This article assumes that you’re already familiar with a professional student line of credit and have been using one to help fund your medical school education. If you need a refresher, check out Your medical student line of credit: What you need to know and our line of credit FAQ.
As you know, a student line of credit can be used for school-related expenses like tuition and books, as well as for other purposes like making a down payment on a home or buying a car. Interest accrues on any funds you borrow. Some banks require that you pay the interest every month, while other banks let you “capitalize” the interest.
That means you don’t have to make interest payments while you remain in school, and instead the interest is added to your outstanding balance. This will gradually take away from your borrowing power as it uses up your available credit. Some financial institutions will allow you to delay making payments on your line of credit for up to 24 months after your residency program ends, depending on the terms and conditions of your bank.
How does interest rate affect your line of credit?
Recent changes to the Bank of Canada (BoC) lending rates have increased the interest rate on student lines of credit — so regardless of whether your payments are monthly or capitalized, if you’ve borrowed money for your line of credit you will be feeling the impact.
It’s important to note that as interest accrues, your overall borrowing limit remains the same. When the interest applied to the amount you have borrowed brings the total above your credit limit, many banks will require that you begin to pay your monthly interest to stay within your credit limit.
We aren’t in a low-interest-rate environment anymore. In October 2018, the prime lending rate was 3.95%. This meant with a balance of $200,000 on your line of credit, your monthly interest cost would be approximately $658. Those days won’t be coming back for the foreseeable future. Today the prime rate sits at 6.70%. This puts your monthly interest costs at approximately $1,116.
Bottom line: Managing your credit is more important than ever. Remember, this line of credit needs to get you through medical school, residency and beyond.
Case study: Not managing your line of credit effectively
John Smith is currently in his second year of residency. He’s single with no kids, and is renting his apartment alone. When he began medical school, he applied for student loans and a line of credit from his bank.
He was sure his $350,000 line of credit was more than enough to cover four years of medical school before he started residency and began earning a salary.
John went into his final year of medical school with $100,000 of room left on his line of credit. He saw all his working friends going on trips, buying their first homes and talking about their investments, and he started to feel like he was falling behind his peers. He reasoned that his interest rate was low, and he would be earning a salary next year so why not use his line of credit to “live a little?”
After reading an article about investing in Bitcoin, which promised record high returns that would far outweigh his low interest rate, he thought it was a sure thing. He used his line of credit to book a trip with his friends at an exclusive resort, and borrowed another $25,000 to invest in Bitcoin — rationalizing that his returns would cover the trip. After all, he’d still have $50,000 left on his line of credit and only one year left of medical school.
Unfortunately, his Bitcoin investment didn’t work out and he lost most of what he had borrowed.
John ended up finishing medical school with $20,000 left on his line of credit. He used most of that to cover moving expenses when he was matched to a residency program in a new city and bought a new car to get to work. He was still under the $350,000 limit on his line of credit and was now earning a $65,000-per-year salary that could cover his living expenses. He had made it!
What John didn’t realize was that his interest payments were being capitalized, which was adding $1,700 to his balance every month, so even though he hadn’t used his line of credit since the beginning of residency he had now reached his borrowing limit within a year.
John was under the impression when he signed for the line of credit that he wouldn’t have to repay it until he completed residency. What he didn’t know was that if he reached his borrowing limit he would have to start making the interest payments. The $1,700 interest that was being added to his balance every month now had to be covered as a payment. How would he afford rent, groceries, bills and his interest payment when that payment equalled one of his biweekly pay cheques alone?
He approached his bank to ask for an increase to his borrowing limit but was denied. His credit cards, with a much higher interest rate, have started to accumulate and his credit score has been slowly declining. He’s not eligible for any more loans or personal lines of credit from the bank, and his future borrowing power is at risk.
At this point, John’s options are limited. Asking family members to help with a loan so he could make payments on his line of credit and get some breathing room was his only option. His interest payments will return to being capitalized, so he needs to stay on top of making payments towards the line of credit to keep from reaching his limit again. In this case, John was lucky his family could provide a loan.
John decided he didn’t want this to happen again and chose to work with a financial advisor to help him manage his finances and stay on top of his debts.
What happens when you run out of funds?
This is the hard truth of not managing your credit properly. It comes with some real and painful consequences. As we saw in the case study, when you run out of room on your line of credit you may have to start to make your monthly interest payments. This cost was always considerable, but at the interest rates we’re seeing today it can be crippling. Going over limit can also come with extra penalties, including: overage fees, an increase in your interest rate and, worst-case scenario, facing bankruptcy and the possibility of not completing your residency program.
The good news?
This is all avoidable. The amount of credit provided to you by your bank should be enough to get you through your studies if you manage carefully to make it last. This doesn’t mean you can’t treat yourself from time to time. You just need to be reasonable, and know what reasonable is for you. Maybe it means taking a local weekend trip instead of a more expensive tropical getaway, buying a used car instead of a new one — or maybe it means getting a roommate.
It also means holding yourself accountable. Start with building a budget and acquiring some healthy financial habits. Speak with an MD Advisor* about your budgeting and cash flow to prepare for the future. The reality is the less you borrow during medical school and residency, the earlier you are able to start investing, saving for retirement and buying your first home. Don’t borrow from your future with poor planning.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
