm living in. (It's about 220, for those who care, or a little over 3000 patients.)

I've noticed that far too many doctors out there are entirely too comfortable with debt. I'm not sure why that is.  Perhaps it is the fact that many doctors who followed a traditional route into medical school have never had a real job and lived for years just signing promissory notes every semester, and then signing IBR statements each year in residency. It is almost as if they don't “feel” the weight of their student loan burden. It seems so light and fluffy to them that as soon as they get out of residency (and often even before they get their first attending paycheck), they stack a big fat mortgage and a car payment or two right on top of it.  Before you know it, they've got a debt slave ratio of 40%, 50%, or even 75%, just like the rest of America. They have squandered their ticket (the high income of a physician) out of the rat race.

Prevention is the Best Solution

The solution to having a low debt slave ratio is, like dieting, simple, but not easy. The best solution is prevention. There are lots of ways to prevent the addition of debt on to your life.

1. Apply broadly to medical schools (so you get into more than one) and matriculate to the least expensive (including cost of living of the city.)
2. Minimize living expenses during school, remembering that everything you buy will really be twice as expensive by the time you pay it back.
3. Learn to live beneath your means as a resident. You've already dug yourself a big enough hole.  You don't have much of a shovel to fill it back in, but you could at least stop digging.
4. Upon residency graduation, live your net worth, rather than your income.
5. Don't buy cars on credit.
6. Don't use credit cards for credit.

Perhaps, like many, it's too late. You have a terrible debt slave ratio. Realize that you're not alone in this situation. I'm now routinely getting emails from doctors who owe $400-500K in student loan debt alone. I recently heard from a two physician couple who owes $950,000 in student loans. You may have a car loan, a few leftover credit cards, and a fat new mortgage. What can you do about it?

1. Consider reversing some of the debt. Sometimes, it is easier to downsize your lifestyle than to pay off the one you've mistakenly purchased thinking that was what you really wanted. Have a $60K Audi costing you $800 a month? Selling it would certainly reduce your ratio.  Same with a house. Rather than trying to pay off that $1 Million mortgage maybe you should sell now while house prices are up and buy a $500K house.  Get rid of that sailboat you bought on a whim and don't have time to use anyway and you may free up all kinds of cash flow.
2. Boost income, cut lifestyle and direct the difference to the debt.  Negotiate hard for your salary, moonlight or pick up a few shifts on the side, eat out a little less, and direct that money to credit cards and student loans until you can get them down to a reasonable level.
3. Remember that debt is debt. Many people like to differentiate “good debt” (like student loans and mortgages) from “bad debt” like boat loans and credit cards. But you know what?  It all costs cash (your life energy) every month. Even good debt must be serviced.
4. Refinance your student loans. This is a no-brainer unless you are going for PSLF. There are so many options for refinancing loans that can save you thousands in interest every year.
5. Remember that “leverage” is overrated. Lots of people like to point out that debt at 1-3% is really like free money, at least after inflation. The math is right.  If you borrow at 2% and earn at 6%, you're going to come out ahead (although not necessarily on a risk-adjusted basis).  But have you considered just how far ahead? Let's say you are lucky and have $100K in student loans at 3% you don't want to pay back too fast since it's “free money”. You manage to make 6% on that money over the long run, 5% after taxes, over 10 years or so. How much money did you make by doing that? Perhaps $10K total.  Not exactly life-changing money. But would your life change in a meaningful way if you didn't have to send $3K each month to the lender? It just might.

The biggest difference I see between physicians who are financially successful and those who are not is their attitude toward debt. Look at debt as a cancer that needs to be wiped out rather than a rheumatologic disease that needs to be managed and you'll lead a healthier financial life.

What do you think? How high of a debt slave ratio is too high for a doctor? What did you do to keep your ratio manageable? Comment below!