It’s no secret that society has encountered a student loan crisis. Politicians from both sides of the aisle share similar concerns but promote widely disparate solutions. With over $1.5 trillion of student debt outstanding and default rates skyrocketing, it’s clear that student loan debt management is important for all student borrowers, particularly medical professionals.
Some 75% of medical school graduates start their careers with student loan debt. In 2018, the average student loan balance for medical school graduates stood at $196,250, while dental school graduates amassed a whopping average of $287,331. Student loans are difficult to pay off because — just like mortgages or any loans — lenders amortize interest.
At the start of a student loan, most of the payments go to interest. As the borrower makes more payments, an increasing share goes to the payment of the principal. By the final payment, almost all of the money goes to principal. For this reason, most student borrowers see a little reduction in their balances during the first few years of repayment.
For those willing to confront their student loan debt head-on, four financial management strategies can help them achieve financial security: investing, refinancing, budgeting and reducing living standard. The exact course of action depends on individual circumstances but employing elements of all four of these strategies is essential to successful student loan debt management.
When to start investing?
Most residents have little-to-no available funds for investing. But once residency is completed, it’s important to start. The question becomes whether it makes more sense to invest or put that money toward paying off student loans.
The decision to pay down student loans or invest in the stock market depends on how stock market returns compare to the loan’s interest rate. For example, the typical interest rate for medical student loans is 6 to 7%, while the stock market has returned an average of 10% from 1950 to 2017. In addition to pocketing the difference, investors also enjoy tax benefits. Even with hefty student loans, 401(k) plans make more sense than additional loan payments.
Doctors’ earnings put them in a high-income bracket, and a 401(k) provides one of the most effective tax havens. The tax savings alone far exceeds the student loan interest. With effective investment approaches, the 401(k) balance soon grows higher than the student loan balance.
For the money invested outside of a retirement plan, investors can reduce their taxable income with tax-loss harvesting strategies and enjoy a lower tax rate for any capital gains.
To refinance or not to refinance
All federal student loan borrowers need to take advantage of consolidation. Federal student loans that are consolidated will lower payments and lock in an affordable interest rate. Consolidation is a form of refinancing for which all federal student loan borrowers qualify. The loans remain within the federal student loan program.
Student borrowers should avoid refinancing federal student loans with a private lender, as private lenders may offer a lower interest rate than a federal student loan. But once out of the federal program, the borrower loses access to important protections, such as eligibility for income-based repayment plans.
Since doctors often have large balances and enormous monthly payments, it is possible to default on private student loans very quickly if a change in circumstances diminishes their income. Under the federal program, doctors would remain safe from default and collections activity.
Budgeting and lowering the standard of living
After undergraduate school, medical school and residency, most doctors are tired of living like students. While they will certainly be able to enjoy a much better standard of living, it’s important for new doctors to plan spending carefully. Setting and implementing a budget is the best and final way to manage debt.
An adequate budget should account for living and discretionary expenses, retirement, and regular savings, all while planning for debt reduction. It is also important to keep three to six months’ worth of living expenses safe in the bank. This money prevents the need to carry balances on credit cards or raid retirement accounts when a financial emergency strikes.
To really get control of student loan debt, consider “living like a resident” for a few extra years as popularized by the White Coat Investor. The basic premise is to continue living on a resident’s salary while putting the difference toward debt reduction.
This strategy pays big dividends because of the amortization of interest on student loans. If making only the minimum payment, most of that money goes to interest for several years. By accelerating payments, the borrower’s payments go mainly to the principal, saving thousands of dollars over the life of the loan.
Since the loans are paid off so much faster, those who “live like a resident” for a few extra years enjoy an elevated standard of living in the future.
Create and stick to a plan
Though student loan debt can seem overwhelming at times, repayment doesn’t have to be stressful. Through financial planning, loans can be steadily minimized. “Living like a resident” provides the most effective way to cut the time period and interest paid on student loans, though doctors should still contribute to a 401(k) to cut their tax bills and maintain an emergency fund that keeps them away from credit card debt.
The medical profession provides one of the most personally satisfying and lucrative career options. By following these student loan management principles, new doctors can focus on the job they love.
Benjamin Yin is founder and principal, Generational Financial Partners.
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