Debt and more debt: What’s a resident to pay off first?

December 19, 2019

In Canada, many residents begin their medical careers with some level of debt — about a third left medical school owing $140,000 or more.1 A resident’s debt is often made up of student loans, credit cards and a line of credit.

For many physicians, the transition from medical school to residency coincides with other expensive life events, such as getting married, buying a home or starting a family. This often means racking up more debt.

Where to start? Well, a tenet of financial planning is to pay down your most expensive debt first. Remember, though: as you focus on the debt you want to eliminate first, you must still pay at least the minimum payments on all other debts, on time, every month. Defaulting on a payment can hurt your credit rating.

Start with your credit cards

Your first step should be to identify which debt has the highest interest rate. Credit cards typically charge higher interest rates than other forms of loans — in Canada, some have interest rates as high as 20%. If you can’t pay off your credit cards in full, use your line of credit to pay them off.

Next: Line of credit or student loan? 

After paying off your credit cards, you will have to decide whether to pay off your line of credit or student loans — or even whether it’s worth carrying a balance and starting to invest. Here are the main features of student loans and lines of credit.

Canada student loans

  • The interest rate is the same as the prime rate, which is relatively low.
  • Each year, you get a 15% federal tax credit on any interest you paid. You can take advantage of this tax credit as long as you owe some income tax; if you don’t, you can carry the credit forward for up to five years and use it at a better time.
  • Six months after you’ve finished your studies, you must start making monthly payments.
  • If you’re a family medicine resident or physician, you could qualify for the Canada Student Loan forgiveness program, which forgives up to $8,000 per year or $40,000 total in student loans if you work in certain rural or remote communities.
  • You may also qualify for repayment assistance in some provinces and territories.

Line of credit

  • Student lines of credit typically offer interest rates that are around or below the prime rate.
  • During residency, you can often continue borrowing from the same line of credit you got during medical school.
  • Interest accrues on the amount you borrow and begins accruing as soon as you withdraw funds.  As soon as you repay funds, even temporarily, interest stops accruing on that amount. 
  • Many lenders require you to pay at least the interest every month. Some allow you to make no payments at all until two years after residency or fellowship. The unpaid interest is added to the original amount you borrowed, which you will need to repay later.
  •  You can make payments on the principal at any time. You can also borrow again any time, up to your limit.

Example: $50,000 in student loans versus $50,000 on a line of credit*

Even if the interest rate on the line of credit is lower, the federal tax credit might make the student loan cheaper, so you have to factor in tax when calculating interest costs.

There are two questions, though, when comparing lines of credit to student loans: after-tax interest costs and repayment flexibility. While the student loan might cost you less in the long run, you might be in a cash-flow crunch right now.

In that case, it might be wise to consolidate your student loan into your line of credit (in other words, pay off the student loan using your line of credit). You wouldn’t need to make any payments on your line of credit until two years after residency or fellowship, whereas student loan payments have to be made every month.

Regardless of your circumstances and financial goals, MD Advisors** can help you start your journey on the right foot.

* The prime rate is currently 3.95%, as of December 16, 2019. For the line of credit, we used an interest rate of 0.25% below prime.

** MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

1 Association of Faculties of Medicine of Canada: Graduation Questionnaire — National Report, 2019.

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