You finally finished your medical training, and now it’s time to get on with your life and reap the rewards of the hard work you’ve put in over the past ten years or so.
You have two options: clear off your student loans as fast as possible to ensure financial freedom or invest what you currently have to make as much money as you can early on.
So, pay off student loans or invest for the future? This guide will show you the answer.
Key Takeaways
- Clearing your debt or investing your money depends on your current situation. There’s no single answer that fits all.
- Even if you are financially capable, clearing your debt right now isn’t always the best approach.
- Sometimes, you can try to invest and clear your debt at the same time, though it is a risky venture.
Table of Contents
What Should Doctors Consider Before Making This Choice?
Here are the factors you, as a physician, should be thinking about before making a decision:
1. The Student Loan Interest Rate
Student loan interest rates are among the biggest deciding factors in the formula.
The Association of Medical Colleges estimates the average student loan debt for medical students at around $200,000, but graduates may end up paying over $300,000 due to interest rates.
The higher the rate, the more you should lean toward clearing off that debt as quickly and safely as possible.
There’s a twist, though. Taxes can affect your interest rate. Some debt, like student loans in the U.S. under certain income levels, might have a deductible interest.
This lowers your effective interest rate (the actual cost after taxes).
Let’s Talk Numbers
Here’s an example. You just took a loan balance of $5,000 with a 12% interest rate. This means the interest you would accrue for the year without tax deductions would be:
Interest paid = Interest rate x Loan amount (12% x $5,000 = $600).
Now, let’s say that your marginal tax bracket is 35%. This translates into a tax reduction of 35 cents per every dollar you can deduct.
This tax deduction allows you to subtract the loan interest from your taxable income, effectively lowering your tax bill. Here’s how:
Tax saved on interest = Interest paid x Tax bracket ($600 x 35% = $210).
Effective interest rate = Interest paid – Tax saved on interest divided by the student loan payment amount ($600 – $210) / $5000 = 0.078 or 7.8%.
When you deduct the interest on your taxes, you effectively reduce your interest rate from 12% to 7.8%, making a seemingly large interest rate seem more manageable and potentially making it less of a priority.
You have the formula. Do the math on your current student loan interest rates and marginal tax bracket, and see whether the final percentage raises or lowers the priority on your list.
2. The Duration of the Debt
Dragging along your private student loans for over five years of completing your medical training will make your life difficult.
Some doctors don’t mind giving themselves up to 10 and sometimes 15 years of leniency, but if you’re stuck between paying off or investing, going beyond five years isn’t recommended.
Otherwise, you will lack the necessary capital to support your investment should it need a financial boost at any point. With the current economy, this is almost bound to happen.
How to Think
If clearing the loan is a bigger priority, you should go for loan forgiveness programs or opportunities whenever possible.
For example, the National Health Service Corps (NHSC) Loan Repayment Program offers financial aid to help clinicians who agree to work in designated Health Professional Shortage Areas (HPSAs) repay qualified educational loans.
On the other hand, if you have a worthy investment opportunity, the money you procure should be from your lifestyle spending, not from your student debt monthly payments.
Unnecessary expenses like expensive watches, designer clothes, overly expensive electronics —all of that can wait. It’s only five more years until you’re debt-free.
3. The Inflation Rate
If you have an eye for predicting inflation or know someone with knowledge of the stock market, you may leverage that to your advantage.
For example, if you borrow money today at an interest rate that’s lower than the current inflation rate, you may be better off not clearing your debt right away.
This is because, as the inflation rate increases, the dollars you pay in the future will be worth less than the dollars you borrowed today.
Let’s Talk Numbers
For example, let’s say that you took a student loan of $10,000 in 2024 for your college education. This loan has a fixed interest rate of 4%.
When you finish, you might feel like you want to pay off the $10,000 immediately, but what if you can rely on inflation to safely invest it, pay your debt, and make a small profit?
If you can find a safe investment option (like a Certificate of Deposit, or a bond) with a guaranteed return of at least 5% (to cover the debt), you can invest and pay off your debt simultaneously.
If you invest the $10,000, and it grows at a steady 5% for 10 years, your investment could be worth around $16,289 (assuming compounded interest).
Meanwhile, the loan balance would have grown only to $14,693 (due to the 4% interest).
In other words, you paid your loan over 10 years and made $1596 during the process.
It may not be much, but after 10 years, your investment will yield a profit + the amount you used to pay for the loan, generating capital for a potentially more significant investment.
4. Your Employer Retirement Plans
Many employers offer retirement-saving benefits, such as 401(k) for private companies or a 403(b) for non-profit organizations and public schools.
These plans contribute additional funds to your treatment account, up to a certain limit, for every dollar you contribute.
If you don’t contribute enough to secure them, you’re essentially throwing away money that can help you either pay your loans or invest.
Let’s assume that your employer offers a 50% match on contributions worth up to 6% of your salary.
If you contribute the full 6% (which translates into $6,000 annually), you’ll receive an additional $3,000 from your employer.
That brings your total annual contribution to $9,000. This return often outpaces what you might find in other low-risk investment options.
Let’s Talk Numbers
The neat part is that you can use retirement plans towards either of the goals (paying off debts or investing) with virtually no risk.
Over a long career, this could serve as your investment to help you retire early. On the other hand, you can withdraw your money early to use it for your student loan.
You can also use it as an emergency fund.
Even with early withdrawal penalties, you’d likely come out ahead due to the power of compounding, as well as potential tax benefits from traditional retirement accounts.
For example, let’s say that you contributed $4,000 to your 403(b) to get the full $2,000 for a full match from your employer (totaling $6,000).
If you withdraw the entire amount immediately, you’ll face a 10% penalty ($600) + income taxes of 22% (for demonstration, resulting in $1,320 worth of taxes).
Despite these penalties, you’d still come out ahead with $4,080 ($6,000 total contribution – $1,920 penalty and taxes) compared to keeping your full salary of $4,000 after taxes ($3,120).
Of course, the compound effect will increase along with the time you wait before withdrawal.
5. Your Current Life Goals
Last but not least, if the scale is still not in favor of clearing debt or investing, you should prioritize your life goals and current circumstances ahead of you. Here are a few examples:
Starting a Family
If you are looking at marriage, having kids, or putting a down payment for a house, you may be better off making small payments toward your student loan and shelving the investment idea for now.
This will give you a breather in your budget to allow for the hefty cost of starting a family.
Emergencies
It’s hard to predict emergencies, but some life circumstances can make it easier to see a problem coming before it happens.
For example, if you have someone who’s chronically ill in your family, a heavy medical bill may be waiting around the corner.
This one may hurt your investment and loan repayment aspects, and, as such, you should have at least one month’s worth of expenses before taking a step in either direction.
Risk Tolerance
People have different comfort levels when risk is concerned.
Some people are more willing to tackle higher risks that come with potentially higher returns, while others prefer more secure and guaranteed returns, even if they’re lower.
If you decide to prioritize investing over clearing your loans, going for secure options is more recommended, as losing on your investment won’t only jeopardize your initial investment but also your ability to pay off your student loan debt.
Clearing Debt Vs. Investing Your Money
This section will provide you with concrete directions that you can apply based on your current financial situation.
When to Clear Debt
High-interest student loans (typically 8% or higher) should be prioritized before they take a good chunk of your income over the years through the compound effect.
Clearing a high-interest debt may also be a better solution for doctors willing to purchase a home but who are currently unable to because of a high debt-to-income (DTI) ratio. In other words, prioritizing clearing debt will:
- Save money in interest.
- Improve your DTI.
- Allow you to become debt-free faster.
When to Invest Your Money
If your borrowed money has a low interest rate, or if you managed to enroll in a student loan refinancing program, forgiveness plan, or an NHSC Loan Repayment Program, investing your money can be a better choice. Focusing on investing will allow you to:
- Make use of the compound interest rate while you’re still young.
- Retire sooner (if you’re planning to).
- Utilize the flexible withdrawal rules offered by some investment accounts.
A Few Extra Words
What you read above is but a small piece of the financial management pie.
The process can get complicated, and before you know it, you’re stuck in the loop of spending as much as you’re earning and sometimes even more.
Here at Physician’s Thrive, we can help manage your federal student loans.
Not only can we help you manage your finances better, but also help you negotiate the best contract.
Contact us now to get your quote and get ready to thrive toward your financial goals.
