I recently heard someone say, “Why do we give free rent in our minds to negative thoughts, ideas, and people”? After reflection, I find myself more and more agreeable with this sentiment. For some reason, we allow “negative interest,” as I call it, to dwell in the incredibly valuable space of our minds and to roam through our thoughts as it pleases. So often we choose to give mental space to people we don’t even know because they cut us off while driving, made a rude comment, or comported themselves in an otherwise disagreeable manner.
Overall, I get it. Most of us naturally seek to please when it comes to our personal interactions, but what benefit is it to us to stew with anger over someone we don’t even know or something we can’t change? Put simply, there is none. Your mental space and time need be reserved for things that are life-giving, nurturing, and inspiring; anything entering that is not, should pay a high price to get in. So, you ask, how does this tie into planning for physicians and dentists?
Debt receives more free rent in the mind of physicians and dentists than most any other stressor, in my experience. All too often will clients come into my office with worry because the amounts they owe seem insurmountable. The thought of repaying the debt can be daunting, even overwhelming, and often creates irrational fear and worry. So I want to specifically talk about how to prevent worry on the topic of debt and create healthy boundaries that keep this stressor out of sight and out of mind.
In general, the issues that dwell in our mind are those that are not resolved, not complete, need attention, etc… While this may sound like common sense, I believe the real reason debt creates stress is because it’s an unfinished project looming in the distance. Sadly, I see so many physicians and dentists, driven by this irrational pressure, unwisely throwing every dollar they have at debt as a way of self-medicating the anxiety. They panic and, because the thoughts about debt have consumed their minds for so long, they believe the only way to mental freedom is to get rid of it as quickly as possible.
I propose a different solution. I believe you can find the mental freedom from debt through rational, calculated planning. While it may be beneficial to aggressively pay down the debt, and it often is, you must take the time to do the appropriate math to determine if that aggressive course is truly best for you. You have a defined set of numbers: income, expenses, and amount owed, so it’s just a matter of taking the time to do the math. Ambiguity and disorganization cause further stress to the weight of debt, so creating clarity by answering these questions for your own situation will provide healthy boundaries for your thinking and put the many unknowns to rest.
Question: How fast or slow should I pay the debt?
Answer: You’ll need to calculate the opportunity cost of several scenarios. Lingering stress can be a symptom of making a decision without fully understanding if it’s the best option. The best way to avoid that would be through calculating the economic benefit over a given period of time through each potential repayment method. We typically run a calculation that compares the advantages and disadvantages of the Federal Loan Forgiveness Program to the option of aggressive repayment.
Two categories of loan forgiveness are offered currently. One - Public Service Loan Forgiveness (PSLF) - is tax free, meaning the debt cancelled is not considered as income for tax purposes. This is the kind of loan forgiveness offered by the Federal government to physicians and dentists and what we consider when projecting the economic benefit utilizing the loan forgiveness option. For the comparison calculation, you’ll want to see what the total cost of repayment would be if you continued to make eligible payments at the current interest rates for 120 months. You will need to make some assumptions about income during that 120 months, but as long as the income assumption is the same when calculating the alternative, the comparison should be accurate. You’ll also need a discretionary income assumption, as well as a rate of return assumption. This will give an accurate depiction of what the leftover income is accomplishing while paying the minimum amount owed over the 120 months, as compared to using that income in the aggressive repayment scenario. At the end of 10 years, you will have a fully paid-off debt with an investment account balance.
The time period needs to be the same in both calculations. In the aggressive repayment calculation, no savings will occur since all discretionary income is being used towards debt repayment until the debt is completely paid; however, once the debt is fully paid, the calculation needs to reflect saving that money at the assumed growth rate until the 120th month. At the end of this lengthy equation, you should have two account balances to compare, and the largest balance is the winner.
Question: Have I considered my liquidity needs?
Answer: Once you contribute money to a loan company, you cannot call them and ask to have it back if an emergency occurs. I understand the desire to be rid of debt, but please do it within the context of a thoughtful plan. Alleviating your debt burden should not come at the expense of foregoing appropriate disability insurance, life insurance, umbrella coverage, and an emergency fund that has enough cash to cover expenses for at least 90 to 120 days.
While I’m on the point of what not to do, make sure you contribute what is required in your group 401k to maximize the employer match. I see physicians delaying contributions in order to maximize income so they can aggressively pay debt, and that is a costly mistake. You are leaving additional compensation on the table that your employer is willing to give you. What benefit is it to pay income taxes on $10,000 (netting maybe $7,000 that can be contributed to debt) at the expense of gaining a match of $10,000 from one’s employer and the $3,000 in tax savings?
Question: Does refinancing my loans make sense?
Answer: According to the American Hospital Association (AHA), in 2014 about 78 percent of the 4,974 US community hospitals were nonprofit entities (58 percent private nonprofit and 20 percent operated by state or local governments). The remaining 22 percent are for profit, investor-owned institutions. I say this because many of you will have the Federal Loan Forgiveness Program as an option if you work at a non-profit; however, working at a non-profit doesn’t mean the program is automatically right for you. Interest rates are very low right now and several companies (SoFi, Meet Earnest, Common Bond, and DRB to name a few) are offering low fixed- and variable-rate loans for those willing to refinance. When we run the numbers to see if the Federal Loan Forgiveness option makes sense, we typically compare it with an aggressive repayment plan at a much lower interest rate than the Federal Loan because those lower interest rates are available to most physicians with good credit.
From doing these comparisons weekly, the Federal Loan Forgiveness Program typically will have an edge if you begin Income-Based debt repayment during your first year of residency. However it gradually loses its edge with each year you elect to defer. DRB offers the unique option of deferral during residency, as long as you make a payment of $100 each month, but the rates will be in the 5% or higher range. The typical rates from other lenders hovers around 2.2% variable and 3.5% fixed, but are only available for those that begin the 5 year repayment plan immediately.
Question: If we determine the Federal Loan Forgiveness option is inferior to rapid repayment, the next question would be is it beneficial to pay off the loan any faster than necessary if my interest rate is as low as those above?
Answer: The calculation needed to compare paying the loan off over 5 years, 7 years, or 10 years at a much lower rate of 2.2% or 3.5% will be similar to the one I walked through in the first question above. The objective is to determine whether or not the dollars available beyond the required payment are better off advancing the debt reduction or being invested. Not a rule of thumb, but the results typically concur it’s best to invest rather than pay off debt if the interest rate of the debt is below 4.3% and the return assumption of the investment is above 5.5%.
Question: Does the aggressive repayment allow for your family goals?
Answers: School debt has increased by 6.3% since 1992 and the median level of medical school debt in 2015 was $183,000. These numbers are significant, which is why 24% of physicians are still paying off debt into their mid-forties. Many physicians that solely focus on debt repayment end up getting a late start on education funding for their children, which means they may have to pay out of pocket for that expense rather than save for it. This could further delay retirement savings if you move from finally paying off student loan debt to preventing student loan debt for your children. Part of assessing how to pay off debt involves considering few things: When do you wish to retire? What will the income at retirement look like in each scenario if you gradually pay debt vs. aggressively pay debt? Will you be able to give to your church or charity as you feel you should? Are you leaving enough money for your kids early education and higher education cost? Do you have enough money to buy in as a partner at your practice within a year or two? These are just a few examples but hopefully the point is clear. Eliminating the stress associated with debt requires a sound strategy that has weighed and considered all the other areas down the road that finances affect. What good is it to pay off debt with all that I have if it creates tension within myself or with my spouse as it relates to other family plans? As I’ve said before, create strategies for each isolated issue in the context of a comprehensive plan, because if not, the looming possibility that other hopes and dreams you eventually wish to get to will fail will continue to weigh heavily on your thoughts.
Question: Once I know the best path forward, how do I prevent worry about whether or not it's getting done?
Answer: The natural tendency is for someone to trust themselves way, way too much. Perhaps it's the "survival of the fittest", "fight or flight" piece in all of us, but I see physicians and dentists managing the execution of the plan manually because of fear. When asked, many will say they want to do it manually so they can play it by ear in case something comes up. That's what your emergency fund, disability, home, car, and life insurance are for! Let's be honest, the money won't be used for emergencies, it'll be used for a new something that's inaccurately labeled as a need instead of a want. When you have the critical components in place, you have to trust the plan will work and avoid manual execution. Automating the payments, structure, and investment transfers is the only way to overcome inevitably disappointing ourselves.
Once you've calculated the best use of the dollar in light of the comprehensive needs of your family planning and set the plan on auto pilot, you should feel a sense of peace. I don't have to continue the daily thinking of how because I know how; I don't have to wonder if it's hurting anything else because I know it doesn't; I don't have to worry about what this means for other plans in my life because I know the impact; I don't have to wonder if there's lost opportunity cost in my strategy because I've done the math. You've successfully convinced the mind that these answers are sufficient and the mind moves on to other thoughts. If you take the time to form solid conclusions, the intensity of these questions diminishes, and a great weight can be lifted from your thoughts.
Remember, charge high rent to stress and free rent to its opponent.