I’m a live and let live kind of guy, but I have to say I have a similar aversion to debt as the good Dr. Dahle. I’ve been debt-free for a couple years now, and it makes me happy despite the potential arbitrage that can come from keeping low-interest debt and investing the balance in the stock market. But that’s a discussion for another day.
This article was first published on The White Coat Investor.
Stupid Debts and the Doctors Who Love Them
I get a lot of comments and emails from docs, and spend a fair amount of time on both physician-specific and financial forums. I’m often surprised to see doctors carrying debt that I see as completely unnecessary.
Unnecessary Debt
A Car Loan
Well, when does your next paycheck arrive? That’s when it should be paid off. I’d be embarrassed to say I’m in debt for a car. Broke people have car loans.The classic example is a car loan. It might be an attending physician several years out of residency going through their financials and they list a $5K car loan. Assuming no working spouse, this person grosses $15-30K a month. How long should it take to pay off a $5K car loan?
People with an income of $200-400K shouldn’t be broke unless they have terrible money management skills. Therefore, if you are a doctor with a car loan, you probably have terrible money management skills. The status symbol isn’t driving a fancy car; it’s driving a paid-for car.
Credit Card Debt
The other silly debt I occasionally see doctors list is credit card debt. Now, take pretty much anything that came in the mail from a credit card company. Turn it over and look for a big box on the back. Read that box. Somewhere in that box it will tell you that borrowing money from that credit card will cost you somewhere between 15% and 30%.
Now, if I could find an investment that paid 15-30%, I would buy as much of it as I could, take out a home equity loan and send my kids out to shovel driveways (it’s December as I write this) to get extra cash to invest. If you are carrying credit card debt, you are somebody’s awesome investment. As my 6-year old will tell you, interest is something you should get, not give.
An Emergency Fund and Debt?
So for us, the point of an emergency fund is to avoid going into debt if you have an emergency. If you are already in debt, YOU’RE ALREADY HAVING AN EMERGENCY. Your emergency began several thousand dollars ago. Use the emergency fund to take care of the emergency and pay off that credit card.
Debt Management?
There seems to be this popular concept out there that encourages people to “manage” their debt so they can use it to get wealthy. The arguments look good. The idea is basically to borrow at 4% and earn at 8%. Mathematically, there is great truth there.
But behaviorally, people don’t really seem to work that way. Once your mindset changes from debt elimination to debt management, people seem to get comfortable, savings rates go down, spending goes up, and 20 years later they wake up and find they are still in debt and really didn’t take advantage of some huge arbitrage.
The other issue is that people don’t really calculate out just how much this arbitrage is earning them. For example, let’s say you are offered a 2% loan for a car. You have the $10K the car will cost, but think you’ll do better than 2% investing. So you invest. Things go pretty well, and over the next couple of years while you carry this debt you make 6%. So you’ve made 4% a year for two years.
What’s 4% of $10K? $400. $800 for two years. And after tax? Maybe $500. How long does it take you to earn $500? What else could you cut out of your budget to get $500? Exactly. Obviously, if you’re making $200K a year you can afford to service a $10K 2% debt. It’s not going to break you. But it’s kind of silly.
I also find it very unusual for wealthy people to have a significant amount of debt. As mentioned, there are good arguments to be made to carry debt throughout your career and even into your retirement. But in practice, I know precious few wealthy folks doing that.
The same mindset that makes people wealthy also makes them pay off debt earlier than required and not take out any more. Dave Ramsey does “Millionaire Segments” occasionally. These are generally Millionaire Next Door types who made $60-150K throughout their careers and are now millionaires. Granted, these are a very self-selected bunch, but few of them ever still have debt (maybe a mortgage) and all deny that debt had any significant role in their wealth accumulation. Same thing with the millionaire retirees over on the Bogleheads forum.
But guess what? At the time of this writing, I would have been better off sending the checks to the mortgage lender. I think that’ll probably come around over the next few years, but there is certainly no guarantee. [Update 6/2015- I am now actually ahead, especially after tax loss harvesting benefits.] Can you do some of it? Sure. I’m doing a little debt arbitrage with a taxable investing account instead of paying off my mortgage. My justification is that my effective after-tax rate (2.75%*56%=1.54%) is less than the rate of inflation.
My wealth has not come from arbitraging debt. In fact, most of my financial success comes from the fact that I lived well below my means, eliminating much need for debt. The recipe is (almost) always the same- make a lot of money, save a big chunk of it, and invest it in some reasonable manner.
Long Student Loan Repayment Terms
I have a lot of student loan refinancing companies who advertise with me. They laugh at me when I tell them I want my readers out of debt in 5 years and that I don’t really care what their 10-20 year rates are. Why do they laugh? Because they know what you guys are actually doing. And you’re refinancing into 10 and 15-year student loan terms.
I think you ought to be a millionaire 10 years out of residency, not a debtor. But hey, if you want to still be in debt a decade after finishing your training, pretend your student loans are a house, then get yourself a fifteen year fixed student loan mortgage. I look at it like this- the longest anyone ought to be in debt for med school is four years after finishing training, because that’s how long it would take to pay for medical school via the HPSP “Scholarship.” If you can’t get out of debt in four years, you’d be better off in the military.
One issue with a long-term student loan is that you get a crummy rate. Sure, 5.5% beats 6.8%, but if you were going to pay it off in 3 or 4 years, not only could you get a 3.5% fixed, but you would probably be comfortable with a 2% variable rate. And 2% is much better than 5.5%.
If your loans have been gone for years and you have a huge nest egg at that point, then you can cut back and pursue other interests. If you’re still in debt slavery, well, sorry. Get back to work. But the main issue is that you still have debt after 5, 10, or 15 years.
It is a very rare doctor who is just as excited about practicing medicine 10 years out of residency as she was one year out of residency. It’s not that she’s burnt out (although that is the peak for burnout as well,) it’s simply that life happens, other interests develop, part-time work starts looking more attractive etc.
Forgiveness programs almost make things worse. With the possibility of federal forgiveness programs and employer loan payback programs hanging out there, many doctors start thinking maybe they won’t have to pay back their loans at all. So they subconsciously take out more or delay refinancing and paying them back as quickly as they could.
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30-Year Mortgage?
Yet another area of silly physician debt is a long mortgage on your primary residence. You might be surprised to learn that nobody used 30-year mortgages prior to World War II. GIs came home and were eligible for a 30-year VA mortgage. Prior to then, shorter mortgages were the norm. Why did they go with the 30-year? Because they figured a typical career was 30 years and wanted the home paid off prior to retirement. Do you really want the VA to decide how long you should be in debt for a residence?
WCI’s daughter &cousins on Angel’s Landing.
Yes, we roped them up.
Now, if you practice in Boston, or Manhattan, or the Bay Area, you may not be able to afford to buy with a 15-year mortgage. The rest of you have no excuse.
Don’t buy a house so expensive that you can’t pay it off in 15 years. Not only do you get out of debt in 15 years, but you get a lower interest rate too.
The flexibility argument is bunk (“I want a 30-year just in case something happens, I’ll still pay it off in 15.”) Your mortgage ought to be such a small percentage of your income anyway that if something happened that kept you from making the payment on a 15-year, you probably won’t be able to make it on a 30-year either.
Plus, you have an extra decade and a half of exposure to “something happening.” Do yourself a favor and get the 15. If you want to be skinny, do what skinny people do. If you want to be rich, do what rich people do. Rich people use 15-year mortgages (and pay them off in less than 15.)
Personal Loans
Paternalistic? Perhaps. I’d certainly be wealthier if I took their money. But nobody borrows their way out of debt, and nobody borrows their way to wealth.I have had a lot of advertisers come to me and want to advertise their personal loan and personal loan consolidation services. I uniformly turn them down. (I took one, which also does business/practice loans. But I demanded they remove any reference to personal loans from their banner ad.) They thought I was strangely demanding, but I don’t want you getting the idea that it’s okay to have consumer debt.
Rich people don’t “manage” debt. They eliminate it. Not stupidly, but reasonably and consistently. It’s a behavioral thing, not a math thing. There’s a reason debt makes you uncomfortable.
What do you think? Do you have “little debts?” Why or why not? Do most of the wealthy people you know carry a lot of debt? Are you “managing your debt” or “eliminating your debt?” Why? Comment below!
What’s the applicable risk free rate? Because paying back a debt is the equivalent of getting a risk free return, so the arbitrage opportunity would presumably be measured against this
I hate debts with passion. Even though I am an accountant that knows how one can leverage on debts to make money by using other people’s money, I choose not to go into debt whether zero or low interest. I know a lot of people may criticise me for this. It is the way of life I choose for myself and this give me peace. When I sleep, I enjoy my sleep
Another vote for near 0% car loans offered by the manufacturer or credit unions if it doesn’t impact the purchase price. I agree that car loans that one can’t pay off if one chooses with the stroke of a pen are foolish, but I’m not against taking free money if it’s offered. I’ll leave that money in the market for 3-5 years and take my chances. Even an ally CD puts me ahead in that situation.
So many dealers offer 0% financing, it’s really hard to pass that up.
As far as paying off educational debt, it is a math equation that’s true, but I never felt like I was a real attending until I paid it off. That was a VERY emotionally satisfying day. Very liberating.
$K
I think a lot of people who are used to carrying debt underestimate how good it could feel to carry none. I know I did.
I look at 0% financing as a perk that probably costs money. I’ll bet most dealers would accept a lower purchase price for a cash purchase as opposed to a 0% loan, which obviously costs the dealer / manufacturer some money.
Best,
-PoF
Why do you think that, since they are, most likely, not servicing the loan? For instance, in the last year, I bought a new car and had to purchase a new AC/Furnace. I could have knocked both out with cash/investments, but they offered 0% financing. I’m not a doc so I make less than what is normally discussed although very much qualify as “high-income.” However, by taking the 0% I am able to cash flow these purchases with little-to-no effect on my household budget rather than dip into savings or liquidate mutual funds.
Also, as an aside, when purchasing, I actually asked if there was a “cash” price and both said nope. In both cases, the lender was a third party bank so they would not be on the hook if I didn’t pay. As soon as the agreement was signed, the dealer received full payment. Now the manufacturer may have had an incentive to offer a discounted cash price (since they are subsidizing the loan to get it to 0%) but the dealers do not care about that. Also, it is not unusual for dealers to actually offer better rates if you finance (see example above, but also happened to my dad purchasing his acura a few years ago) since they get a kickback from the financing company for every loan they write.
You make some excellent points. I haven’t dwelled much on it; I don’t think I’ve financed anything but my education and homes. There might have been a computer or something at Best Buy back in college, but that was a loooong time ago.
Cheers!
-PoF
I have had loans for a long long time. I had some stupid loans (for instance our wedding) and spent the first 3 years of my practicing life fighting the stupid loans, digging our way out of 300K plus debts (100 k + in just stupid non-school or mortgage debt ), and just trying to play catch up for all of the years I spent with little remorse.
Now we are way better off. A lot of that was insurance money influx, but all of the reading I have done for the past 5 years helped me know what to do with it and how to manage it!
Hmmm. I financed my car for 0%. I think I would do it again, too. Of course, I had the cash to cover it, but that seemed silly (it was equally silly for me to not be investing more than I was at the time). We also have a 30 year mortgage but should have it paid off in 11-12. So I guess we’ve done some stupid things 😉
Around here (NY area) most doctors (scratch that) most PEOPLE I know lease their cars. I’m not sure what’s worse that or getting a loan.
Most Docs I know lease through their corporations.
To quote Jesus from The Big Lebowski: “Joo said it Main!”
I needed a slap in the face post like this when I was a resident. Sadly, your site didn’t exist. I learned the lessons in time but it cost me a major job change, about $100,000, some legal fees (house related) and plenty sleepless nights.
I love the comment that “broke people have car loans.” I wonder if this is one of those chicken and the egg things. Do broke people like loans or do loans make people broke?
When you are ready to stop managing debt and start eliminating it you should read “The Doctors Guide to Eliminating Debt.”
Dr. Cory S. Fawcett
Prescription for Financial Success
I don’t see you playing out the “debt free” argument out to the end game. The amount of time you have is finite and the magic of compounding relies on you using the most of that “time” for the compounding to occur.
If you invest $10,000 @ 6% return at age 25, your $10K becomes $42k at age 50. If you delay investing that $10K till age 40 while your screwing around with “student loan-home loan bla bla bla” that retirement money when you are 50 is only 17K. By age 60 the $10K at 25 guy has $78K while the $10K at 40 guy has $32K. Even if the $10K at 40 guy invested $20K at 40 he would still be behind at age 60 with only $64K in the bank That “paid off early student loan bla bla bla” is long forgotten and , retirement is roaring at your doorstep and you gave away 15 years of early compounding when it counted the most just so you could feel good.
Dave Ramsey peddles his stuff to people who overspend themselves into oblivion with irrational use of credit. If you are steely eyed clear about relative rates of return you can make rational decisions about leverage. The way you pay off your student loan while side by side investing is to NOT go out to dinner 5 days a week, NOT buy a McMansion, and NOT buy a Porsche etc.
Best
I had to laugh at the car loan situation as well. It amazes me how so many physicians have car loans. It almost seems as if it didn’t even occur to them to not get a car loan. Case in point, a colleague of mine and his wife are both physicians. Kids are in public schools. He has student loans, she does not. He is halfway through a debt forgiveness program. They have three cars: his, hers and the nanny. The car the nanny was using was 15 years old and on its last legs. The wife wanted to replace it, he was not sure. He didn’t want to have to buy a new car because he didn’t want the “car payment.” When I mentioned he could buy a reliable used car for cash and skip the payment, he looked surprised. It was as if he forgot he could purchase a car for cash.
On the flip side, many of the residents I speak to with loans, all express a desire to pay it off within five years. That always warms my heart. The few that have no plan or act as if it will take their whole entire life to pay off the loan, I direct to the WCI book and website. Heck, I even bought it for one particularly overwhelmed resident as a graduation gift. I told her to send me a text or email when she had her loans paid off in five years.
I think you have to consider liquidity.
I’m in that camp who have good med school consolidation rates (mine are at around 2%. I’m jealous at those of you in the 1s or the person above with <1%!). My mortgage has about 15 years left and has been refi'ed a few times down to 3.875%. It's funny since I just bought a car and was ready to buy the thing in cash but I had to take the financing (1.9%) to get a better price on the car (factory to dealer incentive).
I could potentially knock out my and my wife's student loans with our savings beyond the EF (the "slush" money). I probably will just pay off the car since I've gone years w/o car payments and find having one rather annoying!
However, that slush allows us to cashflow vacations and other purchases. I guess to me having the cushion helps me sleep at night versus the low interest rate debt.
Well , I guess I fall into the “manage debt ” camp. I was never a huge fan of paying off the mortgage ahead of investing. Mathematically it never made sense, still doesn’t but having said that I am paying it off in the next two years. It is just annoying at this point. However, I have been practicing for over 20 yrs., the nest egg is growing, the financial plan is solid, etc..
It’s all about balance , and everyone is different and should have a different approach. For instance, we financed the purchase of a rather large boat. Boats are massively depreciating assets, in my mind it made no sense to pay cash for that. We are likely going to finance a BIGGER boat and at retirement I have factored in the boat mortgage pay off when I sell out of my practice, or one of my other business investments. A strict no debt mentality would say, never buy a boat, and certainly never finance a boat. But I love sailing and so does my wife, and frankly it’s my life and we are on this planet to enjoy ourselves ( and help others).
So my point is, a strict dogmatic approach to no debt in my opinion is way too restrictive. Also, the comments that wealthy people don’t have debt I find to not be a valid statement. Again, based on my experiences , in my part of the country, the dudes I know that are worth over $10M all manage some degree of debt. Just my opinion.
I am going to graduate from fellowship this summer. The contract I’m signing with a hospital provides ~$50k/year at the end of each of the five years for loan repayment. After taxes thats about 30k I’m guessing. I have $243k total right now.
My tentative plan is to refinance from 6.8% to about 2.58% variable over a five year pay off plan. The hospital would effectively pay about $145k and I would have to pickup the rest over those five years (which would be about $115k or $1900/month for 60 months). Does this sound like the most reasonable plan? I could pay them off sooner, but I don’t see a point if I can get a low interest rate and the hospital is helping out.
I’m looking at SOFI. If I refinance this spring after I sign my contract, any idea when my first payment would be due?
Looking forward to getting back into the black!
Thanks
Your plan sounds great, and I agree that you should get the max amount from the hospital, so definitely do not pay it off until you’ve received every penny the employer will give you towards the loans, unless the money isn’t contingent on you carrying a student loan balance.
SoFi should be able to tell you when your first payment is due. Be sure to get a cash bonus by going through a favorite blogger’s links. My offers are available on The Student Loan Resource Page.
Cheers!
-PoF
Be very careful of the contingencies/contract fine lines for the hospital paying your loan… if you decide you don’t like the job and leave before 5 years are up, you will likely have to pay back what the hospital gave….
There are clearly different types of debt
I must admit I was lucky to have a physician as a father who paid for my public undergrad and med school tuition so no student loans I paid $342 a semester at UC Berkeley back in the day…I plan to do the same for my two children and one of the great gifts is to not burden your kids with student debt. I am facing 70k a year for Tufts undergrad next year for my oldest. It is actually something that gives me great joy to provide a debt free education for them.
Earlier in my career while in private practice, a group of us took out a loan to buy into our office building. That was a great investment and the loan is paid off but I never could have afforded it at that time in my career. Maybe I could have afforded it but would have been eating ramen in a cardboard box. The value has quadrupled and I get a nice quarterly dividend.
I am debating paying off my relative small mortgage of 350k on a house worth conservatively about 2.5. Not much has been said in this post about mortgage vs investment arbitrage. The real question in my mind is should I hold bonds with pretty meager returns vs paying off the debt. Most think of the return in the equities markets vs mortgage which has a pretty big spread these days, but it might be better to think of other less robust asset allocation returns as well.
Like the physician philosopher, we have tried to find a balance between frugality and living life. I think you can do both depending on your circumstances. We still clip coupons but fly first class. They are not mutually exclusive. I do think you can become too frugal and both miss out on some great life experiences as in the case of my investment in the medical building some great opportunities.
Finally, a comment on life and disability insurance. I consider myself well past FI by most models. However I continue to work at 51 yo because I still love what I do and I am terrified of sequence of returns risk and a prolonged market correction/downturn. I still have both DI and LI. I have posted before that I lived through 2008. I know if I retired tomorrow I could go back to work if I had too. If I died or was disabled that would no longer be an option. I watched my 54 year old brother-in-law die of stomach cancer and although he was FI having a solid life insurance policy was a huge emotional safety net for his widow and children. I know it makes my wife feel more secure that we still have the policies even though financially we probably don’t need them.
It feels so great to be debt-free! For those who are on the fence of pay down debt vs invest, I recommend getting out of debt. It is as much emotional as it is financial.
I admittedly take a more moderate view on this topic than most.
I think that having an extremely strong hatred for debt is a good thing, but not so strong that you are living on ramen noodles and living in a card board box. This is hyperbole, but my point is that a balance can be struck where you are still spending some money on things that bring you Joy, while also being financially responsible and destroying debt.
Historically, physicians are terrible about not spending money and increasing debt. This is why this “debt is the worst imaginable thing. Ever.” mentality exists.
That said, people can become frugal to the extent that it hurts their mental health, marriage, or other relationships. My most recent post is actually about how I adopt a 90% frugal/10% fun rule.
This isn’t an all or nothing argument in my mind. I think it’s not quite so black and white.
Debt free is true freedom!!
When I finished training, my line of credit was at prime (2.8%), and my plan was to pay it off slowly while investing as much as I could. Almost three years out of training, and I now passionately hate my debt. The numbers haven’t changed, but my feelings towards it have, so I am aiming to pay it off before I officially hit the three year mark.
Congrats! It’s a wonderful feeling when those hundreds (or thousands) of dollars stop disappearing from your checking account every month. I had a similar good feeling when I was able to drop term life and disability insurances after I realized we were financially independent. That was another $300 or so that remained in my checking account monthly.
Cheers!
-PoF
I’m financially independent myself and don’t need term life either but my wife has a big policy on me anyway. Should I be scared of her?
Look I hate debt as much as the next guy but I graduated med school at a time where my loans were locked in at 2.25% and with deductions for direct deposit and one time paying for 3 years that rate is now 0.75%. even if I put my money in an online savings account I am coming out ahead. Instead of paying the loan early like you suggest I put that money into Roth’s during residency and fellowship and have come out ahead then if I would have used the cash to have no debt at all.
That’s awesome, and I was in a similar situation. I was able to consolidate to an interest rate that I believe was under 2%, but not under 1%. That’s impressive. A few years ago, I decided I was ready to be done and just paid off the balance. Financially, I would have made a bit more in the stock market, but of course we only know that in hindsight.
New grads don’t have that option that you and I had, though, despite interest rates being near historic lows. They’re stuck with 6.8% or sometimes higher.
Cheers!
-PoF
I agree my strategy would have been alot different if I was coming out today.
Exactly. Sounds like you came out about the same time I did. ~2003, right? My classmates all refinanced to 0.9%.
Came out in 2005 which was the last year before Congress capped how low our rate could go. Actually used UHEAA which I think doesn’t offer refis anymore too bad they have been great for me.
Have your views changed at all with the rising cost of medical school? Is 4 years still the goal?
What do you say to people who say they’ve put off their life long enough with studying hard in Med school and residency and want to take some vacation ?
WCI may weigh in (he wrote the post), but I would say you’ve got to do whatever makes the most sense for you. I definitely believe in taking vacation, but I don’t think you have to choose between taking vacation and paying down debt. You can do both — there are lots of ways to travel without blowing a budget.
Is 4 years the goal? With the average debt now approaching $200,000, that’s $50,000 a year (plus interest). That’s aggressive, but most physicians could pull it off if paying down debt is made a top priority.
Best,
-PoF
No, my recommendation is to pay off student loans within 2-5 years of finishing training. The only exceptions I can think of are PSLF (max of 7 years) and if you get your loans refinanced to 1-2% then I guess it’s okay to drag them out a bit more.
I would add a private practice pediatrician with $300,000 or more in debt would most likely be better off using something like PAYE while optimizing for loan forgiveness. NPV looks much better than a 4 year refinancing.
Who is offering 1-2%?? Fixed?
Random comment, I know, but I lived in Seward, AK for 2 years and the Train Wreck happens to have one of the town’s best places to eat – The Smoke Shack. When I saw the picture in your post and as its post image, I just had to comment.
As a side note, I’m a pediatric OT and had about 83K in student loan debt. Clearly our salaries are quite a bit different, but by my calculations, I’ll have it paid off by November of this year (7 years) and am so excited!
Thanks!
That was taken on our honeymoon in 2007. I don’t believe we ate there, but I do recall having fish and chips down by the harbor and loved the fact you could choose salmon as the fish.
Congrats on the debt paydown!
-PoF