help me figure out a good loan repayment plan

[bravotwozero]

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So, let's say you're a FP doctor out of residency, making 150k a year somewhere in south texas. You have 250k of student debt, married to a spouse who is also a physician, no kids, no mortgage, and no car payments.

I want to get rid of these god awful loans as quickly as possible, so I can be done with them. How much should you set aside every month? Do we have any flexibility in terms of paying back principal first, then interest with staffords?

 

[Gute]

You don't pay principal entirely before paying interest unless you are paying above the your monthly minimum payment (the amount above that minimum should go entirely towards your principal).

Really there's no secret to eliminating your debt asap, set a budget, live within your means, even if that is living like a poor med student who is making no money. Just remember to keep your entire financial/life picture in perspective, you need emergency savings, you might want/need to own your own home, you might need to begin save for retirement if you were a non-trad who started later, etc. What I'm saying is that eliminating debt in the shortest period of time is great, but might not be the best option for some people (though you can't beat a guaranteed 6.8% return of paying off those staffords)

You sound motivated so paying off your debt as much as possible shouldn't be a problem, but your wife might not be so motivated, make sure that you are both on the same page about this.

 

[IMnerd]

Just remember to keep your entire financial/life picture in perspective, you need emergency savings, you might want/need to own your own home, you might need to begin save for retirement if you were a non-trad who started later, etc. What I'm saying is that eliminating debt in the shortest period of time is great, but might not be the best option for some people (though you can't beat a guaranteed 6.8% return of paying off those staffords)

You sound motivated so paying off your debt as much as possible shouldn't be a problem, but your wife might not be so motivated, make sure that you are both on the same page about this.

My wife and I have have $450,000 in medical student loans! I had the exact same gut feeling that I wanted to get rid of this god awful debt as soon as possible, but then I met with a financial advisor who specializes in doctors.

He made us realize that student loan debt is "good" debt just like a mortgage. It is very low interest, so starting a retirement account (average return 9.8%) instead of devoting all your discretionary funds to paying off this loan (~7%) will get you a net +2.8%. The earlier you start that retirement account the greater the benefits of compound interest (Eistein called this the eighth wonder fo the world)!

So I was advised to pay off our loans over 25 years in order to have the lowest monthly payments (can always pay more than the minimum prn). Then pay off "bad credit" like high interest rate loans (residency relocation loan) and credit card debit. Then put 3-6 months salary into emergency fund, then put ~10% directly into retirement. That is likely all of our resident income right there, but any extra, and we can start saving for a house!

 

[Gute]

My wife and I have have $450,000 in medical student loans! I had the exact same gut feeling that I wanted to get rid of this god awful debt as soon as possible, but then I met with a financial advisor who specializes in doctors.

He made us realize that student loan debt is "good" debt just like a mortgage. It is very low interest, so starting a retirement account (average return 9.8%) instead of devoting all your discretionary funds to paying off this loan (~7%) will get you a net +2.8%. The earlier you start that retirement account the greater the benefits of compound interest (Eistein called this the eighth wonder fo the world)!

So I was advised to pay off our loans over 25 years in order to have the lowest monthly payments (can always pay more than the minimum prn). Then pay off "bad credit" like high interest rate loans (residency relocation loan) and credit card debit. Then put 3-6 months salary into emergency fund, then put ~10% directly into retirement. That is likely all of our resident income right there, but any extra, and we can start saving for a house!

Be careful with financial planners...I always question others motives when it comes to my money.

I would throw caution at the 9.8% figure that you cite. Historical returns are hopefully going to keep repeating, but there are no guarantees.

Paying off a 6.8% student loan however is like buying a bond that guarantees a 6.8% return on investment as you will no longer be liable for that interest in the future. Note that this is a 100% guaranteed return, unlike invested monies that will hopefully return 10%. In addition, paying off the loans also has a psychological benefit to you, though I don't personally think that financial decisions should be based off of feelings.

Although student loan debt is "good" debt, 6.8% is not "very low", I actually think it is a pretty high of an interest rate, at least compared to what you can get on a home mortgage these days (obviously its low relative to private loans and credit card rates, but comparing student loan debt to those debts isn't necessarily fair since those are "bad" debts and home mortgages are usually thought of as "good" debts).

With a 25 year repayment plan on 450k of student loans at 6.8% (might be generous to assumes all your student loans are at this low of an interest rate since that much loans probably includes some PLUS loans as well), then you and your spouse are gonna have to pay >$3k/mo (at least once you are at attending level income, you will either have to do IBR or forbearance during residency since $3k/mo is not doable for a 2-residents income) and owe >$930k over the course of the loan...in other words you will pay more in interest than you originally took out!!!! All the while, over the course of paying off the loan you are missing on adding this $3k/mo of principal to your investment to take advantage of the miracle of compound interest.

At the same time, I agree with having a small % for retirement even early on as you need to take advantage of 401(k)/403(b) match (free money: 100% return on investment) and IRA contributions (tax deferred or tax free growth depending on type).

I'm not saying I know what is right for you, but I would be very hesistant to leverage myself so much if I had that much debt. My advice is to keep in perspective that the future is always uncertain.

 

[IMnerd]

All the while, over the course of paying off the loan you are missing on adding this $3k/mo of principal to your investment to take advantage of the miracle of compound interest.

Choosing the 25 year repayment plan offers the lowest monthly payments after residency. So its probably not correct to say that I would be "missing out" on the miracle of compound interest. In fact it is quite the opposite.

Let's say that I am an individual with $180,000 in federal loans. The difference in the monthly payment for 25yr vs 10yr repayment plan is about $1,000. Let's use a classic compounding scenario to see what I should do:

Attending #1 invests $1,000/year starting at the age of 30 for 10 years, so he only invests $10,000.

Attending #2 invests $1,000/year, but doesn't start until the age of 40. He invests for 30 years for a total of $30,000.

Who has saved more for retirement at the age of 70?
Attending #1 only invested $10,000, but because he started investing right out of residency his nest egg has grown to $278,000

Attending #2 payed off all his loans the first 10 years, he did not have an extra $1,000/month to devote towards retirement. Instead he invested an EXTRA $20,000 to try to catch up, but at 70, he only has $164,494 saved for retirement.

You may be asking, how much more does it cost to choose the 25 year repayment plan over the 10 year. Given my debt, I would have to pay an extra $160,000 in interest over 25 years. Remember Attending #1 made $278,000 by investing his extra $1,000/month right out of residency. So the 25 year repayment plan actually produced a net profit of $118,000.

I love my financial aid office, but they have blinders on. They only see that extra $160,000 in interest over 25 years, so they always suggest to pay off loans as fast as possible, but they aren't looking at the entire financial portfolio. By having a lower monthly payment as an attending, we can invest more earlier, and really reap the benefits ($118,000!) of compounding interest.

I know Gute is a little skeptical of financial planners, and I appreciate his/her concern for my best interest. But I have run these numbers and multiple additional scenarios with 3 financial planners and they all agree. The 25 year repayment plan is usually the best option (given that I won't qualify for PSLF). It helps that 1 adviser is my best friend, and the other is my Dad, so I think they have my best interest in mind.

As always, this scenario is particular to me, and I would recommend that every one finds a trustworthy financial adviser to find the best plan for you.

 

[Gute]

IMnerd, the biggest caveat to your analysis is the unstated and assumed rate of return you used in your analysis.

Even if the market does meet that arbitrary rate of return in the long-term horizon (probability is actually pretty high), your analysis is also dependent on that rate of return happening over the next 10 years, which is a pretty short (and therefore less predictable based off of historical data).

A quick search found that as of today, the S&P500 10 year annualized return is around 3.2%, much lower than the 6.8% minimum your federal loans are (granted you could buy low for many of those months, so you might have broken even, I didn't bother to calculate it over that time period but it does illustrate my point). Now hopefully we aren't sitting in March 2001 and going to see that same market the next 10 years, but what if that is the future we are about to see?

 

[IMnerd]

IMnerd, the biggest caveat to your analysis is the unstated and assumed rate of return you used in your analysis.

My analysis used the historical Average Annual Rate of Return (price appreciation + dividends) of about 10%. This number comes from 110 years worth of data. [FONT=arial, helvetica]"Although it is always perilous to assume that the future will be like the past, it is at least instructive to find out what the past was like." -William Sharpe, Nobel Laureate. .

The average annual rate of return in the last 20 years 10.2%. The last 10 years 3.1%. The last 5 years 4.2%. Let's look a little closer.

The 10 year average includes both the Dot-Com Bubble ('99-'00) and the Great Recession ('08). Our most recent 5 year average is actually better because the markets were affected by the Great Recession for only 1 year; you can see in the last 2 years we are back to about the historic 10% rate of return. Despite many Americans who are still struggling, businesses have become more efficient with less workers. So the last two years have been the strongest the market has seen in the last decade.

None the less, the stock market is a roller coaster, but the overall trend has always been up (DOW index below).

So buckle in early and enjoy the ride.

 

[dpmd]

Choosing the 25 year repayment plan offers the lowest monthly payments after residency. So its probably not correct to say that I would be "missing out" on the miracle of compound interest. In fact it is quite the opposite.

Let's say that I am an individual with $180,000 in federal loans. The difference in the monthly payment for 25yr vs 10yr repayment plan is about $1,000. Let's use a classic compounding scenario to see what I should do:

Attending #1 invests $1,000/year starting at the age of 30 for 10 years, so he only invests $10,000.

Attending #2 invests $1,000/year, but doesn't start until the age of 40. He invests for 30 years for a total of $30,000.

In the second case they would be able to invest more than the 1000 you have listed. The loan payment would be 2000 so at age 40 they would now be able to invest that whole amount (it is really the monthly payment not yearly but the idea is the same). In the first case the guy is only paying 1000 so they can invest the other 1000 until age 55 (when the loan is finally paid off) then move up to 2000. Not sure how it changes the calculations, but would be interesting to see.

This of course assumes that the choice is strictly between loan payment or investing (and ignores taxes). A more likely scenario would be a choice between a bigger house/fancier car and loan payment while retirement planning would stay the same. In that case you are in a much better situation if you pay off the loans especially if you want to retire earlier.

 

[goodoldalky]

You may be asking, how much more does it cost to choose the 25 year repayment plan over the 10 year. Given my debt, I would have to pay an extra $160,000 in interest over 25 years. Remember Attending #1 made $278,000 by investing his extra $1,000/month right out of residency. So the 25 year repayment plan actually produced a net profit of $118,000.

I'm no CPA, but I think your math is off on the actual cost of a 25 vs 10 year repayment on your 450K loan.

The difference between a 10 and 25 year repayment plan for your 450K loan is almost $315,000, not 160K. In your case, if you did invest an extra $1K a month and it made 10% interest like clockwork (unlikely) for the next 10 years, as you stated, you would still be losing almost $40,000, and that is before you are taxed on capital gains, etc. on your investments.
As a previous poster stated, you also do not take into account the 15 years that physician B will have without a >$3,000/mo loan payment to invest, etc.

I'm interested in this philosophy you've adopted but I am not seeing the math.

 

[The White Coat Investor]

This of course assumes that the choice is strictly between loan payment or investing (and ignores taxes). A more likely scenario would be a choice between a bigger house/fancier car and loan payment while retirement planning would stay the same. In that case you are in a much better situation if you pay off the loans especially if you want to retire earlier.

There's a lot of wisdom in that statement.

Personally, my plan would be dependent on the interest rate on the loan. If less than 5%, I'd probably max out my retirement accounts prior to paying extra on loans. If 8% or more, I'd probably put everything toward paying down the loans. Anywhere in between I'd split the difference.

 

[doc1107]

IMnerd,

First of, what nobody mentioned is the fact that you have to pay capital gain tax on any investment profit you make. That's around 30-40 % because you will most likely be in the higher income tax bracket on a doctor's salary.

That alone knocks your "9.8%" return down a few notches.

2nd of all, you can not use the average from 110 years of investment. Are you going to invest for 110 year? No. Will you even invest for 30 years? Probably not that much money. This isn't your retirement fund, this is an income investment.

3rd of all, financial advisers should be taken with a grain of salt. It's not their money, you are taking the risk. Also by the time you find out their advice is horrible, it will be years down the road and they could care less.

4. Other loans have lower interest rates. A month ago I got a line of equity for a 15 year fixed interest of 4.0% on 500K. You have to look and you can find these and even lower! since both u and your spouse have 'earning potential" and are very low risk with a MD in the health field currently compared to other fields.

So what I would do if I were you is max out your Roth/traditional IRA, 401K and maybe a tax free educational fund if you have kids. Then take out enough for living and pay off that loan!

As for emergency money, I doubt both of you will be out of work at the same time, plus you will have health insurance so you should be fine. I wouldn't put too much into that pile. Plus, you do have at least a couple credit cards for emergencies right?
(ps. if you have higher interest debt, pay those off first, credit card, etc)

( There is also many more complex tricks you can do using credit cards and loan transfers and stuff, but thats a bit tricky. )

good luck

 

[rgerber85]

Does anyone in here speak english? 😀

 

[The White Coat Investor]

IMnerd,

First of, what nobody mentioned is the fact that you have to pay capital gain tax on any investment profit you make. That's around 30-40 % because you will most likely be in the higher income tax bracket on a doctor's salary.

That alone knocks your "9.8%" return down a few notches.

2nd of all, you can not use the average from 110 years of investment. Are you going to invest for 110 year? No. Will you even invest for 30 years? Probably not that much money. This isn't your retirement fund, this is an income investment.

3rd of all, financial advisers should be taken with a grain of salt. It's not their money, you are taking the risk. Also by the time you find out their advice is horrible, it will be years down the road and they could care less.

4. Other loans have lower interest rates. A month ago I got a line of equity for a 15 year fixed interest of 4.0% on 500K. You have to look and you can find these and even lower! since both u and your spouse have 'earning potential" and are very low risk with a MD in the health field currently compared to other fields.

So what I would do if I were you is max out your Roth/traditional IRA, 401K and maybe a tax free educational fund if you have kids. Then take out enough for living and pay off that loan!

As for emergency money, I doubt both of you will be out of work at the same time, plus you will have health insurance so you should be fine. I wouldn't put too much into that pile. Plus, you do have at least a couple credit cards for emergencies right?
(ps. if you have higher interest debt, pay those off first, credit card, etc)

( There is also many more complex tricks you can do using credit cards and loan transfers and stuff, but thats a bit tricky. )

good luck

A few rebuttal points:

First, long term capital gains tax rates are currently 0%-15%. They may go up a bit, but they'll likely never get to 30-40%.

Second, many investors NEVER pay capital gains taxes. All investments inside 401Ks, IRAs, Roth IRAs etc grow without capital gains taxes. If you hold the investment until death neither you nor your heirs pay on those gains either.

Third, most investors will need to invest for ~50+ years. Think about it. 10-30 years during your career, then another 20-30 during retirement. While I agree that the future will not necessarily resemble the past, and while I expect lower returns in the future (at least the next 10 years) then we've seen on average over the last 100, we don't need to be too negative about future returns.

Fourth, agree that advisers are usually snakes. Unfortunately, most financial advise is quite biased by conflicts of interest.