Nobody plans to dig a hole that's $326,956 deep.
Even when Tara D. decided to go to medical school back in 2001 -- knowing she would incur a lot of debt -- she never dreamed she would end up with $308,407 in student loans and $18,549 in consumer debt.
In fact, Tara, who is now completing a residency in western Massachusetts, didn't even know how much debt she had until a couple of months ago.
"I just kept borrowing money," she admits. "I told myself, this is what you do when you go to medical school. I knew one day I'd earn a good salary, and I'd pay it back -- and that's what most doctors do. So I didn't think about it."
But without a trust fund or wealthy parents as a cushion, Tara decided it was time to get a grip, and she ordered copies of her credit reports.
"That was the first time that I added up everything I owed," she says. "I was totally shocked. I realized I had to get this under control."
Where she is now
Here is Tara's detailed debt breakdown:- She has $117,702 in government student loans, which she consolidated last year into a fixed-rate loan at 4.25%
- She has another $190,705 in private loans, all at variable rates, ranging from 7.91% to 9.25%. These are already accruing interest.
- Her car loan is $12,404 at 6.09%.
- The balance on her MasterCard is $6,145 at 0% for another eight months.
- Total: $326,956
While that sounds like an insurmountable debt load, remember that when Tara completes her residency in 2009, she anticipates that her starting salary will be in the $150,000 range.
Also, she lives in a small town where her cost of living will be relatively low -- if she stays there.
A community approach
I first read about Tara's predicament last month on the Women in Red message board, and I was struck the sheer size of her debt problem.I posted a message challenging the board to come up with solutions that Tara could use. And in the meantime, I solicited some help from a pro: Galia Gichon, a New York-based financial adviser and founder of Down-to-Earth Finance, an educational organization.
The challenge was to help Tara create a workable get-out-of-debt strategy, given her current situation and her projected income when she begins working as a full-time physician.
An honest tally
As with most people who take those first, painful steps toward taking control of their finances, Tara faced a few of her own miscalculations.With about $2,650 coming in and only $2,115 going out that's accounted for, obviously there's a cash leak somewhere. Tara thinks part of it is shopping for clothes and perhaps going out with friends, but she isn't sure because she's new to tracking her expenses.
Tara also backed off from a tentative plan to pay down all her consumer debt before June 2009, when her student loan payments kick in. "I don't think it's possible to pay off all of it."
She also thought that her private loans couldn't be consolidated at a fixed rate, and that she would be stuck paying the variable rates.
Continued: Setting things straight
Setting things straight
Both Gichon and the WIR members who joined this informal Community Challenge to solve Tara's debt debacle were in agreement about the basics:- Don't wait, consolidate. Gichon points out that there's no reason Tara can't consolidate her private loans at a fixed rate, ASAP. "If you strike out with your current lenders, check out Bankrate.com or Myrichuncle.com," she says. As soon as the private loans are consolidated, Tara can start paying little chunks toward those; the private loans should be paid first, given their higher interest rate (probably about 8%). While her income is still relatively low, Tara may also be able to deduct up to $2,500 in student loan interest.
- Erase the credit card debt. Like Gichon, the WIR members are adamant that Tara can and should blast her $6,100 MasterCard balance. Getting on a budget, plugging that cash leak, breaking the plastic habit ("No credit, debit or store cards!" Gichon says) -- and then using the extra money to pay at least $500 a month would do the trick. "Ideally she could have her credit card paid off in a year," Gichon says.
- Save, save, save. Both the WIR members and Gichon couldn't stress this enough. Besides the fact that Tara needs an emergency fund so she doesn't incur more debt, Tara would do well to establish good savings habits now, before her salary skyrockets and that spending instinct revs up again.
Tara just started saving $25 each paycheck, and Gichon recommends that she move her savings to a high-interest account at an online bank.
Gichon and the WIR members agreed that Tara should open a Roth IRA now, and she should increase her contributions when her credit card is paid off. (Once she starts earning more than $100,000, she won't be able to contribute any more, but this will strengthen her savings habits.)
Gichon suggested finding an institution, like Vanguard or T. Rowe Price, that waives the minimum opening deposit if you agree to make automatic contributions of at least $50 a month. "Then put that money in one of their target date retirement funds," she advises.
What the future holds
The real challenge for Tara will be how she decides to live -- and pay back her debt -- once her student loans come due in mid-2009 and she's earning triple her current income, or about $150,000.At that time, Tara's net income, after taxes, insurance and retirement contributions, will be just over $6,000 a month. How should she allocate her money?
(The following calculations are based on a total average interest rate of about 6.5% for all of Tara's student loans.)
- Scenario No. 1: Tara continues to live like a medical resident for several years and puts the lion's share of her income toward her student loans. That would mean living on $2,600 a month and putting $3,400 a month toward her student loans -- and being debt-free in about 10.5 years.
- Scenario No. 2: Tara bumps up her standard of living a little and puts less toward her student loans. If she pays about $2,700 a month, she could live on about $3,300 and be debt-free in 15 years.
- Scenario No. 3: Tara takes her time and pays off her loans over the course of about 30 years (roughly $1,900 a month), but enjoys a much higher standard of living from the get-go.
Defining quality of life
There are many "right" roads to financial sanity. What you choose to do with your money and your life is always a balancing act, weighing one goal or priority against another.While some of the WIR members strongly advised Tara to pick Scenario No. 1 (and if I were 27, that's what I would do, but hey), that option is the least appealing to Tara herself.
After years of hard work, Tara would like to escape the student lifestyle. She also wants to start saving for a down payment for a home.
One WIR member agreed: "I'm a big believer in paying off debt, but we can get hung up in that mode," she wrote. "We must feel like we're living, not suffering for 'the cause' all the time."
Gichon also felt that Tara had to balance her debt repayment with the need to save -- and to invest in both retirement and a small starter home, like a one-bedroom condominium.
Gichon felt that finding a middle ground between Scenarios No. 2 and No. 3 would be ideal. Tara could start by paying $2,000 a month, but as she got raises and bonuses she could increase her payments. "Even an extra $500 a month would substantially shorten the life of the loans," Gichon says.
Tara herself was pretty daunted by all this. "It makes me a bit queasy," she said at first, after tallying up all her debts and expenses.
But once she realized that it wouldn't be hard to implement a plan -- in fact, she could enjoy a nice quality of life and not remain mired in debt -- she grew excited. "It's a relief to know that when I get out of my residency that I have a strategy," she said.
Published Aug. 9, 2007
