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Until debt do us part

Linda Drake
Med J Aust
Published online: 21 January 2013

Could your financial health be in need of a lifestyle prescription? While doctors traditionally carry a high level of debt, it’s often the personal, not business, decisions that block the way to a debt-free future. Here, experts explain how to overcome your debt hurdles.

I can sit with a client and tell them they’re spending $5000 a month more than they can afford and they tell me, quite seriously, that there is nothing they can cut back on”, says Yves Schoof, director of Perth-based financial planning group Maxim Private Office.

Having many doctors on his client list, Mr Schoof knows all too well the issues that impact the financial health of medical professionals. In his experience, it seems that one standout issue comes into play time and again. Doctors, it seems, find peer pressure hard to resist.

When it comes to overspending, Mr Schoof says it’s the main reason many end up with considerable debt. The desire to maintain a lifestyle consistent with their peers, combined with banks all too willing to lend, means creeping debt often becomes an uncomfortable burden as time goes on.

Suddenly, a doctor can find they’re in their 50s carrying more than $1 million in debt, with no clear idea how they will repay it, despite earning a good income.

“Doctors talk to their colleagues as they work and discuss their expensive cars, twice-a-year overseas holidays and skiing trips. It’s easy to fall into that pattern of spending and very hard to get out. Peer pressure is considerable”, Mr Schoof explains.

“I see it particularly among those in private practice.”

Put simply, it’s excessive consumption of easy credit.

Surprisingly, it’s rarely loans related to setting up or running a private practice, or investment borrowings that lead to debt problems. It’s almost always lifestyle.

This view is shared by managing director of BFG Financial Services Suzanne Haddan, who says doctors’ relatively high incomes can give them a false sense of security.

“Banks will readily top up any loans as expenses rise over time. And doctors are often not concerned about how to get that debt down until, one day, there is the realisation: ‘Hello, this is not going to go away’ ”, Ms Haddan says.

What then?

Whether it’s a slow dawning or a shock awakening, doctors usually need to come to grips with their true financial situation, according to Mr Schoof.

“People often have no idea what they spend. That’s the first step for them to deal with. They need to look at what’s coming in and what’s going out. Is there a surplus? Many just don’t know at all”, he says.

Both Mr Schoof and Ms Haddan agree it’s often sizeable mortgages that are the root cause of debt problems. Doctors tend to buy expensive houses in desirable areas because it’s expected by their peers.

“In Perth, they want to live in prestigious suburbs and will easily spend $1 – $1.5 million early in their careers. If paying down this debt is not planned for, they will carry it for a long time, and often want to upgrade again too”, Mr Schoof adds.

Banks will readily lend up to 95% or even 100% of the purchase price of a house to doctors because of their reliable incomes.

“Doctors may be quite conservative about borrowing for establishing themselves in private practice; we see that in the seminars we run. But personal debt is far more of an issue. Doctors tend to be much more inclined to borrow for their residence”, Mr Schoof says.

“And because banks lend so generously to doctors, they have not had the same pressures as others to save a deposit, nor has it been possible during their long training period.”

Ms Haddan also cites this problem, but suggests: “When you are ready to borrow to buy a home, do projections to see if can have your mortgage cleared by the time you are 50. If not, borrow less. You should not take out a mortgage then actually take 30 years to pay it off.”

Life stages have an impact on debt accumulation. Early in a medical career, there will often be one income because of young children, combined with rising costs as families establish themselves, then school fees. Debts grow almost as inevitably as kids’ feet.

Getting back on track

Can doctors solve their own debt problems or do they need professional help? It depends, but either way the principles of reducing debt are the same. There are, however, generational differences. Younger doctors — those in their 30s and 40s — tend to seek help earlier.

“Some doctors try to manage their own affairs, but most realise they don’t have the required time or money management skills”, Mr Schoof says.

The older generation has traditionally been more determined to manage their own finances, but there will often come a stage close to retirement where affairs are complex — with a mix of family trusts, companies and self-managed super funds — leaving many doctors wondering what they should do.

“While they are working, money is plentiful, but they come to realise they will not be working forever, or at this pace” , Mr Schoof says.

“In their 50s they often find they need to sort themselves out. It might be because a colleague becomes ill or they see their peers getting ready for retirement. There will often be a greater sense of urgency.”

While the maximum impact can be achieved with professional input, because sophisticated financial modelling and strategies are used, some first steps are necessary no matter what:

Document your debt: What do you owe on credit cards, mortgages, equipment, cars? What is the interest rate? Is it competitive or can you do better? Is the interest tax deductible? What if you pay out your debt early — are there fees?

Get a grip on cash flow: What is coming in and what is going out? How much do you spend? Is there a surplus?

Educate yourself: Financial literacy among doctors is generally poor, as with the general population. It’s important to understand basic concepts like the power of compound interest, the difference between “good debt”, which is tax deductible, and “bad debt”, which is not.

Putting strategy into practice

Mr Schoof’s client, Dr X, was in his early 40s, single, had finished specialist training in the public system and was starting in private practice. He had a $600 000 mortgage and had been diligent in saving, accumulating $200 000 which was invested in a portfolio of managed funds.

His goal was to reduce debts quickly and get into a strong financial position for asset accumulation. So, Mr Schoof implemented a debt “recycling” strategy to gain tax advantages. This is where non-tax-deductible debt is turned into deductible debt. The portfolio, which Mr Schoof believed was “not ideal”, was sold — $200 000 was paid off the mortgage with the proceeds. Then Dr X drew down $200 000 on his mortgage and invested that amount.

The loan facility kept interest payments for the investment separate so they could become tax deductible. The result? A $14 000 tax deduction for Dr X and a $7500 increase in cash flow.

At the same time, an offset account was attached to the mortgage, reducing the interest to be paid when funds were in the account.

“We sought advice from the client’s accountant first, and then did the refinancing through a mortgage broker. We saved money on his mortgage too. These steps can be thought of as financial engineering”, Mr Schoof explains.

A debt recycling strategy that increases cash flow can be successful if the money freed up is then committed to increased mortgage repayments or paying off other debts. However, this means there is less to spend elsewhere.

“It’s not what you earn, it’s what you spend”, Mr Schoof says.

He warns that offset accounts need to be used with caution. “Offset accounts can be very effective but it can be hard to be disciplined and control your cash flow. Often there is lifestyle creep, where if you have more cash available, you simply spend more.”

However, Mr Schoof finds that once doctors have refinanced, restructured and set up an offset account, most stick with it. Some become highly motivated as they see debt reduction accelerate.

“Know that debt reduction is a long-term process. Be more mindful. Don’t wait for pain before you react”, he says.

Mr Schoof strongly advises that you seek tailored, individual advice for your own financial circumstances as there is no one-size-fits-all solution. These are just examples of strategies that can be applied with appropriate advice on your personal circumstances from a professional, he says.

Tips to regain control

Suzanne Hadden’s top debt-reduction tips:

  •  Isolate debt that is tax deductible — business and investment debt. This is “good” debt because it’s tax deductible. Pay interest only on deductible debt until consumer debt is cleared. Consumer debt — mortgages, personal debt and credit cards — is “bad” debt because it costs about twice as much as deductible debt as it is being paid for out of post-tax income. Clear these debts first, starting with the one with the highest interest rate.
  •  For any borrowing, always have a plan for complete repayment, normally within 15 years.
  •  Beware of having a high income yet failing to accumulate assets. Doctors need financial discipline like everyone else.
  •  Do a budget. Boring, but essential to work out what you can sensibly spend.

“Debt must be looked at in the context of an overall plan. What impact does any loan have? If you borrow to spend, the opportunity cost needs to be considered. Even if you borrow to invest and use tax deductible debt, it’s so you ultimately have an asset to sell off”, Ms Haddan says.

“If an asset doesn’t grow, then it’s a waste of time. When you borrow for investment, you must do so with a profit motive in mind. Even if you borrow for investment in a practice, it’s important to make sure it’s not disproportionate to the return you will ultimately get. The principles don’t change.”

 

  • Linda Drake


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