[Editor's Note: This is a guest post from Andrew McFadden, MBA, CFP, a financial advisor at Panoramic Financial, a “forward-thinking virtual advisory firm specializing in the needs of physicians, with a focus on Generation X and Generation Y, with expertise in student loans, investments, retirement planning, employee benefits, and tax mitigation.” This post addresses some important financial issues for residents. Although this is not a sponsored post, Panoramic is a paid advertiser on this site.]
I’ve been helping residents with their finances for a few years now.
My biggest takeaway has been that every resident has a hundred things going on, and one of those things isn’t learning about how to be wise with your money. Unfortunately your crazy schedules don’t really afford you the time to get a side major in personal finance. So when I get the opportunity to speak to a residency program, or I get to grab coffee with a few residents on the fly, the question I often hear is, “What are the smartest things we can do when it comes to our money?”
I don’t hear, “Teach me everything you know about finance so that I can become a financial expert.” Because residents don’t have free time and they want to keep things simple. Especially when it comes to their money. So here is as simple as I can make it. In this post I'll list three of the smartest financial choices you can make as you prepare to leave residency.
# 1 Pay Off Your Student Loans In As Efficient A Manner As Possible
Andrew McFadden, MBA, CFP
For most of you, in today’s interest rate environment, this will mean refinancing your federal loans into a private loan once you’re done with residency (whether you choose a fixed or variable rate will depend on how fast you plan to pay off the loan). The reason being is that the interest rate on your federal student loans will be about three to four percentage points higher than what you could get on the private side (assuming you have good credit), once you are making an attending’s salary. Unless you plan to work for a PSLF-eligible (Public Service Loan Forgiveness) employer once you complete residency (you need to stay on an income-based repayment plan to qualify for this), the reasons for staying in the federal loan system for physicians are few!
This is contrary to the “common knowledge” out there. Most outgoing residents assume it will be best to stay on their income-based repayment plan, because their monthly payment will be lower and their remaining loan balance will be forgiven after 20 to 25 years. But remember, that’s 20 to 25 years of a much higher interest rate than what you could likely get with a private loan, and any balance that gets forgiven will be completely taxable as income (likely a 50% effective tax rate at that stage of your career). So even if you get a balance forgiven [which you probably won't after 20 years of attending level payments-ed], you’re going to see half of that on your tax bill.
But that’s not all. Refinancing to a private loan is only half the battle. The term you choose is also a crucial decision when it comes to payoff efficiency.
Assume a $180K student loan balance at a 4.5% interest rate over a 15 year term. If that was your loan, you’d pay $102,239 in total interest. However, if you chose to blitz your repayment and refinanced into a 5 year term, assuming the same balance and a 3.5% interest rate, you’d only pay $18,984 in total interest. That’s a drastic difference! Yes, your payment amount would be twice as high ($3,315 vs. $1,568), but you’d have your loan paid off in just a third of the time. That’s the smart way to go! And just think, five years later when the loan is paid off, you’ll have $3,315 per month (or about $40K per year) to decide what to do with. Think of the possibilities!
Some physicians might be concerned about all the benefits they’d be leaving behind if they left the federal loan system. Benefits like deferment, forbearance, and forgiveness. But you shouldn’t be concerned, because physicians who are diligent with their spending aren’t going to need any of these provisions. Even still, some popular online lenders are starting to offer some of these benefits to compete for your business.
At the end of the day, it all comes down to these two simple principles:
- The faster you pay your loan off, the less interest you’ll pay.
- The lower interest rate you have, the less interest you’ll pay.
And with that fresh in your mind, we go to the next smart choice you can make…
# 2 Use a 15 Year Mortgage to Buy Your First House
The interest you’ll save versus using a 30 year mortgage is ridiculous, especially if you live in an area with high real estate prices.
Consider this example: You find a $500,000 home you love and have saved enough to put 20% down (another super smart move!). You’ll need to secure a mortgage loan for $400,000. Your options in today’s interest rate environment are likely a 15 year mortgage at 3.0% or a 30 year mortgage at 3.75%.
The difference in interest over the life of these loans is about $170k (in favor of the 15 year mortgage). And if you choose a 15 year term, your mortgage will be paid off in half the time! Yes, your monthly payment will be about 50% higher ($2,762 versus $1,852), but the extra $900 per month you’ll be paying will be totally worth the interest savings and shorter term. Also remember, in 15 years when your loan is paid off, you’ll have $2,762 each month (or about $33K per year) to decide what to do with. It’s like getting a raise without even working harder!
The major caveat to this recommendation is that you can’t buy as big of a house as you might qualify for on a 30 year term. But since it’s your first house, you can totally get by not buying your dream home. And if you end up selling the house before you’ve paid off the mortgage, you’ll have a lot more equity in your home than you would have had using a 30 year mortgage.
Win-Win!
# 3 Max Your Retirement Savings Starting… Now!
I know retirement is seemingly a long ways off and it seems impossible to save for this and pay off your student loans and take on a 15 year mortgage. But nothing good in life comes easy, right?!
The truth is, taking on these three recommendations is absolutely within reach, it will just mean living like a resident until you have saved for a down payment on your home. And once you’ve done that you can begin enjoying the fruits of your labor, while sitting confidently that you are on the fast track in your financial life. There’s the bitter truth too.
You really can’t afford to delay your retirement savings, because you’re already getting a much later start than everyone else, who enters the workforce after graduating college at age 23, not at age 30. Unfortunately, choosing the Physician career path means that you are starting out late, which puts even more importance on the decision to begin maxing your retirement plan once residency is over. A simple example will help make this choice easy, though.
Consider this: A physician starting work at the age of 30, saving $18K per year (which is the current maximum contribution an employee under 50 can make to a 401K), and earning 8% annually, would have about $5 million saved after 40 years. Contrast that to a physician putting off retirement contributions until age 40. That same physician would only have about $2 million saved at age 70. That’s a huge difference in retirement lifestyle that simply can’t be ignored!
So there you have it. These choices won’t be easy, but they will pay off big in the long run. If you have any dreams of a nice retirement, paying for your kids’ college tuition, or traveling around the world at your hearts’ content, then you will heed my advice. You’ll be sitting pretty if you do!
What do you think? Do you agree these are three critical things graduating residents should do? Do you think it's better to drag out student or mortgage loans? Comment below!
Interesting points and definitely things that every graduating resident needs to keep in mind. I agree that refinancing your student loans to get a lower interest rate is key, especially if you’re not going for PSLF. I’m also a fan of paying off student loans quickly even with a lower interest rate. I’d rather just get rid of that debt ASAP. In terms of buying a home, I think it might be more wise for graduating residents to rent first rather than buy a home. More often than not, your first job isn’t your last job. I personally was at my first job for only a year. If I were to buy, though, I’d go with a 15-year mortgage like you said.
+1 for this
One of the first points I make to our residents is make sure you love (at least like) your job and your family likes the area before buying. Better than dropping a ton on closing costs and being stuck with a mortgage
I completely agree with the recommendation to rent in residency as well as into an attending career. You’ll need to do that just to save for a down payment.
The title of the article makes it a little tricky to note that I am not recommending to buy a house right out of residency (or in residency). By saying, “taking on these three recommendations is absolutely within reach, it will just mean living like a resident until you have saved for a down payment on your home,” I am hoping to imply that you need to save for that 20% down payment. Which means continuing to rent.
My intention is to get residents to start thinking about the decision of whether to use a 15 year or 30 year mortgage when they eventually end up buying a house. It is rarely talked about and lenders will never propose the idea. And the financial implications are substantial.
I also agree most should rent. However in my experience working with residents, some are already dead set on buying. It’s a non-negotiable. The 15 yr mortgage helps frivolous spenders not get carried away.
Also physicians moving to a brand new area crazy enough to buy and use 100% financed doc loan should really be serious about building some equity or at min not being upside down (because of acquisition costs). I like the 15 yr because it forces them to build equity faster.
These “frivolous spenders” that probably arent reading this will be telling themselves…. No, I think I’ll get a 30 and overpay (or invest). I like the flexibility. We all know that’s not going to happen.
Nice article Andrew!
On the housing front, many of these excellent comments echo themes that I think almost everyone can agree on: rent until you figure out if you’re in your town for the long haul, don’t buy the trophy house right out of training with 0 down, etc. I think there are a number of ways to approach the first house purchase and the 15-year loan will not be right for many (most?) people. I agree it can be a way to “force” you to buy a more modest and truly affordable house, I think the audience of this blog is a bit more savvy. Here are some reasons why someone may opt for a 30-year:
1. Time horizon: Unless you have rented for several years and are really stable in your job, you probably won’t be in that first house long enough to pay it off no matter what loan term you choose. Your job or your circumstances will change and you’ll never pay those additional 15 years of interest. Many people will be better off paying down student loans more aggressively than having slightly more equity when they sell.
2. Interest rate spread: For our theoretical early-career physician without a ton of excess money, she needs to feel good about the trade-off between putting extra money into a housing payment that is building equity and using that money to pay down loans faster. For me a 0.75% spread between the 15 and 30-year loans probably wouldn’t be enough to justify the larger payment. Everyone will have a different number that makes sense to them, but most would agree that 0.25% is too small to choose the 15-year whereas they would love a 1.25% spread.
3. Purchasing power: It’s great if your circumstances allow you to work close to a really inexpensive area with great schools, etc but that’s not a reality for many. Two years out of residency my oldest child was going to enter the school system and I could choose between an expensive intown neighborhood with great schools and a quick commute or move to the suburbs, pay half as much for the house and spend 90 minutes or more in the car every day. Even though I made a good salary and had no student loans to speak of it was daunting to consider a 15-year payment on an 800k house. For me it made more sense to buy with 10% down and a 30-year loan. Once it became clear we’d be there for the long haul and I could easily absorb the monthly payment I refinanced to a 15-year loan.
My situation was quite different from most and I’ve made more than my share of real estate mistakes. I agree that it makes sense to rent for as long as you can get away with it. I don’t advocate buying with zero down (though I have a senior colleague who argues for that) but I think in high-cost, hot housing areas it can work out better to put 5 or 10% down than try to wait until you have 20%.
Don’t mistake the audience of this blog for the 1% who actually leave comments or participate on the forum. Most readers are lurkers and far less financially savvy than the commenters.
I agree that paying off student loans is often a better use for your money than paying down a mortgage at today’s rates.
Great high-yield advice.
I failed to contribute to my Roth as a resident and I am regretting that decision. $5500 for 4 years compounded tax-free at 5% interest over 35 years would be over 100K. Expensive decision.
I would second the advice to rent first rather than buy. That will give you time to save up that 20% downpayment, learn about the area, and figure out whether your first job will be a long-term position.
I like the big-picture advice here. It is easy to get lost in the details. Thank you for the post.
Are you regretting not saving at all during residency or not saving in a Roth? If it’s the latter, the cost is not so bad, since you are only losing the taxes on your gains when you cash in at retirement (assuming you don’t sell your shares before them). In that case, the loss is only about 20K, not 100K.
I did not invest at all during residency. I did save up about 15K as an emergency fund (which helped with the 10K move to Alaska), but I really should have lived a little leaner and contributed to my Roth.
All three are great points and your guidance on student loans for residents is excellent and shows. However, while your point about starting to save for retirement early is extremely important, you lose credibility when you start using examples that assume an 8% return annually (I hope that’s not what you use with your clients when modeling out realistic portfolios). It’s higher than the historically average (6-7%) and ignores thoughtful research (e.g., McKinsey) arguing why we will see lower returns in the future (4-5%). (Let’s not even get into nominal vs real returns, which would shrink the difference further). If a doctor earns 50% annually, the difference would be even more!
The insight you make holds regardless of the number, which is why I don’t think it’s fair to subtly anchor physicians on what the preponderance of the investment and advising community would agree is an unrealistic expectation of 8% year over year. I would recommend that you either use a realistic number or use a number that is so absurd on its face that no one would be mistaken. 8% fails both tests.
To defend the guest poster, I think 8% nominal returns is reasonable based on historical data (for example, http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html). What he is presenting is an average or typical scenario, not the worst case scenario. While I think financial planning decisions should be based on a more conservative investment return (remember that the 4% rule is based on ensuring that you don’t run out of money in retirement with a high probability, but you on average end up dying with significantly more than your net worth in retirement), the example Mr. McFadden presented is strictly to illustrate the importance of saving early, which we all agree on.
Its actually lower than the average nominal return. There is nothing wrong with it. He doesnt know the future any more than the guys saying we’ll only get 2% from here on out, they just happen to sound smarter since thats how pessimism sounds.
I don’t find 8% terribly unrealistic for an aggressive portfolio and frequently use it in examples (and in fact my own portfolio has long-term returns of about that.) Considering the long-term annualized return of the S&P 500 (1871-2016) is 9.07% I don’t think there is any sin in using 8%. If your assessment of the data is that future returns over your investing horizon will be dramatically lower, then I suggest you use those in your own calculations rather than demanding that everyone else adopt your assumptions. But bear in mind that there are very real consequences to very low future returns as I blogged about here:
https://www.whitecoatinvestor.com/making-different-choices-due-to-low-expected-returns/
People always say this and I find it a bit confusing. Everyone always says that past performance does not predict future returns but have no problems relying on historical data for the S&P 500 or US total stock market or whatever. Why is looking at past results in this case acceptable? Because it is looking at an aggregate of companies? What about (actively managed) mutual funds?
In a more general sense, most people would agree that the United States has had a phenomenal run in the 20th century. However, is there any reason to necessarily believe that this will hold true in the future? Nations rise and nations fall. I believe (but did not research) that returns for earlier developing countries such as those in Europe and the world as a whole from 1871-2016 has been substantially lower than 9.07%. Why should we expect the past performance of this country to hold true in the future?
You are correct that there are no guarantees. You make your bets and you take your chances. Investing is far from a science, but it is worth at least looking at the evidence.
For sure. But the question remains. Why the disconnect between it being “acceptable” to look at historical data for the S&P 500 but not for individual companies or mutual funds?
I don’t have a great explanation for that except for that we’re looking at a lot of companies for the longest available time period/data set.
Fair enough. Just something that I’ve been wondering about recently and can’t really justify to myself.
You certainly can and people do, this is basically the whole premise behind dividend growth investing, the aristocrats etc…Obviously with such a smaller sample you’re more at risk of abrupt change of any kind negatively impacting that history or a management related error than the protection of diversification by having hundreds of them.
A couple of things to keep in mind. The S&P 500 is Dynamic and Constantly Changing. Companies that make up the S&P 500 are not the same companies – as Cap Size change, Companies are dropped and replaced with others. S&P 500 (20 years ago) was a different make up of companies, than today’s S&P 500. Note: Research shows that Actively managed Mutual Funds underperform the S&P 500 on a long-term horizon. Maybe on a given a year or two, an Actively Manage Mutual Fund might outperform the S&P 500, but over the Long-run it will not.
You should look at Credit Suisse’s yearly investment returns yearbook. It gives country-specific nominal and real returns for all bonds and equities that there is available data on. It’s built on work from the book “Triumph of the Optimists.” Global equity returns have averaged about 5% real. I think if you stay relatively close to a true global portfolio, the 5% is achievable without having to worry if the US is the next Japan for the next 30 years.
https://www.credit-suisse.com/us/en/about-us/media/news/articles/media-releases/2016/02/en/credit-suisse-global-investment-returns-yearbook-2016.html
We should send this discussion on over to Dave Ramsey for input. He says 12% all day – and recommends using commission based Advisors.
12% is unreasonable and hurts Daves credibility. 8% is reasonable.
Check out Rick Ferri’s 30 yr future return projections – https://portfoliosolutions.com/latest-learnings/blog/portfolio-solutions-30-year-market-forecast-2015
Even with 2% inflation, they’re within range of 8% for equity.
One alternate way to present your last example is to model out how much more the physician who delays saving until age 40 will have to save per year in order to achieve the same financial goals as the physician who start saving at age 30. In order to have $5 million at age 70, the new attending can either save $18,000 a year starting at age 30, or save $40,000 a year at age 40. Doctors have the ability to start late and still achieve their financial goals, but it’s harder when you don’t start early.
Great idea! It’s great to look at the scenario from different perspectives. Thanks for the comment!
I disagree with the mortgage recommendation.
You are completely ignoring that the physician would be able to save and invest the difference of $900/month. After 5 years, with zero growth, that is $54,000. So what they lack in equity, they should make up in other investments.
Remember the interest on the loan example you used is tax deductible. So assuming home interest remains a deductible expense, the physician may pay 170k more in interest over 30 years but they also pay less in taxes over that time. Effectively it may be a difference of $100k over 30 years. Not bad at all especially because they could have invested 162,000 over the course of the first 15 years. Do the math and you’ll see with even a 3% growth rate on their extra 900/month savings, they come out ahead after 30 years.
As a general rule, if the physician can’t afford to pay the 15 year payment and can only afford the 30 year payment, they are buying too much house.
How close are they to being able to afford their dream home? 10 years? Then maybe it makes sense to buy a house now. 5 years? Much riskier and more likely to lose money when they sell.
Lock me in at 3.75% for 30 years in a house I’m likely to stay in? Sign me up.
I wrote a post on my site on why I went with a 7 year arm. I received the lowest rate (2.8%) and in 7 years will refinance to a 15 year loan. The home will be paid off in 22 years and the interest payment savings are significant. Just another consideration.
I would recommend not buying a home in residency and waiting to buy until 3 to 4 years into the first attending jobs. Most docs leave their first job after a few years.
-ej
Great plan….unless the interest rate jumps to 10% or more in 7 years. I’m not suggesting it will, just that it can. If it does, you will be kicking yourself for not going for the 15 or 30 year fixed rate. Any mortgage is a “gamble”. Taking the 30 year fixed bets that the interest rate won’t drop below what it currently is AND that you won’t be able to refinance if it does. Taking the ARM bets that the interest rate won’t drastically jump when you 7 years are complete. Future….very difficult it is to predict.
Its not that concrete. Taking the ARM now just bets that interest rates wont rise fast enough to offset the principal pay down that occurred early on. It has been a total winning move so far. Interest rates could reset to higher than the fixed they were offered and they could still come out way ahead.
For it to be a bad bet rates have rise fast and hard, and usually when that happens its right before they start dropping anyway.
Not only your example which is true, but the reality of housing in America and for doctors as well. What is the average time people stay in houses? It certainly isnt anything close to 30 years, and I bet its less for doctors who need to either upgrade, move for job, or give it to their formerly SO. It has crept up in years since the housing bust towards 13 years, but varies.
Getting your money back from a home is more of a low probability and high transaction cost than putting it in the market and the time value of money works against you not with you. Which of course assumes you’re investing the difference, which you should be.
I am glad someone else has come out of the closet to admit they have an ARM. I have a 5(!!!) year ARM at 2.375. Saving $600 per month after refinance. Planning on moving in 7 to 9 years after kids in college. In very high cost of living area and a 15 year mortgage not feasible. I just don’t think (I am not just making this up, have done a lot of research) that interest rates are going to shoot up to 10 percent in a few years. It all depends if you think you are in your forever home.
There’s a significant risk that you’ll be refinancing into a much higher rate 7 years from now.
I think the ARM is up in about 2 years, so will be forced to refinance anyway. But would get another ARM because of plan to eventually sell. Probably a 7 year at that point. It just pains me too much right now to refi because we would be giving up such a good rate.
You don’t have to refinance “when the ARM is up.” It just becomes a variable mortgage.
You can always show that mathematically borrowing at a low rate and investing the difference is likely to work out. But there are two serious assumptions there that are generally glossed over- # 1 That investing the difference isn’t guaranteed to work out and more importantly, # 2 that you will actually investing the difference instead of buying stuff with it, a much less likely assumption.
Another thing to consider is what can be gained from not earning that extra money you’d need for a 15year. In my family it allows me to stay at home with kids while still contributing to IRA. It would have been a harder choice to take the 15yr smaller house and lack of IRA/stay at home parent or rent another 6 years. 15yrs are a great option if it fits within your goals but that doesn’t mean there isn’t a place for ARM / or 30yrs. I do however agree that people are highly unlikely to actually invest the savings from a 30yr.
I agree. I’m weighing the same question as I struggle with whether to pay my 15 off early. I don’t think I’m actually investing the difference. I think I’m spending it on wakeboats and heli-skiing. It’s really hard to say because I am investing and money is fungible, but I’m definitely leaning more toward the behavioral side rather than the mathematical side of this issue these days.
I agree with the numbers. You can get a 30 yr, invest the difference and the math says the investment ends up making you wealthier.
It’s interesting how many young people talk about the mortgage stretching strategy. I’m guilty myself.
But so few high net worth people (at least those I’ve associated with) have mortgages even in today’s interest rate environment.
I’ts harder to find people that have already made all their money that are high on this strategy. Maybe this will change as the people that grow up in the low rate environment build wealth. Who knows.
I fully believe that the initial question is “What are the smartest things we can do when it comes to our money?” because that’s the same question law students ask. The disappointment comes when you give them the advice they need to hear (pay off loans, spend reasonably on housing, save for retirement). They were expecting you to tell them The Secret and instead you gave them advice closer to what grandma would have said. Well, it turns out grandma was right.
Unfortunately time-tested and practical doesn’t sell.
Nice post. All 3 points might be doable in a high income specialty. For the remainder of us, I would recommend focusing on retirement first, then loan payoff. If in order to make it happen you need the additional cash flow a 30 year mortgage gives you, use the leverage to your advantage especially at current interest rates. Your first house will likely not be your forever house so keep it limited to needs not wants. You’ve worked hard to get through med school and residency. Use that same drive to your financial benefit. You can “have it all” – just maybe not at the same time right out of residency.
+1
Saving up that nice, fat 20% down for the house deserves its own step. I’ve yet to meet a resident who has had that ready by graduation day. The example 500K house needs 100K down. Average school debt is 170K, so that’s like tacking on an extra 60%. Accumulating that 100K, isn’t as quick and easy as the author implies.
Overall, good post.
You’re right. That was one reason the house we bought out of residency (with a 20% down payment) was $138K. There were other reasons we bought such a cheap house too, but even that ended up being a mistake in the end. Should have rented.
Some of housing choice like investing comes down to luck. Good ways to stack luck in your favor are low price and bigger downpayment. We did 95% financing back then. But, we listened to my mom who was a real estate agent about what to get for a quick resale if it didn’t work out, which it didn’t. Lower price homes can offer a wider range of buyers and are easier to carry if it turns out to be a mistake.
I guess we’ve never met 😉 I had the down payment, but rented for a year to make sure the job was stable. Ended up being a painful decision as the rental was broken in to and ended up costing me about $25k and the headache of identity theft (long story about the loopholes in insurance coverage). Logical decisions, but the older I get the more I realize there’s a big luck component (although you can certainly stack the odds in your favor).
I disagree with #2, and would say #1 depends.
Paying off debt quickly has an opportunity cost. By increasing payments the spread becomes money you are not investing. Of course this is a moot point of you are simply spending the difference and not investing, but the math would indicate the investor will come out ahead in the long run. I think many would benefit from the ‘forced savings’ that paying off debt quickly enforces, but not all.
Secondly, paying off debt quickly decreases flexibility and liquidity. This is something people often don’t consider. Simply put, I would rather have a 500k mortgage and 500k in liquid investments than own a house outright with no investments. If I need money for something I can liquidate my investments, but the bank doesn’t have to lend me money on my house. In 2008-2009 I know more than a few people where this became an issue. Physicians have more job stability than most, but life happens.
I’m aware at the extremes this argument become a bit absurd (ie: why not take out millions of dollars of low interest debt and invest), and at some point the risk and leverage would probably not make complete sense.
I am in total agreement. I never get those extreme arguments either, its not as if someone is offering a several million dollar loan with rates and terms comparable to a mortgage anyway. If someone was, I would probably consider it as it would make total sense to lump sum invest now and instead of directing a sum towards retirement each month you just pay the loan. Obviously the terms would have to be favorable, but my answer is always, yes, I totally would consider that if tax wise, etc…it was at the very least a wash.
Once you understand time value of money, that its fungible, etc…that also makes great sense. So much sense that no one in their right mind would offer it to you and so thus it does not exist.
Hey all the wife and i are a 2 doc family putting 250k away yearly to profit sharing, cash balance, roths and hsa. Would you put extra money into…
– school loan 2.5% $180k left
– school loan 1.625% $130k left
– investment property we rent with a 30yr 3.875% $400k
investment property 2 30yr 3.75% $250k left
– brokerage
we live in california
Tough choices. All good things to do. None very easy to get excited about. No really wrong answer there. I’d probably pay on the student loans, starting with the 2.5% one. But I don’t think investing while borrowing at those rates is wrong either. You can split the difference if you’re having a hard time deciding. I’m assuming fixed rates on all those loans.
I am always skeptical of arguments that don’t work out mathematically
1. If the author assumes an 8% ongoing return to investing, why in the world would I pay off my 2.75% mortage (ARM)?
2. If everyone is so convinced I won’t invest the difference between my payment and the one on a 15 year mortage, why are they sure I would start investing that money once the mortgage is paid off
I have had an ARM for almost 12 years (2 houses, 3 different mortgages) and have come out far, far ahead than I would have with a fixed rate. I have invested the difference.
Excellent points.
This is basically my argument ad nauseaum (the forum can vouch for this). If you cant be trusted to invest the difference now, you wont later either, makes no sense.
I do get that the commenter subset is absolutely not average and what works for us maybe isnt the best prescription for the brand new to finance person.
I love the old argument about paying off low interest debt vs. investing. I am always drawn to reading these articles and comments following them even though the points are always the same. To me, this is a lifestyle question, not a question of math. I invest more than enough money in retirement account to live the retirement I want to live. So paying down the mortgage is more about decreasing risk. Sure, I might be able to make more a little more money other places, but that is not guaranteed and I do not believe the difference will impact my life at all if in fact I did make some amount more. I am not in a competition to have the most money when I retire. Why keep playing the investing game (or do so with a more aggressive strategy) when I do not need to.
Awesome comment!
My feelings exactly!
I have to disagree with the Author (Andrew McFadden) on his advice.
Many of you have already made the Points, but just to reiterate those and some additional reasons for the flawed advice:
1. Opportunity Cost – $900 per month (invested over 15 years at 7%) equals $287,830.12! NOTE: This figure jumps to $642,126.55, if you add in the $100,000 down payment – suggested.
2. 20% down – why? You, as Doctors, have Mortgages that the General Public do not have access to! 100% Financing (NO Mortgage Insurance) and with Midland States Bank – Low Fees and Lower Interest Rate (as of Our Current Rates) versus a Conventional (Fannie Mae or Freddie Mac) Mortgage.
3. Understanding the Current Real Estate Market – It is appreciating (in 2016 the U.S Housing Market was up 6.2%) and the Forecasts for 2017 are for an increase of 5.0 to 5.5%. Inventory is LOW.
4. Tax Savings for Interest Paid on a Mortgage versus Renting.
5. Rents are rising 4.0% each year.
I could go on with more and different scenarios – I have been on both sides (I was a Financial Advisor for 6 Years, before moving into the Mortgage Side of Finance for the last 17+ years.) Trying to breakdown these decisions into 3 categories that generally apply to everyone is a HUGE disservice to you.
One thing I have learned over the years – even if the numbers make sense, the individual or couple have to live with the Product, Home, and Financial Plan they choose – comfort factor – no one size fits all.
I guess I’m not surprised to see a mortgage lender advocating taking out a large mortgage and carrying it as long as possible. Your points need a rebuttal, not that I’m entirely against your conclusion.
Regarding # 1, your calculation doesn’t include the benefits of getting a lower rate on the 15 nor the fact that the 15 builds equity faster. Yea, $287K sounds like a lot, but the saved interest and increased equity decreases that figure quite a bit.
Regarding # 2, 100% financing isn’t free. There are more options, lower fees, and lower rates for a conventional than a doctor mortgage. Lots of moving parts out there, but the general truism will usually be there. Doesn’t mean using a doctor mortgage is bad if you have a better use for your down payment (7% student loans, max out 401(k) etc).
Regarding # 3, using the present tense suggests you know the future. I suspect if I really pinned you down on it you would admit you don’t know what real estate prices will do in the near or even remote future and if you did, you wouldn’t bet much of your net worth on that prediction. Real estate prices were certainly “appreciating” in 2006. Doesn’t mean borrowing to get a big fat home was a good move that year. Besides, whether to use a 30 or 15 has nothing to do with the purchase decision. Totally separate decisions.
# 4 Classic argument from a lender/realtor. There might be tax savings. Or there might not. It will certainly be less than you think. Only the amount above the standard deduction is really deductible, and if you make a lot, Pease limitations will limit the deduction. Don’t buy a house just because you think it will lower your taxes.
# 5 This might be an argument to buy instead of rent, but it certainly isn’t an argument for a 30 over a 15. Lots of costs associated with owning a house are also going up at ~4% a year- property taxes, maintenance, upgrades, insurance etc.
There are a number of way to calculate out particular Scenarios. I was using figures given in the Article and conservative on the Percentage Return for the S&P 500 (using 7%, instead of 8%.)
#1. Using an Easy Accessible Website for calculations [Bankrate.com] and using the current Rates for a 15-Year Fixed (3.375%) and Our Doctor Program – Midland States Bank 30-Year Fixed (4.125%) – Noting in these calculations; 1. Different Loan Amounts and Down-Payments – 15-Year Fixed with Loan Amount of $400k with Down-Payment of $100k and 30-Year Fixed with a Loan Amount of $500k and Down-Payment of ZERO:
Mortgages:
A. 15-Year Fixed at 3.375% – Monthly Payment is $2,834.06. Total Interest at End of Mortgage is $110,131.24.
B. 30-Year Fixed at 4.125% – Monthly Payment is $2,421.80. Total Interest at End of Mortgage is $371,846.71.
Difference in Down-Payment ($100,000) and Monthly Payment ($412.26.)
Savings:
A. Start Saving (No Mortgage Payment) on First Month of Year 16 = $2,421.80…Using Savings Rate of 8% for a 15-Year period adding $2,421.80 each month compounded monthly (Year 16 to End of Year 30.) Total amount Saved = $846,044.07.
B. Start Saving with $100,000 and add $412.26 per month for 30 years (Year 1 thru end of Year 30.) Total amount Saved = $1,501,545.81.
Difference between Option A and Option B:
Total Savings for A = $846,044.07.
Total Savings for B (subtracting the Extra Interest Paid from overall Savings) = $1,501,545.81 – ($371,846.71 – $110,131.24 = $261,715.47) = $1,239,830.34
Difference [$1,239,830.34 – $846,044.07] = $393,786.27 …Not taking into affect any Tax implications.
Regarding #2 – I do not know what the other Doctor Programs have in the way Fees and Rates, but Our (Midland States Bank) Doctor Program Fees and Rates are currently and have been LOWER than Conventional Fees and Rates. Call or email me, I will be happy to share them with you. Like the example (I gave above) – Those are Today’s Rates – if you want a 15-Year Fixed (100% – Doctor Mortgage) – Rate Today is 3.25% Conforming and 3.125% Jumbo – NO Points, Bank Fees run approximately $750 (same as out Conventional) – that is an 0.125% to 0.25% better that Conventional.
Regarding #3 – I cannot predict the Future, but I know the Markets and stay informed on all of the different inputs that effect my Industry. Note: In 2006 – Everybody and their brother could qualify for a Mortgage (just need a Heartbeat), however, a lot has changed in 10 years. The buying pool – number of qualified Borrowers – was shrunk in 2009 to 2011 (Government Regulations, Reduction of Mortgage Products and Stricter Underwriting Guidelines.) From 2006 to about 2014, there was a Surplus of Homes on the Housing Market (Foreclosures, Buying Pool being reduced, etc.) Fast-forward to Today’s Housing Market – Larger Number of Qualified Buyers, due to an easing of guidelines, Income has been increasing, reduction on Mortgage Insurance premiums – both Private and Government, Economy improving and number of other factors. Housing Supply is Low. Whether someone wants to believe that the Housing Market is Flat, Appreciating or Declining is up to them – I just watch the numbers and the trends – Conventional Loan Limits increase for the 1st time in over 10 year $424,100 from $417,000. So, I would not be going out on a limb to say that we are in a lot better situation, than 2006, 2008, 2010 and even 2014. I do believe in the Forecast that Housing prices will rise again in 2017 about 5.00 to 5.50% – it is not a sure thing, but a solid educated guess.
Regarding #4 – I never make a decision or tell people to make a decision base on Taxes or Taxes Savings…Just like buying a Stock – if you rely on what the Tax Consequences are to sell – you might miss the opportunity to Realize a Gain/Opportunity. Plus, everyone’s situation is different.
#5 – I was just pointing out that Renting is not Stagnant.
Thanks,
Kent
Just wanted to offer another perspective to other young docs about our stupid financial moves. the silver lining is that its not too late to clean up your act (if you’ve found this page you’re on to something)
–made the “mistake” of buying right out of residency.
–bought new construction and had to rent while home was being completed
–used a 7:1 ARM
— used a physician loan with 5% down
–didn’t even have the 5% and had to take a line of credit from a bank to use for down payment
–didn’t invest in 401k my first year out (not my fault technically I wasn’t eligible)
–didn’t pay down $207,000 in student loans b/c I was too busy paying my downpayment
–2 cars on lease
OUCH. Just writing all those bad decisions hurts. Did I mention that I left the job after 2 years when practice folded/sold? recipe for financial disaster? Not so fast…
I found and really started taking stock in WCI and read his book. Now just 3.5 years out from residency I am happy to say the ship has been righted. Now, I am in a highly paid field and had some good luck along the way, but i’m happy to report that by year end my net worth should be ~500k.
–landed job in same area and negotiated large signing bonus without even having to move
–home has appreciated ~100k (according to Zillow and recent comps)
–Student loans paid off
–refi into 15 yr fixed 3%
–saved my a$$ off and built a about 300k in combined savings (taxable/retirement accts)
–have “max” life and DI insurance
–1 car still on lease, own the other outright
–have achieved (and plan to stick with) a 50% savings rate (based on take home pay)
I write this just to let you know that financial mistakes can happen, and you will make them. Just keep reading this and other blogs and right your wrongs.
Sounds familiar. Good job!
Hello WCI,
Recent addition to the community; love the podcast, site, and own but have not yet started the book. I’m brand new to the financial education side of things, and am nearing information overload, haha.
Anyways, how do you weigh the difference of paying down loans (380k with an averaged out 7.3% interest), and investing? The only investing I’m doing is my residency matched 6% into a 403b. I have 1.5 years left in a 4 year residency. Part of my wants to start investing a bit more, whereas the other side of me wants to start paying my loans bit by bit. I am on REPAYE for most of my loans (there are a couple lower balance Stafford’s in there that I have not converted because I have a 1.0% interest deduction for 48 months of on time payments on them). I am also, of course, planning on refinancing as soon as residency is near over.
Should I start chipping away if can comfortably afford it?
Will refinancing in a little over a year make any contribution I make now worthless?
Would you recommend investing in this instance?
Thank you
# 1 Are you going to pay off the loans or is someone else? If someone else, then you don’t want to pay them down. If you’re not sure, then maybe you don’t want to pay them down. I’m guessing you’re going to pay them off since you’re talking about refinancing, and once you refinance you can’t go for PSLF.
# 2 Get your match, no matter what.
# 3 Assuming you’ll be paying off your loans, a 7.3% guaranteed return on an investment is pretty attractive. But so is funding a Roth IRA. No right answer there. Both build wealth. Both are good things to do. Try to do as much as you can of either.
Refinancing would NOT make a contribution worthless.
This post may help:
https://www.whitecoatinvestor.com/student-loans-vs-investing/