Navigate Debt with Self-discipline as Your Beacon

Physician's Money Digest, April 2006, Volume 13, Issue 4

Debt management is not a new problem,but it is becomingan epidemic, and one of the chief culprits is theuse of plastic. According to the American BankingAssociation, delinquent credit card accounts nowencompass 4.81% of all accounts. This trend is expectedto continue, especially in light of new payment policiesthat increase minimum payment requirements whileraising interest rates.

According to the Office of the Comptroller of theCurrency, these new policies—which require paymentsto cover interest, fees, and a portion of the loan principaleach payment period—could mean a doubling ofminimum payment amounts for many credit cardholders. And that's only the beginning.

"Most people don't understand that even if they makeminimum payments on their credit cards, there are otherexpenses to be concerned with,"explains DaveSchwartz, CEO and founder of First Capital Equities, afinancial counseling firm based on Long Island, NY."Once you're in debt on a credit card, the accrual of debton new purchases starts immediately. You lose the graceperiod."Debt management, Schwartz says, is both aneducational and psychological problem. A finance educationis a great tool, but it's often the psychology ofmoney that plays tricks on people's minds. Overcomingthese issues is not easy, but it can be done.

Physicians Under the Gun

For people of all income levels, debt has become afact of life. According to Cate Williams, vice presidentof financial literacy for Money Management International,debt has become a function of increasing prices.Today, physicians—especially younger physicians,Williams says—are particularly susceptible to gettingcaught in the web of debt. "In the past, once physiciansgot through the initial years of getting theircareers started, there was a reasonable expectation ofa steady and upward climb in wages,"Williams says."That's probably not as true today."

Mary McGrath, CPA, CFP®, of Cozad AssetManagement, Inc, says that the problems facing youngphysicians today are twofold. Due to increases in thecost of an education, they're coming out of medicalschool with much more debt than in past years. In addition,this younger generation of physicians has generallylived a nicer lifestyle than their predecessors. As such,they're taking on more debt while in medical school orresidency because they're used to having certain luxuries."They haven't really tried to pull back from thatlifestyle,"McGrath says. "So they're coming out ofschool not only with student loans, but car loans andcredit card debt. They have much more debt to managethan the physicians I used to see 15 years ago."

Williams is very familiar with the financial challengesfacing today's younger physicians. Each year shevisits the medical schools in Chicago to talk to theyoung people who are the future of the medical profession."I give them each a paper bag,"Williams says. "Itell them euphemistically that it's a gunny sack in whichthey're going to drag around their college debt."Themedical students laugh, Williams says, but it's no laughingmatter. The key, she explains, is that physiciansneed to live within their means. In the past, the physician'searning power was limited only by the amount ofwork or hours put in. Today's doctor, however, is workinglonger, dealing with more restrictions and regulations,and getting paid less. "Doctors certainly willenjoy a good income stream, and job security to adegree, but it's not what it used to be,"Williams says.

Credit Card and Debt Management

Scott Bilker, founder of DebtSmart.com and authorof (Press OnePublishing; 1996), says that if a physician is earning$250,000 a year, they are not rich. To be rich, heexplains, an individual has to have $2 million in cashon hand. "If you have a large home and a boat and aBMW, and you make $250,000 a year, you're just abig spender and you're probably leveraged to the hilt,"Bilker says. "Physicians are notorious for being bigspenders, because they feel they have to live up to thestereotype. But the key is to live modestly, and to behappy with what you have."

Credit Card Monster

Financial experts agree that the greatest contributorto debt problems is the credit card, although Bilker isquick to point out that credit cards aren't the real culprit."People say, ‘If I have more credit cards, I'll be inmore debt.'No, if you do more spending you'll be inmore debt. Don't buy it if you can't afford it."Ofcourse, that's easier said than done.

Schwartz uses an investing example to help illustratehis point. He explains that on a well-balanced portfolio,if an investor is fortunate, they would earn an 8%return. That return is somewhat taxable. However, ifthat same investor is running up credit card debt andpaying 18% interest, which is completely nondeductible,then every year they are running at least 10%behind. However, the psychological aspect is hard toovercome. "I dealt with a cardiologist who had morethan $80,000 on credit cards,"McGrath recalls. "I satdown with him and his spouse and tried to help themrealize that they had a debt that needed to be paiddown, and that they would have to make sacrifices toaccomplish that. But he just kept looking at me, saying,‘I make $320,000 a year. I can afford this.'In his mind,he felt that if he wanted to take his family on a $20,000cruise, he could afford it. But you can't do that toomany times before you get in trouble."

Part of the problem, Schwartz says, is that peopletend to focus solely on the aspect of making money,while few people focus on losing money. "One dollaris too much debt when it comes to anything other thanyour home,"Schwartz says. "As a physician, if youhave a credit card balance, you clearly have too muchdebt."He explained that physicians, while they maynot be the highest income earners in the country, areway over the mean. "If they can't be fiscally responsibleto cover their expenses with their income, then theylikely also have no savings beyond their pension contributions,so there's a problem from the get-go."

Is there good debt? Williams believes there is. Sheclassifies good debt as the type that relates directly toan individual's professional goals. Her mantra is thatphysicians should use cash to purchase consumablesand credit to buy durables. She points to owing $2600on a washer and dryer as good debt. "Hopefully, youwill have paid for them before they wear out, so you'restill getting utility of the item purchased,"Williamsexplains. "But when you owe $5000 on a Visa orMasterCard and you have no idea what that debt represents,that's not good."

Home and Office Debt

A second culprit in the debt management war ishome equity debt. Often, young physicians get caughtup in acquiring all the trappings they believe a doctorshould have. As McGrath explains, they go from earning$40,000 a year in residency to somewhere in thevicinity of $200,000 in annual income. They feel theycan afford everything. "I had one couple who wereabout a year out of residency,"McGrath recalls. "Theyhad purchased a $400,000 house with a $400,000mortgage. They had $110,000 in car loans, $32,000 ontheir credit cards, and just under $200,000 in studentloans. When I sat down with them, they thought theywere going to be investing money. I told them they werea long way from investing."

The problem is that many physicians look attheir income in a vacuum. Then, Schwartz says,they get a phone call with an offer to lower theirmortgage rate from 6% to 3%. That's a very enticingoffer, Schwartz admits, and the knee-jerk reactionis to jump on the opportunity without talkingto a financial advisor. "They think they can save3% a year,"Schwartz explains. "But what they'regetting is a 3% floating rate compared to their 6%fixed rate. Before long, that 3% rate will rise andmay even exceed what they had with the fixedrate."The problem is that everyone is looking forthe next new deal. "But there is no deal,"Schwartzsays. "People just do things without taking the timeto sit down and read the contract."

In addition to home mortgage loans, many youngphysicians are hit with a double whammy when theylook to start their own practice. The cost of doing so,explains Roy Wagman, chief credit officer forNational City Private Client Group, has risen considerablyover the years. "I remember we used to makeloans to physicians of $50,000 and $60,000 to gointo private practice,"Wagman says. "I suspect thattoday it costs hundreds of thousands of dollars to gointo private practice. So if a physician wants to opena practice, or buy into an existing practice as a partner,they incur a lot more debt than they once did."

Managing Your Debt

To cope, many people enlist the services of a debtmanager or a debt resolution firm. McGrath, however,has mixed feelings about this approach, and saysthat physicians should use the services of a debt resolutionfirm cautiously and as a last resort. "I don'tthink physicians get the respect or the service theywould if their earnings were in the same ballpark asthe debt manager sitting across the desk,"McGrathsays. "If I'm a physician and I show an advisor myW2 indicating that I earned $200,000 last year, thatadvisor will have a hard time understanding how Icould have debt problems."

Bilker suggests that physicians need to use theirleverage to negotiate better with banks. If credit cardissuers want them as customers, doctors shoulddemand the lowest interest rate. "When physicianshave a lot of debt, they're actually in a better positionto negotiate,"Bilker explains. "If I owe $10,000 andI'm paying 15%, I'll tell the bank to lower it to 9%or else I'll transfer my balance, and then the bank willmake nothing. Which do you think it will choose?"

Bilker has employed a tactic that has enabled him toavoid paying interest or finance charges for the past 8years. Credit card offers featuring 0% interest for 12months are always arriving in the mail. Bilker simplykeeps moving his balances from credit card to creditcard every 12 months, maintaining a 0% interest rateon his debt. "The key is you have to be disciplined,"Bilker advises. "Having a plan to get out of debtrequires some work, and people often hate to hear thatthere's work involved. But it's worth the time."

Bilker also urges physicians to track their spendingand stay mindful of their credit rating. Individuals areentitled to obtain a free copy of their credit report oncea year at AnnualCreditReport.com. However, freecredit reports can also be obtained online once a yearfrom each of the three major credit reporting companies:Equifax.com, Experian.com, and TransUnion.com. "If you get your credit report from one companyin January, you can get it again from another company4 months later, and so on,"Bilker says. "Youshould stay on top of that, because your credit reportis your financial resume. People will judge you basedon that information for loans, employment, insurance—everything."