Doctors: How to Use Debt to Your Advantage
When to Use Leverage as a Means for Growth
For many people, doctors included, the word “debt” has only negative connotations. After all, most of us took out considerable student loans to finance our educations. However, debt can also be used to your advantage when you leverage it for growth.
Investing for Growth Versus Paying Down Debt
Some doctors are quite comfortable with excessive debt, choosing to invest more of their income in tax-advantaged accounts, while others eschew investing at all in order to throw every available dollar toward erasing their debt. Most doctors, though, fall somewhere in the middle and are constantly asking themselves how to best balance investing in tax-advantaged accounts versus paying down debt.
If you find yourself in this middle ground, here are a few basic recommendations, in order of financial importance:
- · Never leave employer match money on the table
- · Always pay off high-interest debt (8% or greater) as quickly as possible
- · Make the maximum contributions to your retirement accounts
- · Invest in assets that will likely produce higher returns
- · Pay off your debts with moderate interest rates (4-7%)
- · Invest in assets with more moderate expected returns
- · Pay off low-interest-rate debt (less than 3%)
Next, we’ll discuss a few scenarios where it makes sense to use debt to your advantage.
Real Estate Investments
Investment properties can be leveraged anywhere from 100% when you’re putting nothing down, to 0% when you’re paying cash. Most often, in real estate investment, you’ll be best positioned to make a profit with a loan-to-value (LTV) ratio of 67-75%. You can get the LTV you’re looking for by the amount of money you put down, through value-adds on the property or if you’re lucky enough to purchase a property for far less than market value. In each case, you’ll have leveraged yourself to purchase the property, but in a way that should produce positive returns quite quickly.
Other Types of Investments
The real estate example is fairly clear-cut, but many doctors fail to realize that the same principles can be applied in other financial areas. For example, you can even leverage stocks, though it takes a bit more creativity to get to the LTV ratio you need in order to make this leveraged risk worthwhile. This is because investment loans, also called margin loans, are usually variable-rate, callable, and will only offer an LTV of 50%. However, you don’t have to borrow against stocks to invest in stocks. Why not borrow against property to invest in stocks instead? This will typically net you fixed-rate, non-callable debt you can use as you please, including investing in stocks.
Timing is Everything
How you take advantage of leverage risk is important, but when you do it is also crucial. Doctors who are best positioned for it are those with low interest, non-callable debt, as well as low net worth – oftentimes a doctor early in her career carrying mortgage or student loan debt. Although many financial professionals recommend a debt-to-asset ratio of 15-35% or less, high-income professionals sometimes have more to gain in the long-run by carrying a higher debt ratio but investing the difference in a thoughtful and strategic manner.
Let’s take a look at an example:
Let’s say you’re a doctor making $300k annually, one year out of residency. You owe $300k in student loans at an interest rate of 4%, and you also have $500k in mortgage debt at 4.5% on a home with a market value of $550k. You also have $30k put away for retirement.
When you do the math ($300k + $500k)/($30k + $550k), you get a debt-to-asset ratio of 138%. However, given your high income and desire to be debt-free in 15 years or less, it may make sense for you to invest in real estate or stocks instead of directing additional money toward debt service. There’s always an inherent risk in investing, of course, but using some leverage risk in order to, hopefully, become debt-free more quickly may be a reasonable option.
Closing Thoughts on Using Debt for Growth
In short: this strategy can work. Even if you feel saddled with your debt and are counting down the days toward paying it off, you must also realize the long-term benefit of borrowing at 1% and realizing returns of, say, 3% or greater. Sometimes, maintaining some debt in favor of increasing your bottom line will be the best financial strategy for you.