The DEBTonator: How to Avoid Common ‘Doc Debt Traps’

As a doctor, or soon-to-be-doctor, you understand the importance of taking care of your body to stay in good health. You may do all the right things—exercise, veggies, wash your hands, floss. (Note: when I look back on this post in August 2020, during a pandemic, that also includes wearing a mask and social distancing!) But are you taking the necessary steps to protect your financial health? 

In the previous post I talked about strategies that can help limit the burden of student loan debt—because, let’s face it, all that education is expensive! But financing your medical education is only one part of the “doctor debt problem.” 

In this post, I’ll talk about debt avoidance. Taking care not to take on unnecessary or excess debt, and paying off what you owe swiftly, are key to healthy finances and your overall financial future.

Below, I cover some of the most common “debt danger zones” and how you can avoid them. These essential strategies can help you to keep your finances in good shape and pave the way to a happy retirement .

Doctor loans (you are the fish) 

Lenders are in the business of making money by loaning money. It is in their best interest (pun intended) to loan as much money to as many people as they can, while taking on the least risk.  Mortgage lenders are anxious to lend to doctors or soon-to-be-doctors who have a high earning potential, a stable job compared with other professions, and are at low risk of not paying the money back.  This is why there are “doctor loans.” These are mortgages specifically designed for young physicians and offer a fast track to home ownership—in a sense, you are the fish mortgage lenders would like to reel in and this is their bait.

The catch

Doctors, especially those in a rush to buy a home, have unique disadvantages that can make it difficult to secure a conventional mortgage. Besides not having a down payment, they also frequently have a high student loan burden. In addition, they may only have a contract and no actual proof of earnings (e.g., pay stubs) demonstrating the income they’ll be using to pay back the mortgage. So the three main features seen with most “doctor loans” are: 1) no private mortgage insurance (PMI) despite a down payment of only 0-10%, 2) special treatment for any student loans owed (e.g., only take required payments into consideration), and 3) a closing date prior to actually starting work.  Also, the lender will often use a higher loan payment to income ratio in determining the amount of eligible loan amount (as high as 50% with some lenders). In return, the interest rate and fees are usually .25 to 1.0 point higher compared with a conventional mortgage. The doctor may be required to open an account from which the mortgage will be paid by auto-draft at the lending bank .  The bank hopes to benefit by establishing a long-term relationship with the doctor so that she will come back for checking, savings, home equity line of credit (HELOC), future mortgages, investing, insurance, and estate needs (this is why they “reel you in”). The bank will also hope the doctor will refer all of her doctor friends to the bank.

For some people and in certain situations, a doctor loan may be a helpful tool, but in general, you’ll probably be better off waiting to buy a house until you can afford a larger down payment and secure a conventional mortgage. This is especially true if taking out a doctor loan means you’re delaying repayment of student loans and digging yourself deeper into debt. 

Credit card loans

Using a credit card to pay for something is a type of loan.  An item can be purchased with a credit card and paid for at a later date.  However, interest is only charged when a payment is not made by the due date.  People are more likely to spend more and get into debt when they use credit cards vs. cash for buying products and services.  This is primarily because of the transparency effect and consumer’s “pain of paying” [1].  The transparency effect refers to the fact that the further you are from cash (as in a credit card or another form of payment), the less transparent it is and the less you remember how much you spent.   The less transparent the form of payment, the less an individual feels the “pain of paying” and thus is likely to spend more. Furthermore, the differing physical appearance/form that credit cards have from cash may cause them to be viewed as “monopoly money” vs. real money, luring individuals to spend more money than they would if they only had cash available [2 ].  

Credit card debt can be avoided by purchasing only what you can afford to pay for.  “If you can’t afford to pay cash, you can’t afford to charge it.” The allure of credit is that it tricks people into thinking they can afford to buy more than they really can.  Incurring credit card debt to maintain a lifestyle one can’t afford (i.e., “keeping up with the Dr. Joneses”) isn’t a wise way to spend one’s future income.  To minimize debt, credit cards should be used as a convenience and to take advantage of cash or other rewards, not as a loan.   

 

If you can’t afford to pay cash, you can’t afford to charge it.

 

Create an emergency fund

Many people resort to using a credit card to pay for unexpected expenses (e.g., medical bills or emergency situations) when they don’t have access to any savings. Having an emergency fund helps avoid credit card debt by providing the cash to use when an emergency arises. An emergency fund is money that has been set aside to specifically cover any unexpected expenses that may come up. It may also be used to help pay bills during a period of unemployment. As a general rule, an emergency fund should cover three to six months of expenses.  The funds should be held in an account that can be accessed fairly quickly. This would include a good money market account or a high interest savings account. Squirreling away enough green to help you stay afloat through a crisis is a smart move. Such preparation can help prevent a scenario where unexpected expenses leave you underwater, driving you ever deeper into debt. 

Get covered (with insurance)

In addition to a good emergency fund, one should have adequate insurance (e.g., home, auto, umbrella, term life, disability, and medical malpractice).  A life insurance policy is essential when a spouse, children, or other dependents rely on the provider’s income.  Without appropriate types of insurance as safeguards for unexpected and catastrophic events, individuals often resort to taking on debt to pay for expenses of daily living.

Opportunity cost (or hey, stop and think for a sec before you spend)

Physicians earn a lot of money, and radiologists earn an above-average physician income.  They generally have access to easy borrowing. This combination can lead to a habit of thoughtless spending, which becomes a problem if spending and borrowing prevent saving for retirement.  Every dollar spent on one thing could be spent on another.  People at all income levels don’t usually think in those terms when paying for something. 

For example, one could buy a new BMW automobile in 2019 for $54,395 (actual prices on one site for brand new models in 2019 ranged from $36,295 to $106,695) or invest that money in a total U.S. stock market fund.  At the end of 30 years, if that investment earns 5% (a conservative estimate), it would be worth $235,123 (using the Dinkeytown.net future value calculator).  If the investment earned the historical stock market return of 10%, in 30 years it would be worth $949,408.  In other words, by not buying an expensive car today one could have almost a million dollars more in retirement.  This example assumes the car is paid for in cash. Taking out a loan to pay for the car would make the car even more expensive.  

This phenomenon is called “opportunity cost” and it doesn’t just refer to money, but also to time and effort. In microeconomic theory, the opportunity cost is the loss of potential gain from other alternatives when one alternative is chosen.  When people stop to think about alternative uses of money before spending, they make different choices.   It’s also called mindfulness. It takes practice, it’s not always easy, it probably entails delayed gratification—but it also feels good to know your future self will thank you.

A doctorly analogy 

In his book “The Doctors Guide to Eliminating Debt,” Cory Fawcett (a retired surgeon) compares spending money with that of gaining informed consent prior to operating on a patient.  Informed consent includes explaining to a patient the diagnosis (if known), why the procedure is recommended, how the procedure is performed, the expected benefits of the procedure, the potential risks of the procedure, and alternative procedures (including foregoing treatment).  

The same process can be applied to making a purchasing decision by answering the following questions: 1) Why do I need a new car (specifically a BMW)?, 2) How much time, effort and money will it cost (including total interest payments if financed)?, 3) How much enjoyment will I get from having the car, and for how long?, 4) Will the enjoyment be from driving the car or having it parked in the driveway where my neighbors can see it?, 5) What will I be sacrificing to have this car (e.g., children’s college fund, more money at retirement, vacations)?, and 6) Are there alternatives to buying this car that would make me just as happy or happier?  

A question you can ask yourself before buying something, especially if it involves assuming debt, is “Am I debt-free yet?”  If the answer is no, then your alternatives to spending also include paying off debt.  

It’s liberating to be free of debt and have the ability to pay cash for everything (e.g., car, boat, house).  I never heard anyone say “I wish I still had a mortgage.” Less debt means less stress. There is no worrying about making the mortgage payment.  No debt means more flexibility to work less, take more vacations, take advantage of sound investment opportunities, and retire early.  

 

I never heard anyone say “I wish I still had a mortgage.”

 

Living within one’s means as a resident and beyond

Debt can be minimized by living within one’s means.  For a resident, this means living like a resident, not an attending doctor.  Too many residents take advantage of loans that lenders are more than happy to provide, not fully understanding how they are borrowing against their future.  Such loans may be “special doctor loans” to live off of, a car loan, a big mortgage, or just running up credit card loans.  

The average medical resident earns $61,200 annually, according to Medscape’s Residents Salary and Debt Report 2019.  Based on recent U.S. Census Bureau figures, the median household income in 2017 was $61,372.  Thus, a resident earns about the same as an average American.  James Dahle, who publishes a blog about physician personal finance and investing, likes to say, “When you’re a resident, live like a resident.”  Six years of living like a resident/fellow during training (in the case of radiology) will show the trainee how her patients (average Americans) live.  Average Americans who live within their means have to make decisions about whether to buy a new TV or upgrade their cell phone, or buy a new car versus take a vacation.  For the average American, contributing 10% of one’s income (i.e., $6,000) to a retirement account each year takes commitment and some degree of sacrifice.  

By living like a resident, the trainee not only gains a valuable perspective of how most people live, but develops good financial habits early that will lead to a healthy relationship with money when their income jumps from a resident’s to an attending’s salary.  It’s just as easy to buy too much car, too much house, and too much vacation when making $300,000 a year as it is when making $61,000 a year.

Dr. Dahle also advises new attending physicians to continue to live like a resident for 3-5 years.  By not automatically committing oneself to a car loan, new or bigger mortgage, and credit card debt to furnish a new doctor house, a newly graduated physician can pay off student loans, pay off any other debt, save up for a down payment on a home (which will result in a better mortgage rate compared with a doctor loan), build an emergency fund, and start putting money into a retirement fund that will immediately benefit from compound interest.  The early years of saving are the most important because they allow growth to compound longer. It’s harder to cut back on one’s lifestyle later than to never have upgraded it in the first place.  

Being financially responsible—not always fun, but makes a radiologist healthier, wealthier, and wiser. 

References

1. Prelec D, Loewenstein G. The red and the black: Mental accounting of savings and debt.  Marketing Science.  1998; 17(1):4-28 
2. Raghubir P, Srivastava J.  Monopoly money: the effect of payment coupling and form on spending behavior.  Journal of Experimental Psychology: Applied 2008; 14(3):213-225