The Biggest Threat to Your Future: DEBT

Physician's Money Digest, June 2007, Volume 14, Issue 6

One of the biggest threatsto a doctor's retirement isdebt. Currently, our country is experiencing a debt managementcrisis of which many physician-investors are a part.Whether you have lingering medical school loans, loomingchildren's education bills, or pesky credit card balances, it isimportant to get a fix on your debt and get it under controlbefore it destroys your nest egg and retirement years.

Consider that the US Commerce Department recentlyreleased 2006 data showing that the United States is at a 74-year low when it comes to the national savings rate. Theaverage American is spending 1% more than they make. Atthat rate, if each of us were a business, we'd be out of businessbefore long.

Financial planner Elaine Morgillo points out that debtmanagement has become an industry in itself because consumerdebt is growing at an alarming pace. US consumer debtnow exceeds $2 trillion, Morgillo explains. If not managedproperly, excessive debt could contribute to economic decline.

"For example, the combination of historically lowinterest rates and dramatic increases in property valuesover the past few years tempted many people to use theequity in their homes to finance lifestyle enhancements,"Morgillo says. "As interest rates have risen, the paymentson adjustable-rate debt are becoming a greater burden andforeclosures are increasing."

In many respects, the problem of debt managementexists because people simply don't budget—or know howto budget—their money.

Credit Card Culprits

Most experts agree that credit cards are the number-oneproblem when it comes to debt. It is far too easy, says AdamBrauer, president of Debt Settlement USA, to fill out a preapprovedapplication and have instant access to credit.

"I often tell people to look at an item they are purchasingwith a credit card. If they don't pay their bill in fulland just pay the minimum payment every month, any itemthat they purchase today, they will still be paying for yearsdown the road."

Brauer further explains that if you are on the lookoutfor those preapproved letters in the mail, it is a sign thatyou are having problems. Juggling credit cards—using oneto pay off another—is a red flag. And taking out equityfrom your home to pay off your bills could turn out to bea huge problem if you have no discipline to rip up yourcards once they are paid off.

It should be noted that not all debt is bad. According toJames Kibler, CFP®, EA, president of Eldridge FinancialPlanning, LLC, properly managed good debt is when theasset outlives the length of the loan, the interest rate is reasonable,and hopefully the interest is tax deductible. Forexample, education loans are often considered good debt,because the asset (ie, your increase in earnings over yourcareer due to the education) generally outlives the loan, ratesare usually low, and, in some cases, it is tax deductible.

"The best debt under current tax laws is home mortgagedebt," Kibler says. "It is one of the few itemized deductionsthat is not eliminated in determining alternative minimum tax,though there are some exceptions to this rule." However, buyingmore home than you need could be problematic.

McMansion Madness

Sean McDuffee, CLU, ChFC, AEP, senior vice presidentand senior partner for North Star Financial, explains thatfor a physician in residency/fellowship, the largest debt istypically student debt, followed by credit card and automobiledebt. Their house is often the final breaking point,because most physicians overspend when it comes to buyingtheir first home.

"[Physicians] are told by realtors and bankers that theycan qualify for a maximum of X dollars," McDuffee explains."That is typically around 27% to 33% of theirincome. They are told a home is a great investment, but consequentlythey end up house poor when you factor in alltheir other debts."

That's because physicians are often carrying $100,000 instudent debt if they went to public medical school, and$200,000 if they went to a privateinstitution. "On top of that, delayedgratification typically sets in aroundthe end of residency," McDuffee adds."[Physicians] typically snap and startbuying, betting on the future incomethey will earn—in a sense, prespendingtheir future income."

Spending money before you have itrisks the possibility of never havingit—a recipe for retirement planningdisaster. And if you're deep in debt,you're less likely to notice if you'vebecome a victim of identity theft,which is a growing problem in allaspects of personal finance. As EmilyDavidson, of Credit.com, explains,having numerous accounts to trackand manage may make it harder toguard against identity theft andincreases the physician's risk of becominga victim. So how can you guardagainst identity theft?

"Be constantly vigilant," Morgillourges. "Do not put your Social Securitynumber on your checks. Shred or otherwisedestroy all documents that containsensitive information. Your SocialSecurity number and date of birth areall an identity thief needs to steal yourcredit identity. To protect yourself, periodicallycheck your credit report. Bylaw you are permitted to obtain onefree credit report annually from each ofthe three major credit reporting agencies."These agencies are Equifax (800-685-1111; www.equifax.com), Experian(800-520-1221; www.experian.com), and Trans Union (800-916-8800; www.transunion.com).

An Education Problem

Morgillo is one of many expertswho believe that the media, at least inpart, has contributed to our country'sgrowing debt problem. She explainsthat Americans have become a societyof people who must have the newestand best technology at work and athome, dress like celebrities, and pursuelifestyles that are more lavish than normalpeople can afford.

"Our schools do a miserable jobeducating young people about personalfinance and debt," Morgillo says."Most high school and college graduateshave never taken classes on eventhe most basic personal money managementfacts. Money can play strangetricks on people's minds. No onethinks they have enough money, butpeople still spend inappropriately anddon't save enough. Too many peoplethink of money as a commodity theycan use now—to buy possessions—rather than as an asset that can workfor them to build long-term wealth."

So, what can you do? Acknowledgmentof a debt management problemis the most important step. Next,take the following steps to lay outyour finances:

•List all debts starting with homemortgage and home equity loans.

•List student loans, auto loans,and/or other notes or liens.

•Itemize each credit card.

•Develop a column for currentbalance, interest rate, and monthlypayment for each credit card.

•Determine how much moneyyou can allocate each month to debtrepayment.

•Subtract the amount you need tocover the fixed monthly payments.

•From the balance, subtract theminimum due on all the others.

Hopefully there will be somethingleft. Allot that amount to the debt withthe highest interest rate (not countingyour home mortgage) until that balanceis paid in full. Then, do the samewith the debt that has the next highestrate, and so on.

"The only exception," Morgillosays, "should be if you have anaccount with a balance that is lowenough to pay off in a month or two.Pay that one first to get rid of it, andthen follow the instructions above. Ifyou don't have anything left aftercovering the minimum payments, youare in debt trouble and you shouldconsult a qualified professional advisorfor assistance."

Debt Management Wary

While there are some reputable debtmanagement firms, there are alsomany that are ineffective or, evenworse, are scams. Experts advise stayingaway from any firm that says it canrestore your credit.

According to Morgillo, the FederalTrade Commission has excellent informationon its Web site (www.ftc.gov/bcp/conline/pubs/credit/repair.htm). Fora small fee, reputable credit counselorswill negotiate repayment terms withyour creditors. They help you determinehow much you can allot to debt repaymenteach month. You send thatamount to them and they distribute it toyour creditors. In many cases, the creditorscompensate the counseling firm.

Remember, however, that when youuse a debt consolidator, you often willhave a mark against your credit.Those companies will typically settlewith the creditors for less than owed,and then that shows on your permanentrecord.