Personal Finance with Student Loans (Part 2): Loan Management

Student Loans may be the bane of our generation.  Expensive, endless, soul-sucking, predatory, possibly criminal.  At some point you realize you cannot save for your kids because you are still paying for you.  I have heard them described as "paying rent on my job." But for now, they exist, so instead of whining about it, let's get winning about it.

I think of student loans in a very specific way--they are bad to have.  They is little to no tax advantages for the interest, practically non-dischargeable in bankruptcy, and now they factor into mortgages thanks to the scumbag mortgage "crisis."  The rates are no longer low like they used to be, lenders buy/sell your loans and the websites generally suck.  Simply put, my goal is to get rid of them as reasonably fast as I can.  Forget that inflation suggests we will be paying with worthless dollars, the margins there are so slim (and the consequences of inflation are so great) that I'd rather not use that as my winning strategy.

So I see pre-paying loans as a very specific type of cash flow investment: Every month, a fixed amount of money leaves my account until some far away total.  By eliminating the loan, I get that cash flow "back."  As far as I know (but you should check), no student loans have pre-payment penalties.

Put differently, putting money towards student loans above the minimum is the equivalent of investing in a non-compounding investment at that interest rate. So if I pay a 5% loan early, I am effectively earning 5% money back (non-compounding) a gain on which I have to pay no taxes.

Therefore, my loan repayment strategy is effectively:

1. Reduce interest rates however possible
2. Organize your loans by interest rate, highest to lowest
3. Order any investment opportunities you have by return rate, highest to lowest
4. Decide on your "transition rate"
5. Consult your budget for how much you "extra" you can spend this month and Go!

Step 1: Reduce Interest Rates

There are basically two ways to reduce interest rates, Autopay discount and Refinancing.  If you aren't already set up for Autopay, which usually has a 0.25% discount, do it.  If you can't afford to Autopay, go back to budgeting.  

Refinancing is a relatively new option in the world of student loans.  Basically someone decides to offer you better terms than your existing lender.  There are bunch of folks doing this so check it out.  We went with Earnest and have not been disappointed.  Best rate, most flexibility, great website, great service.  It is worth shopping around, but they are awesome thus far (about 3 months in). Refinancing for us took a chunk of loans around 7.5% and brought them down to 4.5%.  That is an insane amount of interest saved.  Put differently, for $100 more per month in monthly payment (which was a choice we made, not forced), we pay off the loan in 9.5 years instead of 25. 

Steps 2-4: "Transition" Rate

There are two basic strategies to choose which order to pay back multiple loans known as Snowball and Avalanche.  Snowball manages your emotions because you "win" faster and more frequently.  Avalanche requires more emotional discipline and saves you more money.  Avalanche is the superior strategy.

The "transition" rate is the interest rate/return rate at which you ought to invest rather than pay back loans.  This number is personal, there is no right answer.  It incorporates all of your loans, what investments you have available to you, your tolerance for risk on investments, and the fact that winnings both compound but also get taxed.  

So, line up your loans by rate, highest at the top. Tuition.io is REALLY good for this.

In my world we have a small loan at 5%, a big loan at 4.5% and a medium loan at 4.25%.  Based on that, and my risk tolerance, I decided that 4.5% is my transition rate.  Now my job is to pay the 5% loan down, and spend the rest of my time looking for investment options that I believe will return greater than 4.5%. If I can't find them then I just pay more in loans that month.  

Investment options, What investment options?

Everyone has investment options.  A 60 month CD right now returns 2.25% guaranteed.  If you have access to a 401K, just putting the money in tax free starts you at a return of your tax rate. Beyond that there are stocks that pay dividends, stocks that grow, bonds, private investments, etc. If you don't know anything about this, than your transition rate ought to be the annual CD or savings account interest rate.  Whatever it is, it is never 0.  

Step 5: Go!  

Once you have decided where to put whatever extra money you have, go decide on how much extra money you have. Make sure this money is extra (after regular and emergency liquidity planning) and don't look back. Once it is paid to loans, it is gone.  Once it is invested, it may or may not be gone.  

 

Negotiation, MD

Earlier this week, I had the pleasure of attending Paul Levy's seminar on negotiation. http://runningahospital.blogspot.com/2010/04/how-much-would-you-bid-for-10-bill.html

It was a great seminar, and covered many of the fundamentals of the art and science of negotiation in a 3 hour period. What I found most interesting, is how innately uncomfortable many physicians are with negotiation, especially with monetary negotiation. I have often thought about this problem as it applies to physicians as a group, as our negotiation skills lag far behind, especially given our training on rigorous analysis, decision making, and interpersonal skills.

Having grown up in a household whose sport was negotiation, I feel I can shed a little light on this issue that has often puzzled me about my colleagues. I can come up with at least three reasons why physicians fail at negotiation:

1. We never hear "No."

As physicians, we are not used to being told No. A real No, the kind that sticks. Sure patients, nurses and colleagues will often say no, but it is usually transient and we can move them to yes very quickly by leveraging our knowledge and positional power. We never have to develop the more subtle mechanisms for reaching agreement, because these tools work so well. In the negotiating world outside of medicine, we often have neither, and yet try in vain to invoke our favorite tools.

2. Physicians are risk averse.

By the nature of our profession, we endeavor to prevent the worst from happening, and it is always on our minds. We see risk as something to be minimized, and when we do balance risk and benefit, it is always on behalf of our patients, rarely for ourselves. We never feel the primary burden of our decisions, only the secondary consequences of a bad decision. If you want to beat a physician in a negotiation, instill him or her with the fear of loss.

3. Our training teaches us to be suspicious of money and tolerant of abuse.
We are the "good people," sacrificing our time, energy and potential earnings to help those around us. In order to rationalize how we earn so little for so much work in our training days, we develop a culture that places money in a strange place; a necessary evil but not for us. Therefore, the people that want money must also be evil, and we are willing to give it up in a negotiation, to rise above. Additionally, we learn from early in medical school that those above us in the hierarchy may act inappropriately, but it is in the best interest of our patients that we accept this abuse. While this phenomenon has improved over the years as professionalism standards grow in import, we still tolerate abuse from colleagues, other non-physician staff and patients themselves all so that we may benefit our patients. Appeasement does not work as a negotiating strategy.

So what do we do about all this? How can physicians improve?

1. Read about negotiation-- it is a skill and an extremely important one, study it
2. Attend workshops, seminars, etc.-- Negotiation is a performance sport, you must have practice time in order to succeed.
3. Develop negotiating mentors-- find someone that helps you think through problems critically, and with negotiating experience.  My father often fills this role for me.
4. Negotiate-- As Jeff Wiese always taught us at Tulane, Playing time makes all of the difference.

Some recommended reading:
Roger Dawson- most of books are great
Getting to Yes by Fisher, Ury and Patton
Bargaining for Advantage by G. Richard Shell