Make no mistake – your investment in a medical education is no doubt a wise one. For those who successfully complete medical school and stay in the field as physicians, your investment will no doubt pay for itself many times over, during the course of your career. For most of you, your investment in a medical education will provide a better ROI (return on investment) over the long term than just about any mutual fund you could buy.
But that doesn’t mean there isn’t a cost to it in the short-term.
Student Loans & Mortgages
When you apply for a mortgage on that starter home, you will have to put down not just your income, but also the monthly payments on your debt. While rules vary somewhat depending on the type of mortgage, you must generally keep your debt-to-income ratio below about 41 to 43 percent in order to qualify to purchase a home with a mortgage. That is, your total debt payments should not exceed 41 to 43 percent of your income.
And that’s where your student debt can have a significant impact: $250 per month debt servicing you take on – regardless of the source – you will reduce your eventual mortgage borrowing potential by about $44,000.
Is that the end of the world for you? Probably not. It’s more a problem for your colleagues pursuing degrees from expensive private institutions in far less marketable fields. For example, behold this young woman mentioned in this article, burdened with a $250,000 undergraduate degree from Dartmouth – in psychology and studio art – working on a contract gig in a clothing store.
That’s going to be a tough nut to crack in those fields.
You are in a good spot
As soon-to-be physicians, you are going to be in a much better position. Yes, you may well owe that much – and more – in student debt. But you will be leveraging that debt into a profession that will pay you much more each month than your student loan payments will total up to. That’s particularly true when you recall that qualifying student loan debt is low interest and tax-deductible. It’s a no-brainer.
But here’s the dirty little secret: The mortgage underwriters don’t care where that debt comes from. They look at your income, and they look at your debt, and if your income looks secure (i.e., you have three years earnings history, for example), and your debt to income is reasonable and you can afford the payments on the mortgage, and you have good credit history (you pay on time), you will likely get the loan.
Your student debt is good debt. It adds to the debt service column, sure. But it almost always adds even more to the monthly income side of the column – especially once you’re out of residency.
You need to decipher between good and bad debt
But watch those credit cards and that car payment! Unlike the interest on student loan debt, including medical school debt, the interest on personal debt is not tax-deductible. For every dollar you put on a credit card or car payment that doesn’t help you earn income, you’re robbing yourself of home-purchasing power down the road.
To help you avoid getting painted into a debt corner that will restrict your freedom of action and your home buying power, know the difference between ‘good’ debt and ‘bad’ debt.
Good Debt
- Helps you buy assets that go up in value over time, not down.
- Helps you increase your income by at least the amount of monthly payments.
- Helps protect your wealth
- Is tax deductible
- Helps to get you to your job.
- Helps you keep your job or do your job more effectively
- Helps you get a better job
- Helps you start a business (if you play your cards right)
- Helps you buy a home.
- Is affordable
- Is agreed to by both spouses
Bad Debt
- Helps you buy assets that go down in value, over time, not up (i.e., cars, furniture)
- Helps you buy status symbols that don’t do much good for your income statement or your net worth.
- Erodes your wealth
- Does not protect your wealth
- Is not tax-deductible
- Buys restaurant meals and alcohol
- Buys vacations and ski trips
- Exposes you to bankruptcy if you can’t pay
- Is not affordable
- Contributes to personal and marital stress
- Is not agreed to by both spouses
What if my debt isn't good or bad?
Not every debt will fit neatly into one of these two categories. And of course there are some financial counselors who would oppose nearly any debt other than a home mortgage and perhaps education debt (and anyone would prefer grants and scholarships to a school loan, anyway).
Remember, too, that unless good debt makes an immediate positive contribution to your income statement, it’s still going to negatively affect your ability to qualify for a mortgage. However, debt that helps you protect your income actually helps preserve your financial situation should you befall some misfortune. (This is why you should have your basic life insurance, disability insurance, homeowners/renters insurance and car insurance in place before you start aggressively paying down debt. These policies all help you safeguard your future ability to pay creditors.)
If you’re not sure about whether your next debt-financed purchased is good debt or bad debt, it may well be best to hold off on the purchase, and wait until you have more clarity about your financial situation.
And stay away from the luxury car lot and the furniture store!
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