Aggressively Pay Back Loans or Aggressively Invest in Residency

[rainyanesthesiaresident]

Hello!

I have been doing some thinking about where I should put my money during residency and wanted to see what your guys' opinions were. A little background: I am an anesthesia intern with 160k of federal loans (with a weighted interest of 5.9%) and make 53k per year. I matched in the city where my parents live, so I have been/plan on living at home for much of residency. While this may not seem like the most glamorous option, I feel like I have the opportunity to really maximize my money during residency and set myself up for success; I live in a city where rents have ballooned in the past 5 years, and I have seen many interns paying anywhere from 1,000 to 1,500 a month for rent. Thus, I have the potential to invest/pay back my loans by not having rent to pay. I have been considering two options for how to approach my loans and investments during residency:

 

Option 1:

1. Refinance my federal loans privately now: I'm not sure if you all are familiar, but First Republic Bank has a student refinance loan that has a few different options. The one that I was looking at is a 10-yr, 2.95% APR loan that would put my monthly payment at $1,541/month. No prepayment, origination, or annual fees.


2. Max out a Roth IRA $5,500 ($458/month)

 

Benefits of option 1:

Graduate from residency with less than 100k of student loans, still have some money tucked away in a Roth IRA. Low risk.

 

 

Option 2:

1. Go with REPAYE and defer trying to pay down my federal loans until after residency ends.


2. Max out both a Roth IRA ($5,500) and get close to maxing out a 401k (~$18,000/yr or about $1,500/month)


3. After graduating, refinance privately with First Republic (or whoever else) at that time (they currently have a 5 year, 1.95% APR that I could foot as an attending, but who knows if that will still be around in 4 years).

- Note that maxing out a 401k would be roughly the same per month ($1,500) as would paying back my student loans through the private First Republic loans (10 year, 2.95% APR).

 

Benefits of option 2:

Maximize my tax deduction benefits in residency (via Roth IRA and 401K) and minimize my REPAYE payment (by minimizing my Adjusted Gross Income), therefore maximizing the interest subsidy that REPAYE offers. Correct me if I'm wrong, but I know your REYPAYE payment is based on your AGI. See calculations below (assuming I max out a 401k):

My Adjusted Gross Income: $53,000 – $18,000 (401k) – $5,500 (Roth IRA) = $29,500, which would make my REPAYE monthly payment $97 (based on what the studentloans.gov website calculator says).

For my federal loans at my interest rate (160k at 5.9%), my monthly interest would be $786.61/mo or $9,439.41/yr. The difference then between my REPAYE payment and accrued interest would be $786.61 – $97 = $689.61, thus making the interest subsidy I'd receive $344.80/month, or $4,137.66/year, making my total yearly interest accrual on my loans $9,439.41-$4,137.66=$5,301.75. This would effectively make my loan interest rate almost half it was before $5,301.75/$160k=3.31% (instead of the 5.9% I would have had otherwise).

 

What do you guys think? I'm tempted to go with option 2, but I wanted to see if you all had any ideas! Thanks for reading!

[jpa]

Disclaimer: I'm just a 3rd year student. But my wife and I paid off her student loans from undergrad, during my 2 gap years and it was a very rewarding feeling.

I'm highly debt averse....I think I'd lean towards option #1.  Perhaps scrounge up enough to put whatever % could be matched into your 401k as well? Do they match up to 3-4%? Can you moonlight? If you could do option #1, plus throw some extra $$ into the 401k from moonlighting at an urgent care, then you'll be able to be debt free after about 6 months of finishing residency.  That could open up so many opportunities to pick the job and location that you prefer---you're not going to have to take the highest offer. That seems like it would be very rewarding

[jfoxcpacfp]

1st thought - you are definitely not going for PSLF, correct? If that is not off the table, you will take it off the table by refinancing. I'm sure you already know this, but not everybody is aware. Have you read this post by WCI?

2nd thought - maxing out your 401k has limited benefit tax-wise as you are in such a low tax bracket. Also, contributing to a Roth IRA does not reduce your AGI; it's not deductible. Of course, if it's really important to you to have that low payment, go for it. I just don't see the benefit at this point when you have so much potential because your costs are low.

3rd thought - does your 401k have a Roth option? This is where you should direct your retirement savings while you are in residency, if you have the opportunity. Otherwise, you'll be rolling over to a Roth when you  (most likely) change employers after you finish training and when you have 1/2 year of income as an attending and are, thus, in a higher tax bracket.

I haven't specifically made the choice for you, but I think you can tell where I'm leaning.

[DMFA]

1. RePAYE to minimize interest accrual in training
2. Retirement accounts
3. Private refinance to lowest rate once out of training

The $1500 or so will mean a lot more per month now than when you're out of training vis-à-vis your overall income. Your debt will accrue at about 3.5% or so (rough mental estimate) since RePAYE wipes out half the unpaid interest each month. Your retirement investments will most likely beat that. With the ability to mitigate interest and your very low income in training, paying off debt at a high rate in training is not usually the best priority overall.

Does your employer plan have matching or a Roth option? Not using matched plans is leaving money on the table, and a tax deduction at your low bracket will not be as useful as letting it grow and be withdrawn tax free. 15% off $18k is almost certainly way less than whatever your retirement bracket and amount will be.

Roth IRAs are not tax-deductible and don't affect your AGI.

jpa: 401k are employer-specific. You can't moonlight and put that into your employer's 401k. You'd have to start a separate one (SEP, solo, etc), and even then, you'd likely only be able to put 20% of your 1099 earnings into it (see the regulations re: elective deferral).

Obv you can do whatever you like. You're not wrong to eliminate your debt ASAP, but mathematically you're most likely to come out ahead in the end using the amount in question to grow at a higher rate and term than what you would reduce your debt losses by.

[DMFA]

I am 15 minutes behind Johanna this morning.

[jpa]

Yeah I wasn't referring to putting his money earned from moonlighting into his hospital 401k...rather live on the money from moonlighting and then contribute some of his paycheck from the hospital into 401k. So, different but same I suppose? Of course, he could draw from his moonlighting income to pay towards his loans, thereby freeing up additional money into his hospital 401k--that's what I was referring to

[jfoxcpacfp]

jpa wrote:

Yeah I wasn’t referring to putting his money earned from moonlighting into his hospital 401k…rather live on the money from moonlighting and then contribute some of his paycheck from the hospital into 401k. So, different but same I suppose? Of course, he could draw from his moonlighting income to pay towards his loans, thereby freeing up additional money into his hospital 401k–that’s what I was referring to

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Your answer was fine, imo, but you are correct: money is fungible.

[jz]

Rainy,  Use this principal:  skew toward loan payback EXCEPT when the market is down.

Routinely  pay on your loans, but be prepared to exploit the opportunity of a bear market.  If/when a bear market opportunity presents, shift toward aggressive investing.

[rainyanesthesiaresident]

Hey Johanna -

 

Thanks so much for your reply!

 

1 - Probably not going to go for PSLF given that I only have 160k of loans and also unclear if I'm going to work for a 501(c)3 after graduating.

 

2 - Thanks for letting me know about the Roth IRA.

 

3 - I don't think my 401k has a Roth option. I'll have to follow-up on that one!

 

It does sound like you think I should just re-finance now? Just wanted to confirm which way you were leaning thank again!

[jfoxcpacfp]

rainyanesthesiaresident wrote:

It does sound like you think I should just re-finance now? Just wanted to confirm which way you were leaning thank again!

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Lol, guess I wasn't as obvious as I thought. Yes, strongly leaning toward Option 1.

[mgarf]

Going into my first few years of residency I had 100K in debt and we payed it off in 3 years. There was NOTHING more liberating than being rid of it. So psychologically it was a no-brainer. Financially, I also think it's a no-brainer. You have no idea what the market is going to do in a few years.... on average it goes up, but there have been many a decade stretch where it did absolutely nothing. Paying off your loans (at the 3% rate you quote for re-financing) is like investing in a guaranteed 3% investment fund. Which is a pretty nice return these days...

So in summary: I'd pay off your loans as soon as humanly possible. I'm not sure if it'd pay to do a little bit of investing in tax-sheltered accounts for tax purposes (you'd have to go over the math)... but I don't think it will. Furthermore, the contribution room should roll-over (atleast they do here in Canada), so you can make the savings later... when your loans are re-payed.

[Zaphod]

mgarf wrote:

Going into my first few years of residency I had 100K in debt and we payed it off in 3 years. There was NOTHING more liberating than being rid of it. So psychologically it was a no-brainer. Financially, I also think it’s a no-brainer. You have no idea what the market is going to do in a few years…. on average it goes up, but there have been many a decade stretch where it did absolutely nothing. Paying off your loans (at the 3% rate you quote for re-financing) is like investing in a guaranteed 3% investment fund. Which is a pretty nice return these days…

So in summary: I’d pay off your loans as soon as humanly possible. I’m not sure if it’d pay to do a little bit of investing in tax-sheltered accounts for tax purposes (you’d have to go over the math)… but I don’t think it will. Furthermore, the contribution room should roll-over (atleast they do here in Canada), so you can make the savings later… when your loans are re-payed.

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Psychological, yes. The same as getting a 3% investment return, not at all. Financially it is a no brainer, paying off a loan with a low rate using your most valuable money you'll ever have (time value of money, compounding period, etc...), investing wins hands down. It doesnt make it the best overall choice depending on every other factor in your life but the math is what it is.

A loan is simple interest in payback, investments are not. Also, if you are going to compare the immediate term investing results (ie, 3-5 years) and then say whether or not it was a good idea than you're not thinking about it correctly. It always cracks me up when professed long term passive investors jump right to short term inappropriate comparisons for choosing best use of their money. What happens immediately doesnt matter really at all, unless that is the time frame for when you will be drawing down that investment. You should compare at that time how it did, and it'd be an incredibly terrible stretch of market history that wouldnt do far better than 3% in 20-30 years. This is all before accounting for inflation which again works in your favor for the debt and against you waiting to invest.

I am very surprised after browsing your website (nice site btw) that you conflated the two types of interest, ignored the inflation aspect AND used such a short term time frame for validation of the choice.

[mgarf]

Thanks for looking at the site!

In response to your comments:

I didn't go into details in my reply, but I'm assuming the individual has a short investment timespan as they will need money in the next few years for a house. You are right however, 30 year timespan you could certainly make the argument that it makes historical sense to borrow money at 3% and invest in the stock market. (although I'm not sure if it would be a guaranteed 3% over this time-span). 20-year timespans though, historically (S&P 500 since 1926), give (worse-case) 0% annually after inflation.. so I'd still pay off the debt if it was shorter than 30 years.

Furthermore this is all based on history repeating itself. Truth is, we have can't be certain what the future will bring. All we can say is that we can be pretty sure that 30-years annualized will give worse case 4% return. However, we can be absolutely certain that if you don't pay down your debt, you will be guaranteed a 3% drain every year.

But you have a point, it is a lot more complicated then I let on in my short reply. Debt just scares the ************************ out of me! So I am perhaps pushing the psychological factor over pure logic.

 

 

[Rutherford]

I think if you ignore the behavioral/psychological aspect and look at it purely by the numbers then option 2 is likely the best. Not only are you essentially borrowing money at 3% to invest it in the stock market (historically speaking a good bet 8 or 9 times out of 10) but you also are limiting state/federal taxes (yes, from a low marginal rate to begin with) and you leave the door open for things like deferment or PSLF if your future plans change.

 

There's also the question of flexibility. You could say that's an advantage of option 2, that you have the flexibility to scale back to the minimum payments and maybe not fund your 401K quite so excessively if something else comes up that you need cash for. You could also view the lack of flexibility as an advantage of option 1: it essentially forces you to pay back your loans quickly.

 

And lets not forget that you basically can't make a wrong choice here. Either of these paths will put you in a great spot 8 years from now. So don't get too stressed out about making the perfect choice, Internet Stranger.

[Zaphod]

mgarf wro

Thanks for looking at the site!

In response to your comments:

I didn’t go into details in my reply, but I’m assuming the individual has a short investment timespan as they will need money in the next few years for a house. You are right however, 30 year timespan you could certainly make the argument that it makes historical sense to borrow money at 3% and invest in the stock market. (although I’m not sure if it would be a guaranteed 3% over this time-span). 20-year timespans though, historically (S&P 500 since 1926), give (worse-case) 0% annually after inflation.. so I’d still pay off the debt if it was shorter than 30 years.

Furthermore this is all based on history repeating itself. Truth is, we have can’t be certain what the future will bring. All we can say is that we can be pretty sure that 30-years annualized will give worse case 4% return. However, we can be absolutely certain that if you don’t pay down your debt, you will be guaranteed a 3% drain every year.

But you have a point, it is a lot more complicated then I let on in my short reply. Debt just scares the ************************ out of me! So I am perhaps pushing the psychological factor over pure logic.

 

 

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Again, compound interest, so totally unnecessary to actually have the exact same return, though you certainly hope its better than that. Agree with shorter time frames, but any house money should be after after putting away for retirement.

Inflation will eat away at that debt and even in our low inflation environment will make the real impact of that nominal payment a discounted one compared to the early years (and make any catch up retirement put off worth less). Debt has been a large focus nationally since the GFC so it makes sense everyone is afraid of it, but we should still be honest about the numbers. One can always still decide to prioritize debt, but the quick 3%=3% apple=orange comparison I think really throws people off and doesnt allow them to truly appreciate the terminal wealth trade off.