[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
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.
# 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!