(Part 2) All right, so we’ve determined that medical school debt is an emergency. In essence, we’ve diagnosed the problem. Now what? Should we pretend the sick patient is healthy, then hide under the covers, and hope the disease will fix itself? NO!! We need to educate ourselves about our finances, instead of ignoring our debt emergency and hoping it will take care of itself. The good news, is that learning finances isn’t as difficult as it seems, and there is more good information out there than ever before!
But first, let’s clear up one thing. No more magical thinking. In other words, you can’t rely on programs that promise to pay off your debt for free. Let’s take the Public Loan Service Forgiveness (PLSF) program for example. This program promised thousands of doctors that they could work for 10 years in a non-profit organization (including the time during residency), while only paying the minimum on the Income Based Repayment (IBR) plan, and at the end of the ten years the remainder of their loans would be forgiven. Too good to be true, right? Unfortunately, it might be. This program began in 2007, meaning that nobody has actually had their loans forgiven. The first wave of doctors hoping to collect on their PLSF bet will find out if this is for real in 2017. In the meantime, recent proposed legislation has included caps on the amount of debt that will be forgiven ($57,500). While the proposed bill didn’t pass, PLSF budget cuts remain a very popular topic, and are still up in the air. Some might say that they are protected from cuts because they are already in the program and it’s described in their master promissory note (MPN). Not so fast magical thinkers. In the terms and conditions of the MPN it states that the MPN can change if the federal rules and regulations change. Even worse, in 2008 the Department of Education clarified that the PLSF program mentioned in current promissory notes does not provide a contractual right to the program. In summary, doctors could work for 10 years in a job that they chose based off this program, accruing an astronomical amount of interest by paying the IBR minimum payment (which sometimes doesn’t even cover the accruing interest, meaning that your balance is growing during those years), and then reach the 10 year mark only to have the laws change, and suddenly they’re alone and shackled to their giant mountain of student debt. Sick, huh?
Now is it possible that PLSF and other get-something-for-almost-nothing programs pay off? Yes. But relying on these programs is like sending your heart failure patient to the witch doctor. It’s great if it works, but you’d rather rely on facts and science. Please note that I do not include military scholarships in this category.
So now we can begin! How should we approach our student debt emergency?
Step 1 Assume that you are going to be paying off every penny of debt you take out, plus interest: Once you take ownership of the debt, you can address it. Personally, I view this as my duty, since I am really borrowing this money from everyone who pays taxes, right down to the single working mother trying to feed her kids. Whatever helps me cope, I guess.
Step 2 Start studying finances: Mrs. DebtAnatomy would grimace at this suggestion, but that’s only because she hasn’t realized how fun it is to learn about investment strategies and how to use an HSA account as backdoor roth ira. If you hate reading about finances and don’t know where to start, here are my suggestions, aside from this blog:
The White Coat Investor: – I consider this the gateway drug into the financial world for medical students. This guy is AWESOME! He is a practicing emergency room physician in Utah. His blog is a detailed Do It Yourself financial guide for doctors. The White Coat Investor eases you into financial topics, and before you know it you’ll be engrossed in the ins and outs of long term investing and estate planning. If you don’t want to search through hundreds of blog posts, then you should check out his book. It is a great introduction into smart physician finances, and I recommend it as an easy introduction into the financial world:
MrMoneyMustache.com: – Are you cool enough to be a mustachian (that’s how followers of this blog refer to themselves)? Probably not. I’m not even sure if I am. But this blog will teach you to view money, and your own standard of living, in a completely different way. This blog is more of a life/money philosophy site, and focuses on the “why” behind smart finances, instead of the “how”. It’s written by a man who retired early, by living on very little, but is still somehow affording an amazing life. The philosophy in this blog, combined with the “how to” in the white coat investor, is a great start to growing your financial chops.
Step 3 Make a budget! I’ve already written on how to do this here, but you’ll need a good budget for the next steps.
Step 4 Calculate how much money you will owe by the end of medical school: Let’s examine a married couple, who have a budget and are living off $25,000 a year. To simplify this, let’s pretend that the spouse of the medical student is making just enough post taxes to cover living expenses. That leaves the cost of tuition, which we’ll set at $42,000. We will also use an average interest rate of 6.8% on the loans.
Debt after year 1: $44,856
Debt after year 2: $92,762
Debt after year 3: $143,926
Debt after year 4: $198,569
Total interest accrued during medical school: $30,569
Step 5 Calculate how much money you will owe by the end of residency: This takes some guesswork. Let’s say the average salary over 4 years of residency is $53,000 (if you want to be more accurate, check out the AAMC survey of resident and fellow salary and benefits). Next, let’s calculate how much take home income we have with a $53,000 salary. I typically just google a take home pay calculator and plug in the numbers. In this case, the married couple would take home $41,792. I am also going to assume that the spouse who was working in order to pay the living expenses during medical school is now a stay-at-home parent to watch over children during residency. At this point, you have to determine whether or not you are going to make payments in residency. There are several options at this point which I plan on writing about later, but let’s just examine Income Based Repayment (IBR). IBR monthly payment for a 1st year resident is estimated to be around $420. If you have children, this number may be as low as zero. But if we use the $420/month example, that means we’re paying $5,040 a year. Since 6.8% of $198,569 is $13,502, our loan still increased by $8,462 during the first year of residency, even with IRB payments. Continuing with this math, we end up with $236,031 in debt at the end of 4 years of residency, while living off $36,752 per year. Technically they would get a $2,500 tax deduction for paying off student interest, so their take home after taxes would be $42,508, leaving them with with $37,468 to live on per year after IRB payments.
If instead, this couple decides they hate compounding debt interest, they would only increase their standard of living to $28,290 per year, allowing them to pay the total yearly interest of $13,502.
Step 6 Calculate expected take home salary as a doctor: This is going to vary wildly between specialties, so I’m going to settle at a nice $300,000 for our imaginary newly minted emergency room doctor. The same take home pay calculator we used before shows this doctor bringing home $186,940.
Step 7 Calculate and compare different debt repayment strategies: We’ll use the example of the couple that paid IBR during residency and ended with a debt pile of $236,031. If they decide to pay off their debt in 10 years, still with an interest rate of 6.8%, they will have monthly payments of $2,716/month (or $32,592/year), and will pay a total amount of $89,919 in interest over the life of the loan. This gives them $154,348/year with which they can use to catch up on retirement funds, start a down payment for a house, and living expenses.
In contrast, let’s pretend this couple are debt-haters, and they want to pay off their debt in 2 years. This would require monthly payments of $10,546 ($126,552/year), leaving them $60,388 per year to live off of. SHUT UP!!! THIS IS CRAZY!!! I’m telling you that this couple can increase their standard of living by $22,920 when they finish residency, and be debt free within 2 years. THE NUMBERS DON’T LIE!
So you might be asking yourself, “If this is true, why are there so many doctors several years into practice that are still complaining about debt?” There are several factors, some including more children, different living circumstances etc. But one of the biggest reasons that you don’t see more debt free doctors is because they haven’t embraced the power of maximizing their disposable income!!! And the most sure-fire way to maximize your disposable income is to only slightly raise your standard of living when you finish residency and get a 6 figure salary. And the real beauty of it is that this imaginary couple gave themselves a raise of $22,920 and still ended up completely debt free in only two years. Two years of self control saved them from countless more years of debt and $72,839 of extra interest!
Will your situation and numbers be exactly like this? Nope. Are there other factors that I’m not accounting for? Definitely. But the point of this is to give you the tools and the vision to plot your way out of your current debt emergency. Don’t ignore your debt disease. Create a plan to treat it, and you’ll replace your imaginary hope with comfortable confidence.