The Best Student Loan Repayment Plans for Medical Students and Residents

If you have ever tried to learn about student loan repayment plans you might have felt overwhelmed and confused. Instead of spending days researching information like I did, I’ve created a summary of the different repayment plans in a question-and-answer format with some key takeaways for graduating med students and current residents. 

1. What is the Standard Repayment Plan and who should choose it?  

With the standard repayment plan, you will pay off your student loans in 10 years by making “fixed” monthly payments. This means you will pay the same amount each month regardless of how much money you make. The government will determine your monthly payment by adding all of your student loans (and the projected interest that will accumulate on them), dividing that number by 10 [years], and splitting the amount into fixed monthly payments. 

This is not the ideal plan for graduating med students and residents, especially those with around $200,000 in student loans. Unless you have very little money in student loans, the monthly payments required under this plan will be higher than you can afford on a resident salary. Unfortunately, you will be automatically enrolled into the standard repayment plan if you don’t select a different repayment plan.   

2. What is the Graduated Repayment Plan and who should choose it?

With the graduated repayment plan you will also pay off your loans in 10 years, but your monthly payments are not fixed. Instead, they will start out low, and increase every 2 years, until you have fully paid off your student loans in 10 years.

This is also not an ideal plan for graduating med students and residents. The payments under this plan will still be higher than most residents can afford. Don’t get me wrong, paying off your loans in 10 years instead of dragging it out over 25 years will save you money in interest. However, if you can afford the high payments under this plan and want to pay off your loans in a few years, you could save even more money by simply refinancing your loans with an outside company since they can offer you can even lower interest rate.  

3. What is the Extended Repayment Plan?

Through the extended repayment plan you will pay off your loans in 25 years by making fixed or graduated payments. This plan is for people who don’t qualify for an income driven plan and want to spread their loans out over 20-25 years. It is not ideal for medical students and residents since we qualify for income driven repayment plans during residency.

4. What are the income-driven repayment plans?

The Federal Department of Education understands that some people may have acquired a substantial amount of student loan debt that they may not be able to repay with their current salaries. Instead of handing you a monthly student loan bill that may be higher than your mortgage, these income-driven repayment plans base the size of your monthly student loan payments on your income.

Keep in mind that there are several different types of income-driven repayment plans and that the names may change over time. As of 2024, the 4 types are Pay-As-You-Earn (PAYE), Saving-on-a-Valuable-Education (SAVE) which replaced the Revised-Pay-As-You-Earn plan, Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR).

Most of these plans cap your student loan payment at 5-15% of your discretionary income. Your discretionary income is your income minus whatever the poverty line is for your family size. In other words, if your income is low, your student loan payment will be low. As your salary increases, the size of your student loan payment will increase. After 20-25 years (depending on the type of federal loans you have) your student loans will be forgiven. Keep in mind that many residents and attending physicians will qualify for public service loan forgiveness which forgives their student loans after only 10 years of payments.

5. Should you enroll in an income-driven repayment plan like Pay-As-You-Earn (PAYE) or Saving-on-A-Valuable-Education (SAVE)?

As graduating med students or residents, you should consider enrolling in SAVE, especially if you have at least tens of thousands of dollars in student loans. With the SAVE plan your student loan payment is never more than 10% of your discretionary income, which is ideal for residents trying to make ends meet on a $60K salary. The amount of your income-driven repayment is recalculated each year after you file your taxes.

Of note, if you file your taxes as a graduating med student with zero income, then there is a high possibility your student loan repayment your first year residency will be zero dollars. Having a student repayment of zero dollars will actually count towards one of your 10 years of required payments under the public service loan forgiveness program. If you don’t file your taxes and instead opt for a grace period (the default option) then that time will not count toward public service loan forgiveness.  

6. What are the advantages of the new Saving-on-A-Valuable-Education (SAVE) plan?

SAVE is the new plan that has replaced the old revised-pay-as-you-earn (REPAYE) plan. Although REPAYE and PAYE were similar, SAVE and PAYE are much different. In fact, many many people will benefit from being in the SAVE plan and the PAYE plan is being phased out.

SAVE has many perks like:

• You pay a smaller percentage of your discretionary income. Instead of paying 10%, you now will pay 5% to 10% depending on the percentage of undergraduate vs graduate/medical school loans you have. If you only have loans from undergrad you will pay 5%. If you only have loans from graduate school or medical school you will pay 10%. If you have a mix of both, you will pay between 5% to 10% depending on the ratio of undergrad to graduate school loans you have.

• The definition of discretionary income is different which allows you to pay less per month. Under the old REPAYE plan, the PAYE plan, and the IBR plan the amount you pay per month is your adjusted gross income (AGI) minus 150% of the poverty line for your state and family size. Under the new SAVE plan it is different. With SAVE you pay your AGI minus 225% of the poverty line for your state and family size. This difference allows more of your income to be protected from the student loan calculation resulting in a lower monthly payment. In other words paying 10% of your discretionary income in the SAVE plan will result in a lower monthly payment than paying 10% of your discretionary income in any other plan because the definition of discretionary income in the SAVE plan is different in a way that favors the borrower.

• No unpaid interest gets added to your loan balance. This means that any interest accruing on your loans that isn't covered by your monthly payment will be automatically forgiven. If you’re like most physicians who graduate medical school with around $200,000 in student loans, it’s very likely that your income-driven payments in residency will not even cover the interest that is accruing on your loans. Enrolling in the SAVE plan will prevent that unpaid interest from being added to your loan balance. For example, let's say your monthly payments over the year add up to $5,000 but you have $20,000 in interest being added to your loans each year. This means you have $20,000 in interest minus $5,000 in payments which leaves $15,000 in unpaid interest each year. Under most repayments plans, that unpaid interest would be added to your loan balance causing the amount you owe to increase. Under the SAVE plan, that is not the case. The $15,000 of unpaid interest that wasn't covered by your monthly payments will be automatically forgiven.

• You have the ability to exclude your spouse's income, if you file your taxes separately. Under the old REPAYE plan, you could not exclude your spouse's income when calculating your student loan payment. With the new SAVE plan, you can. As long as you and your spouse file your taxes "married filing separately" instead of "married filing jointly" you have the ability to exclude his/her income from consideration when determining your monthly student loan payment.

7. Who should consider enrolling in Pay-As-You-Earn (PAYE) or Income-Based-Repayment (IBR)?

The SAVE plan is the best option for most people. However, there are 2 advantages of PAYE and IBR that some people may benefit from.

1) The payment cap. PAYE and IBR will cap your payments at the standard 10-year repayment plan level even as your income rises. This means you will pay payments that are either 10% of your discretionary income OR...whatever your payment would be if you enrolled in standard 10-year repayment plan, whichever one is lowest. This may benefit some highly paid physicians who don't want to make payments based on their income and would rather make payments based off the standard 10-year repayment plan. The higher your salary and the lower your student loan balance the greater chance you may benefit from being in PAYE or IBR. Look on the federal website for their payment estimator to see whether PAYE or IBR could save you money.

2) An earlier timeline for IDR Forgiveness. The other advantage of PAYE or IBR is that you have a chance to get your student loans forgiven in 20 years instead of 25 years. Although some people enroll in other student loan forgiveness plans like Public Service Loan Forgiveness (PSLF) which will forgive their loans after making 10 years of qualifying payments, not everyone qualifies for that program. If you do not qualify for PSLF, you are still eligible for the default Income driven repayment forgiveness. With this program, your loans will be forgiven after making 20-25 years of qualifying payments. Everyone in the PAYE plan and many people in the IBR plan will have their loans forgiven in 20 years (instead of 25 years) under this default income driven repayment forgiveness program. Those enrolled in the SAVE plan will have to make 25 years of qualifying payments. There is no forgiveness in 20 years under the SAVE plan.

Of note, PAYE and IBR are very similar. Those who do not qualify for PAYE may want to consider the IBR plan. PAYE plan is being phased out over time. A person should consider PAYE or IBR if they are not going for PSLF and would benefit from making payments based on the standard 10-year repayment plan instead of making payments that are 10% to 15% of their discretionary income. Be aware that the PAYE plan is being phased out over the next couple years.

8. What the heck is Income Contingent Repayment (ICR) and who should enroll in that one?

Income contingent repayment (ICR) is a type of income-driven repayment plan for those with Parent PLUS loans. People with these loans are those who took out student loans on behalf of their kids to help their kids pay for college. My point? This plan is only for those who have Parent PLUS loans. If you aren't sure, check your loan type on the federal student loan website.   

9. Can you change from one student loan repayment plan to another?

Yes. Oftentimes people may choose one of the income-driven repayment plans after they graduate from school, but then change to another type of plan as their salary increases or their life circumstances change. For example, a recent graduate might choose to enroll in SAVE for a few years to enjoy the benefits of the government interest subsidy, then change into PAYE if their income skyrockets so that there is a cap to place on how high their payments can be. Switching was much more common when the old REPAYE plan was in place. Now that there is the new SAVE plan much fewer people need to switch plans but it is still possible.

Trying to get your student loans forgiven? Consider public service loan forgiveness

Public service loan forgiveness got some bad press in the news in the past, but as a physician, I am still enrolled in it. Just in case you have some questions about the program, I’ve answered some common ones below:                                                                                                          

1.     What is Public Service Loan Forgiveness?

Public Service Loan Forgiveness (PSLF) is a government sponsored student loan forgiveness program. If you work in public service for a non-profit organization, academic institution, or government agency and make 10 years of on-time qualifying monthly payments towards your student loans, the government will “forgive” your remaining student loan balance.

This program was designed for public servants like teachers and police officers who have lots of student loan debt but may be unable to pay it off in a reasonable time, partly because the salary they receive working in public service is less than the salary they would have received in a different profession. The goal of the program is to allow people with a passion for public service to pursue careers in that field without saddling them with an eternal burden of student loans.

The great thing about this program is that many health care professionals qualify too. Before you roll your eyes, hear me out. Many doctors, such as myself, obtained an average of $200,000 in student loans during medical school. Then we entered residency where we were mandated to spend 3-7 years earning a government salary of around $60,000 while working 80 hours a week before we could make “the big bucks.” If we choose to continue working in an academic setting or for a nonprofit health system, we qualify for public service loan forgiveness as well.

2.     Wait, isn’t it sketchy?

I’ll admit, there was some bad press about public service loan forgiveness (PSLF) in the past. During that time, people who thought they met the requirements were finally able to apply for loan forgiveness. Unfortunately, many people were not granted this forgiveness and hearing this news scared many people who were depending on this program.

Although this is less than ideal, there are several reasons why previous applicants were unable to get their loans forgiven. When the program first came out, the rules were vague. There was a lot of misinformation about how to enroll and many people who thought they qualified for the program did not actual qualify for it. Nowadays, the requirements for PSLF are much easier to understand. Now that people are more aware of how to properly enroll into the program, many people who have met the qualifications have gotten their student loans forgiven.

3.     Is it wise to depend on this program?  

A few years ago there were some proposals to eliminate PSLF, or potentially limit how much money can get forgiven through it. Many people got worried that the program would change and didn’t want to depend on it. Nowadays, most of that worry has gone away.

The department of education has made several changes to the program that 1) make the rules much easier to understand and 2) have expanded the number of people who qualify for forgiveness.

As of 2024, many many physicians and other professionals with $200,000 or $300,000 or more in student loans have gotten their debt completely forgiven with the PSLF program.

4.     How do you qualify?

According to the website, you need to have direct federal student loans, work full-time in public service via a 501(c)(3) nonprofit or academic institution, and submit 10 years worth of on-time qualifying payments (i.e. Pay the full amount of your student loan repayment each month through one of the income-driven repayment plans).

5.     How do you actually enroll?

Go to the student loan website, complete the PSLF form, and have your employer sign off on it. Your employer can submit it themselves once they sign it electronically, or you can upload the form yourself, if you have your employer sign the form on paper. Once you’ve submitted the form, the federal loan servicer “Mohela” will verify whether you submitted the paperwork correctly and confirm whether you qualify. Mohela is the official servicer of the PSLF program (they took over for the pervious company Fedloans). You must contact Mohela annually to verify all of your payments and re-submit the employer verification enrollment form so that they know you still work in public service for a qualifying organization. If you have a different loan servicer (such as Nelnet, Navient, Great Lakes, etc), your loan servicer will be switched to Mohela as soon as you enroll into Public Service Loan Forgiveness.  

6.     Do you need to protect yourself if something goes wrong?

I understand that going for PSLF is a risk. There is a chance that the government could change the rules of a program that allows relatively high earning doctors to avoid paying hundreds of thousands of dollars in student loans. If you’d like to protect yourself you can consider creating a “student loan investment side fund.”

Instead of using the money you’re saving in PSLF to buy a better car, a larger home, or have a wealthy “doctor” lifestyle, you can save that money. Specifically speaking, you can take money from each check and put it into a high-yield savings account or put money in an account that is invested in a combination of real estate deals, index mutual stock funds, and money market funds. That way, if PSLF changes in the next few years or for some reason you can’t get your loans forgiven, you will have created a nice nest egg of money that you can use to quickly pay off the rest of your student loans.

If the PSLF program stays the same, then you can keep on investing that money and use it to pay for your retirement or your kids’ college education.

Tell me, are you thinking of going for Public Service Loan Forgiveness too?

Why I don’t plan to buy a home after graduating from medical school

I’m a graduating 4th year medical student and as most physicians know, this has been one of the best years of my life. I just matched into my top choice residency and am one step closer to becoming a primary care sports medicine physician, my dream job. Many of my classmates have capitalized on this time of excitement by making the controversial decision to buy a home before they start residency. I have not. Here’s why: 

1. I don’t have money saved for a down payment. During medical school, I was so busy completing rotations and studying for exams that I barely had time to sleep, let alone work a job. Thus, I didn’t save money for a house down payment. Although my status as a graduating medical student with a residency contract qualifies me for a physician loan, very few of these loans offer a 0% down payment and the ones that do require a higher interest rate in return.

2. I don’t have cash for the transaction costs. Transactions costs associated with buying a home are expensive. The cost of attorney fees, escrow, home inspections, etc. add up to an estimated 3% of the entire cost of the home. Although some banks can roll these costs into your mortgage, that usually increases your monthly payment, something that may not be a wise decision for a first-year resident on a fixed income.    

3. I don’t have an emergency fund for repairs. As a renter, if something breaks I contact my landlord and she calls someone to fix the issue. Most importantly, she pays for it. If I were to buy a home, this responsibility would fall on me. Having to coordinate repairs is not something I want to add to my plate. Plus, I haven’t had time to save money to pay for these inevitable costs and don’t want to rely on a credit card for these charges.

4. I already have a lot of [student loan] debt.  Despite getting scholarship money, I took out student loans to help pay for my education. Like most medical students, I have over $200,000 to repay. Taking on an additional $250,000 in debt to buy a home I don’t need seems unnecessary. I need to prioritize paying off debt instead of accumulating more.

5. Homes cost more than I can afford in my area. Many homes in the city center of Atlanta (where I will be doing my residency) cost at least $500,000. As a single person with a resident salary of only $60,000 and substantial student loan debt, I couldn’t even qualify for a mortgage that big, let alone afford one. There are cheaper homes outside of the city, but they are further away from the hospital which would add tons of traffic to my work commute.

6. I need to save money for other things. I have other uses for the money I’d be able to save a resident. Along with paying down debt, I also need to put money into an emergency fund and save up to buy another slightly used car. Although I love my 2012 Toyota, I may need a different car in a few years. Instead of financing a new car, I’d rather save up money to purchase a slightly-used car in cash. 

7. It won’t save me money in taxes right now. Before the Tax Cuts and Jobs Act, many young professionals bought a house and used the mortgage interest deduction to save money on taxes. Nowadays, that is much less common. Why? Because with the new tax changes, taking the standard deduction saves us more money. If I wait to buy a home as an attending, I might be able to take advantage of those tax savings.

8. Homeownership costs are expensive and renting is cheaper. After learning about the home-buying process, I’ve realized that you cannot just compare the average rent payment to the average mortgage payment and make a decision. There are many other costs associated with buying a home in addition to monthly expenses like property taxes, homeowners insurance, and repairs that add another 40% to your monthly budget. Renting is cheaper.  

9. My residency is only 3 years. If you live in a home for less than 5 years, there’s a good chance you will lose money in the deal, even if you sell the home for more than you bought it. Why? Because the closing costs associated with buying a home, recurring costs associated with maintaining a home, and transactions costs associated with selling a home are really expensive. It generally takes about 5 years to break even on a home when you consider these costs. Since my residency is only 3 years, there is a good chance I would lose money if I bought a home now.

10. I’m currently single. On a more personal note, I am an unmarried female. I don’t have to be married to purchase a home, but having a spouse who works would certainly help. As a graduating medical student who has substantial debt and a resident salary for the next 3 years, purchasing a home and paying the homeownership costs by myself is a heavy load I’d rather not bear alone.

11. I like living in the city. As a young professional, I love living in the city. Restaurants/bars are within walking distance, Uber rides to city events are affordable, and my commute to work is shorter. If I were to purchase a home, this may not be the case. Homes in the middle of the city are more expensive than I can afford as a single resident.

12. My life may change drastically in the next few years. As an unmarried female, my life could change drastically during my time in residency. I’m no Julia Roberts, but there’s a good chance I could get married and have a child in the next 4 years. If that were to happen, the things I’d want/need in a home would be significantly different. Right now, I loathe the thought of doing yard work and prefer to live closer to the city. However, if I were married with a child I might opt for a place in the suburbs with a backyard and better schools.

My point? Although you may not have all of the same factors in your life as me, I’d venture to say that some of my reasons for not buying a house are applicable to you as well. I’m a firm believer in free choice, but I would caution any graduating medical student against buying a home at the start of residency if they share many of these things in common with me.

Of note, I published this article on KevinMD.com on March 31, 2019.

How To Tackle Student Loan Debt

If you’re like me, or one of the millions of Americans who have student loan debt, I understand your plight. Learning about the different servicers, figuring out the repayment plans, and familiarizing yourself with terms like “refinance” and “consolidation” can be a bit daunting. Although many young professionals may have already come up with a plan to tackle their student loans, there can be a bit of a learning curve for new graduates. Here are some simple steps to help you tackle your student loan debt:

Step 1 = Figure out how much student loan debt you have. If you filled out a FAFSA form and received student loans from the federal government, then you can go to https://studentaid.ed.gov/sa/ to see your total student loan debt balance. You will need to input your FSA username and password in order to login (this is the same username and password you used to fill out your FAFSA form). Keep in mind, the total amount of student loan debt you have will include the principal (how much you actually borrowed) and the interest (the amount the government charges you each year until you pay the money back). If you took out private loans from outside banks, foundations, or corporations you will need to contact them directly (if they haven’t already started contacting you first) to determine how much you owe.

Step 2 = Find out the interest rates and the servicers of each loan you have. When you took out a student loan from the government, it was issued by the Federal Department of Education. However, there are different sub-departments within the Department of Education that handle your loan repayment. These “sub-departments” are called loan servicers and they are who you actually contact when you repay your student loans.

For example, I took out loans through the Federal Department of Education, but my loan servicer is Nelnet. Thus, Nelnet is who I pay when my loan is due. You might have taken out a loan through the Department of Education just like me, but have a different servicer (such as Great Lakes, Mohela which took over for Fedloans, Navient formerly known as Sallie Mae, etc). You must pay back your particular loan servicer directly. Once you login into the website and find out the servicer each of your student loans, you need to look at the interest rates on these loans. Chances are that you have different interest rates on each loan since the interest rate may have fluctuated as you took out loans from year to year. Your goal is to determine the range of interest rates you have on your student loans.

I know this may sound complicated, but it’s quite easy. I’ll walk you through what it was like for me. As soon as I logged into the website I had to accept a waiver. Then, I was able to see the total amount of student debt I owed (which was pretty high given my status as a medical student, but I digress). Anyway, I could also see the number of loans I had taken out and the fact that all of my loans had the same servicer (Nelnet). You may have different servicers for different loans, so be careful. Once I saw this listing of my student loans, I could then expand the tab (by clicking an arrow) and see the amount of each loan, the interest rate on each loan, and the date on which my next payment on that loan was due. If I click “view details” I can see the date on which I took out the loan and the interest that has accrued on it up to this point, among other things.

Step 3 = Understand the pros and cons of student loan debt consolidation. Debt consolidation is when you combine all of your loans into one giant loan with one interest rate. Consolidating your loans has advantages and disadvantages. The advantages of consolidating your loans (through the federal government) is that you combine all of your loans into one giant loan. Your new interest rate will be the weighted average of the interest rate on all of your loans. If you do not consolidate then you will have a different loan for each semester in which you took out money, each with different interest rates and potentially different loan servicers. This can get confusing.

By consolidating (through the federal government) you are able to combine all of these loans into one loan and focus on paying that one loan only. Having one giant loan, instead of many different smaller loans, tends to look better on your credit report. Another advantage of federal consolidation is that any loan that may not have counted towards loan forgiveness programs can now count towards those programs after you consolidate your loans (through the federal government).

The disadvantage of consolidating your loans is that any interest that has accrued on your loans will be added to the principal amount. Let me explain. If you took out unsubsidized loans, then interest accrued on those loans while you were still in school. Once you consolidate your loans, all of the interest that has accrued on your loans to that point will be added to the principal amount of the loan. For example, if you have taken out a total of $50,000 in student loans and $3,000 in interest has accumulated on the loans during that time, then if you consolidate your loans you will have a new loan with a new principal amount of $53,000 (that includes the $50,000 you borrowed plus the $3,000 that had already accumulated in interest).

I should mention that you have the option to consolidate your loans through the federal government or through a private company or bank. Although a private company may be able to offer incentives to get you to consolidate through them, I would advise you to consider consolidating through the federal government instead, if you choose to consolidate in the first place. The advantage of consolidating your student loans through the federal government is that you are still eligible for many of the benefits that come with federal student loans.

The federal government is much more understanding when you go through life changing situations. If you lose your job, become disabled, or have some life altering event that prevents you from making your student loan payment you can ask the government to put your loans into deferment or forbearance. Although they are slightly different, both of these options will grant you temporary relief from having to pay back your loans for a few months up to a few years. Most private companies will not give you this option.

Plus, many federal loans can usually be “forgiven” after a certain length of time. In fact, many federal income-driven repayment plans and programs will forgive your loans after 10-25 years. So unless you are secure in your job and are making a lot of money, I’d suggest consolidating your loans into one giant loan with the federal government if you feel you need to consolidate at all. Doing so, allows you to keep the protections that come with federal loans and makes your student loans easier to manage in the process.  

What am I doing? Consolidating. Even though my loans are already with the same loan servicer (Nelnet) with fixed interest rates, I need to consolidate in order to waive my grace period and start making payments under Public Service Loan Forgiveness as soon as I can. Graduates have a 6 month grace period before they have to start paying back their loans. While most graduates appreciate this grace period, I plan to opt for Public Service Loan Forgiveness (PSLF). Under PSLF, I'll be enrolled in an income-driven repayment plan that caps my repayment at 10% of my income until my loans are forgiven. However, PSLF doesn't kick in until after the grace periods ends. If I wait 6 months for the grace period to end, I will miss out on 6 months of low payments that could count towards PSLF. In order to waive the grace period, I must consolidate.

My point? If you have multiple loan servicers, variable rate loans, loans that don’t automatically qualify you for a loan forgiveness programs, or plans to pursue PSLF specifically, then consolidating through the federal government may be beneficial for you as well. 

Step 4 = Think twice before you refinance your loans. Although refinancing can be similar to consolidating, the terms are different. Consolidating your loans is when you combine all of your loans into one giant loan and the interest rate you pay is the average of the interest rate you had on each individual loan. Refinancing is different. Refinancing is when you combine all of your loans into one giant loan and pay a LOWER interest rate than what would have been the average on all the loans. Refinancing can only be done outside of the federal government through a commercial bank, credit union, or some outside company.

The advantage of refinancing is that you pay a lower interest rate than you would have otherwise which can save you thousands of dollars. The disadvantage of refinancing is that you lose the protections and benefits that come with having federal loans. After you refinance, you are no longer eligible for federal deferment or forbearance if life takes a turn. Most importantly, you are no longer eligible for federal student loan forgiveness programs. Unless you are certain that you will not be pursuing any student loan forgiveness programs and have enough job security that needing deferment or forbearance is unlikely, then you may want to wait to refinance.

What am I doing? Choosing not to refinance right now and revisiting the subject in a few years. As a graduating medical student who will start residency training as a physician, I am in a unique situation. My plan is to enroll into an income driven repayment plan through the federal government. I will pay my student loans on time each month until I finish residency training and fellowship. Afterwards, I will decide to work in academics or private practice. If I choose academics I will keep my loans with the federal government and opt for public service loan forgiveness (which forgives my loans within 10 years). If I do not choose to work in academics, I will refinance my loans with a private company and plan to pay them off in 5 years.

Step 5 = Enroll into a repayment plan that is best for you. There are many different repayment plans. You need to check with your loan servicer to see which repayment plan options you qualify for or use the repayment estimator to get a general idea. If you don’t choose a plan, you will be automatically enrolled in the standard repayment plan which puts you on track to pay off your loans within 10 years. Although this plan will save you money in interest payments, the monthly payment required may be higher than you can afford.

If this is the case, enroll in one of the income-driven repayment plans. These plans only require you to pay 5% to 15% of your income in students loan payments and will automatically forgive your loans after 20-25 years, if you haven’t already paid them off. (If you opt for public service loan forgiveness, then your loans will be forgiven in 10 years).  Income driven repayment plans are ideal for anyone who plans to get their loans forgiven via public service loan forgiveness or some other type of loan forgiveness program.

Step 6 = Look into loan forgiveness programs and submit the necessary paperwork. I alluded to this above, but as you think about your student loans it’s important to consider whether or not you are considering some sort of loan forgiveness program, most notably public service loan forgiveness. Although this program will forgive your loans after making 10 years of payments, you need to ensure that you have properly enrolled into it.

You can refer to the student loan website but essentially you need to have direct loans through the federal government, work at some sort of academic institution or non profit organization, and make 10 years of on-time qualifying payments. If you know you want to enroll in this program, then you can fill out the form on the student loan website.

To summarize: there are 6 steps you need to take to start tackling your student loans. First, go to the student loan website and figure out how much money you owe. Then, determine your loan servicer and the interest rate on each of your loans so you can figure out who to contact to start repaying them. Next, you need to understand the pros and cons of federal debt consolidation so you can figure out if you should combine your loans into one giant loan or not. Remember to think twice before you refinance your loans since doing so will make you ineligible for federal loan forgiveness programs. After that, enroll into an income-driven repayment plan, if your monthly payments under the standard plan are higher than you can afford. Lastly, look into government loan forgiveness programs and submit the necessary paperwork to enroll.

Tell me, was this helpful? Do you feel more like you have a game plan on how to tackle your student loans?

Adulting 101: Pros and Cons of Buying a Residential Home

As a young professional establishing your career, you may start to consider buying a house. Before you make a decision on whether to buy a home or keep renting, weigh the pros and cons listed below:

Pros: Buying a home can help you….

1. Purchase an asset that can increase your net worth. One of the perks of buying a home is that it is usually considered an “asset.” Unlike cars which depreciate or go down in value each year, homes tend to appreciate or go up in value. Clearly, things can change, as many people painfully saw during the housing market crash in 2008, but that is not the norm. Plus, even when there are rare “down years” the housing market usually recovers shortly afterwards. If you buy a home there is a fairly high chance that in a few years, that house will be worth more than you originally paid for it. As the home appreciates in value, your net worth increases.  

2. Build equity (or value) in your own investment. Many people like the idea of owning a home. They would rather send in a monthly check towards something that is “theirs” and feel like renting is “throwing money away.” Although I disagree with this statement, I understand where they are coming from. When you rent, your money goes to the landlord and someone else uses that money to build his or her net worth. In contrast, when you buy a home, the money you pay the bank each month is used to pay off your mortgage. As you pay off your mortgage, you decrease your debt. Each payment you make to decrease your debt, decreases the percentage of the home the bank owns and increases the percentage of the home you own. Thus, you are able to increase the equity (or value) you have in the home, which again increases your net worth.

3. Potentially save money in taxes. When you buy a home you usually take out a mortgage (aka a home loan) from the bank. As you pay off this mortgage each month, you are paying back a portion of the amount you borrowed (the principal) and the fee the bank charged you when they gave you the loan (the interest). The first few years you pay a mortgage the majority of your payment is interest. According to the tax law, you can actually deduct the part that is interest from your taxes each year which can save you money.

   Keep in mind, you can only use this tax deduction if you “itemize your taxes.” Many young professionals don’t itemize their taxes because they opt for the standard deduction which saves them even more money. My point is that buying a home has the potential to save you money on taxes if you happen to have a very high income, are already planning to purchase an expensive home, or have to itemize your taxes for some other reason.

4. Achieve that feeling of accomplishment. Let’s face it. Many people like the idea of owning their own home. It’s a major part of the American Dream many of us want to achieve. Plus, it makes us feel like we’re finally maturing and have reached true “young professional status.” While I may not be able to quantify the “feeling of accomplishment” that comes with homeownership, its value is definitely there. If you are established in your career and plan to stay in same area for at least 5 years, homeownership is viewed as the next step and often provides internal and external validation of our life choices.

Cons: Unfortunately, if you buy a home you will have….

1. Less mobility. Unlike signing a one year lease to rent a house or an apartment, purchasing a home is more binding. When you take out a bank loan to purchase a home, you sign an agreement to pay back that loan (aka the mortgage) over 15-30 years. Although you can sell the home if you decide to leave the area, it is not as easy as you may think. In fact, most people who buy a home plan to stay in that home for at least 5 years (I talk about why that’s the case in a previous post). If you are going to stay in a home for at least 5 years you have less mobility than if you would have simply rented an apartment or a home using a one-year lease. If you change jobs or have to move to a different state, it is much easier to break a rental lease than it is to put your home back on the market and sell it in a reasonable amount of time.

2. More debt. Perhaps the biggest disadvantage to purchasing a home is that you have to take a large loan in order to do so. The vast majority of people don’t have $300,000 lying around to spend on a home so they put down a small percentage of the purchase price (usually 3-20%) and get the rest of the money from a bank in the form of a mortgage. While there is nothing inherently wrong about getting a mortgage and making a payment each month towards it, you cannot ignore the fact that doing so puts you in a large amount of debt.

   Although a mortgage is considered “good debt” since you are purchasing an asset that can go up in value over time, you may not be in a position to do so right now. Many young professionals already have credit card debt, car payments, and a large amount of student loans they already have to pay back. Taking on another $200,000 in debt may not be ideal. Plus, the more debt you take on, the longer it will take you to pay it all back. The longer you take to pay back your debt, the more money you waste in interest payments and the harder it becomes to dig yourself out from under this pile of debt to actually build your net worth.

3. High upfront costs- I talked about the added costs associated with buying a home in a previous post, but in case you missed it let me state it again. Buying a home is expensive. The transaction costs (or closing costs) associated with buying a home are an estimated 3% of the entire purchase price. So, if you buy a home for $250,000 expect to spend another $7,500 in transaction costs. Along with this expense, you also have to purchase furniture and appliances. Lastly, you have to factor in decor items and moving expenses. Those who rent don’t usually have to worry about the majority of these high upfront costs.

4. Additional monthly/annual expenses. Along with high upfront costs, there are recurring expenses you must add to your monthly budget if you buy a house. Every homeowner must factor in the cost of property taxes and homeowners insurance. Some people even have homeowners association (HoA) fees they must consider as well. Plus, when you own a home you are responsible for any repairs. This means you have to put aside additional money each month to cover these inevitable costs. Altogether, the cost of property taxes, homeowners insurance, and repairs typically add another 40% to your monthly costs. For example, if your mortgage is $800 a month then you can estimate spending an additional $320 a month ($800x40%) on top of that $800, in added homeownership fees.

To summarize, before you buy a home as a young professional, there are several things you must consider. By purchasing a home, you are able to buy an asset that increases in value and build equity in an investment that can increase your net worth. You also have the potential to save money on your tax bill while experiencing that feeling of accomplishment knowing you are making boss moves in your life. On the other hand, purchasing a home gives you less mobility in the event that you need to relocate. It also causes you to take on a large amount of debt (in the form of a mortgage), has high upfront costs, and adds additional expenses like property taxes, homeowners insurance, and repair costs to your monthly budget. Before you purchase a home it is important to consider these pros and cons to ensure you are making a sound decision.  

If you are unsure whether to buy a home or keep renting you can refer to my post “Should you buy a home or keep renting part 1 (and part 2) and use to the New York Times’ rent vs buy calculator as a guide.  

Should you buy a home or keep renting? Part 2: Four Practical things to consider before you buy a home

If you are like most young professionals you may be wondering if you should buy a home or keep renting. Before you make a decision, you must first consider whether or not you can afford to purchase a home. As I mentioned in “Should you buy a home or keep renting? Part 1, you cannot simply compare the average mortgage price to the average rental price and make a decision.

There are many other expenses associated with becoming a homeowner that you must consider. However, if you do determine that buying a home is a financial possibility, your next task is to determine whether or not buying a home makes practical sense at this point in your life. Here are 4 additional questions you can ask yourself to help figure that out:

1. Are you going to stay in the same area for at least 5 years? As a general guideline, it takes about 5 years to break even on a home. If you live in a home for less than 5 years and decide to sell it afterwards, there is a good chance you will lose money overall, even if you sell the home for more than you purchased it. Why? Well, because the transaction fees you must pay to buy a home and the expenses associated with selling a home are really high.

   By the time you pay your real estate agent 3% of the purchase price, pay the buyer’s real estate agent another 3% of the purchase price, AND consider all of the costs you had when you first bought the home, there is a good chance that your expenses will still outweigh your costs until the 5 year mark. If you know you are likely to move to another area in less than 5 years, it may be wise to wait to purchase a home.

2. Are you going to want to live in that same house (consider size and location) 5-7 years from now? The first home that many people purchase is usually a “starter” home. It typically has 3-4 bedrooms and is a decent sized space for 2-3 people. Although that type of home may be ideal for you now, you need to consider whether it will be ideal for you 5-7 years from now. You may get married, have a child or two, and even change jobs. Is the home you want to purchase now ideal for that kind of lifestyle as well?

   For example, is it a place with good school districts for your [future] kids? Is it close to your job? Does it have enough space for you, your spouse, a kid or two and a pet? The answer most people come to is: no. As a result, they end up looking for a different home, or paying a large amount of money to upgrade their current home, a few years after they purchase the "starter" home. This process of buying one home, just to sell it a few years later, and purchase something bigger can be quite expensive.

   I am not suggesting that you buy more house than you can afford to protect yourself against these life changes. However, I am stating that if there is a good chance you won’t want to stay in the home 5-7 years from now and it takes 5 years to break even on a home, it may not make practical sense to buy a house right now. Nevertheless, if you doubt you’ll experience drastic life changes in the next few years, or feel fairly confident that the type of home you want to purchase will still fit your lifestyle in a few years, then purchasing a home now might make sense.

3. Are homes affordable in your area? Let’s face it. Not all cities are created equal. Before you get set on the idea of buying a house, you must figure out if homes are actually affordable in your area. If you are not sure, go to a website like Zillow.com or Realtor.com, type in the size of your desired home in the the city of your choice, and check out the home prices. Once you see what homes are selling for, you can then go to your bank to see how much money they are willing to lend you.

   For example, if you live in a low cost of living area like Orlando, FL the average house is probably around $240,000. Thus, there is a better chance a bank will loan you the money you need. However, if you live in a higher cost of living area like San Francisco, CA where the average house is $1.61 million then it may be difficult to find a bank willing to lend you that much money.

   In addition to cost of living, you also have to look at the neighborhood in which you plan to live. Some of the nicer neighborhoods in better school districts often charge a “Homeowners Association (HoA) fee." This is a monthly expense you give to the neighborhood that covers the cost of private parks, neighborhood events, community pools, and general upkeep. Some areas don’t charge an HoA fee, other places may demand an extra $1200 a month in these fees. Before you decide to buy a home, examine the cost of living, average home prices, and HoA fees in your desired area to see if purchasing a home is feasible.

4. Is it a good time to buy houses in your area? Many people assume that houses appreciate in value from year to year. Unfortunately, this is not always the case. Sometimes houses go down in value. You need to examine the housing market in your area and see what the latest trends have been. Along with looking at appreciation trends, you also need to consider home pricing trends. In the real estate world we use the phrases “seller’s’ market” and “buyer’s market.” A seller’s market means that the demand for homes exceeds the number of homes available. This is bad for people looking to purchase a home because it means that houses might be selling for more than they are worth.
   
   In contrast, a buyers’ market means that there are more houses available than people who are looking to purchase. This is a good for people looking to buy a home because it means that houses might be selling for less than they are worth (which increases the chance that you can find a good deal). Before you decide to purchase a home, take a look at the housing market in your area. If it is a seller’s market, you may want to wait to buy a home. If it is a buyer’s market, then you may be able to find a great deal and should consider purchasing a home sooner rather than later.

My point? Even if buying a home is a viable financial option, you still need to consider if it is practical to purchase a home at this time. For starters, it usually takes about 5 years to break even on a home, even if you purchase a home and end up selling it for more than you bought it. In order to avoid losing money, you need to make sure you plan to stay in the same area for a significant amount of time. You also need to make sure that you would still want to live in a home of that size and in that location 5 years from now.
Once you determine those two things, you need to look at different housing websites and determine the average home price in your area. Are homes affordable in your desired city? Have houses been appreciating at a decent rate where you plan to buy? Is it a buyers market in which home prices are lower than normal or is it a sellers market in which home prices are higher than normal? After answering these questions, in addition to the financial questions listed in the previous post, you should be better able to decide if it makes more sense to buy a home or keep renting.

Tell me, was this post helpful? If so, what additional topics would like me to address?

Should you buy a home or keep renting? Part 1: Ten questions to ask before you decide to buy a home

The real answer to the rent-vs-buy question is “it depends.” There are several advantages and disadvantages associated with buying a home. Figuring out the right choice depends on a lot of factors that are unique to your situation.

Oftentimes, young professionals who have recently finished college choose to rent an apartment. Signing a single year lease with an apartment complex gives them more mobility in case they change jobs and allows them to better enjoy the perks “city life.” As their income improves and their job stabilizes, they may begin to wonder if it is time for a change. The high amount of taxes they pay and the need for more space in a less congested area makes them strongly consider moving on to bigger and better things. They realize other people in their late 20s or early 30s are starting to purchase real estate and all of a sudden buying a home becomes the next item on the young professional “List of Things To Do to Prove You’re Finally “Adulting.”

Although the idea of buying a home makes you feel like you are progressing in life, you need to truly evaluate whether buying a home makes financial sense for you at this point in your life. You cannot simply compare the average mortgage price to the average rental price and make a decision.

Here are 10 financial questions to ask yourself before you decide to purchase a home:

1. Do you have money for the down payment? Buying a home is expensive. The average house in my home state of Florida is nearly $200,000. I don’t know about you, but I haven’t stacked that many coins in my piggy bank just yet. While it is true that the vast majority of people don’t pay the full price of the home when they buy it, most banks like for you to have at least 20% of the money for a home before they agree to give you the mortgage. Before you make up your mind to buy a home, you need to check your savings and make sure you have enough money to cover the down payment on a house.

   Fortunately, many banks will still allow you to purchase a home when you don’t quite have the 20% down payment. In order to do this, they make you pay something called “private mortgage insurance.” Private mortgage insurance is a small insurance policy banks make you pay in order to protect themselves. (In the event that you fail to keep up your monthly mortgage payments, the private mortgage insurance will refund the bank part of the money you owe.)

   I should mention that medical doctors have access to physician loans which allows them to buy a home with no money down and without having to purchase private mortgage insurance. Many banks have realized that doctors finish medical school with high debt burdens but still have very high incomes and rarely default on loans. As a result, they give doctors preferential treatment. If you are a physician, or will be one soon, this a great deal. However, it does not make the decision to buy a home a “no-brainer.” There are many other factors to consider. Keep reading.
   

2. Have you saved enough money to cover the “transaction costs?” The process of buying a home is more than just giving the bank a down payment and securing a mortgage. There are several “transaction costs” (also known as “closing costs”) that can be quite expensive. Some examples of transaction costs are: the appraisal fee (to have a professional determine the actual value of the home), the processing fee (to have someone evaluate your loan application and prepare any other necessary documents), title insurance (to make sure that the home is actually in your name and ensure there are no problems when the seller transfers it to you), escrow fees (the third party that holds the money from the buyer and the home from the seller until all of the inspections and concessions have been completed), etc.

   Typically, these transaction costs amount to about 3% of the total price of the home. So if you are buying a home for $200,000, then expect to spend an additional $6,000 in “transaction fees.” Occasionally, banks may offer a “no-cost-closing” to certain buyers who have great credit but do not have the cash to pay for the closing. A “no-cost-closing” simply means that instead of making you come of up with $6,000 in cash for transaction fees to buy that $200,000 home, they will instead charge you a higher interest rate on the mortgage and/or add those closing costs to the total cost of the mortgage (both options usually increase your monthly payment).  
   

3. Is your credit score good enough to get a decent loan? Once you have money for the down payment (or opt for a physician loan) and figure out how to cover the transaction costs, you need to make sure you can actually secure a good loan from the bank. Unless you have $200,000 lying around, you are going to need to get a mortgage from the bank in order to purchase the home. Typically, the bank loans you the money and you agree to pay them back over the next 15-30 years. However, the bank isn’t going to loan you an unlimited amount of money and the money they do loan to you will not come free. Just like the government charged you interest to take out a student loan and set a limit on the total amount of money they would let you borrow, banks charge you interest to take out a home loan and set a limit on how much money they will give you as well.

   The amount of money banks loan you and the percentage they charge you in interest for that loan is largely dependent on your credit score. I talked about credit scores in a previous post, but essentially anything over 760 is really good and you will be able to secure a mortgage with a decent interest rate. A credit score under 500 is pretty bad and you will have a hard time getting a bank to even consider your loan application. A score between 500 and 760 is on a sliding scale. The higher the credit score, the more money the bank will loan you and the lower your interest rate will be. Keep in mind, if you are married and your credit score is good but you spouse’s credit score is not (or vice versa) you may still be able to get a mortgage but the person with the better credit score may have to purchase the home is their name first (and add the spouse’s name on the title at a later date).
   

4. Can you afford the monthly mortgage payment? If you have decent credit score and show a genuine interest in wanting to purchase a home, your real estate agent is going to do everything in his (or her) power to help you in this endeavor. Oftentimes, they make the home seem more affordable by pitching you on the idea that you can secure a 30-year mortgage from a bank. The benefit of 30 year mortgages is that it reduces your monthly mortgage payment (since you are paying back the loan over 30 years). The bad part about 30 year mortgages is that you end up paying tens of thousands of dollars in added interest payments over the life of the loan.

   The rule of thumb for most people seeking to become financially stable in a reasonable amount of time is to get a 15-20 year mortgage. While this saves you a ton of money in interest it increases your monthly mortgage payment. If you decide to opt for a 30 year mortgage in favor of the lower monthly payments, make sure the bank won’t charge you a “prepayment penalty” if you decide to pay off the loan sooner. Although the decision to pursue a 15, 20, 25, or even 30 year mortgage is a personal one, make sure you ask your bank what your monthly mortgage payment would be (when you factor in interest) so that you can determine if the monthly mortgage payment would be affordable.
   

5. Do you have a stable job with a steady income? Because of all of these added fees, in addition to your mortgage, lenders want proof that you can truly afford to purchase a home. Before they approve your mortgage loan, they will verify your income and work status. If you are employed, they will make you verify your income by submitting W-2s, pay stubs, proof of any bonuses, and reports of any additional cash flow. If you are self-employed or own a business, they will likely ask for even more documents. If you have a good credit score, but your income appears unstable, then you may not be approved to purchase a home.
   

6. How much debt do you have? Along with considering whether your income is steady, it is vital to also consider any other debt you have. For many young professionals this means taking a hard look at your existing credit card debt, car payments, and student loans. If you already have a significant amount of debt, many banks will be reluctant to lend you a couple hundred thousand more dollars for a house. The more debt you have, the bigger the chance you could have a problem paying it all back. The ideal debt to income ratio for most banks is about 35%.

   Nevertheless, there are exceptions to every rule. For example, many physicians have a lot of debt after graduating from medical school but banks will overlook this debt because their income potential is so high. While this is a great perk for physicians, it may be a financial disaster. Having nearly $200,000 in student loans and adding another $250,000 for a mortgage (in addition to all of the other home-buying expenses), isn’t exactly a recipe for financial freedom. In fact, one of the biggest wealth killers for many physicians is buying a home before they are truly able afford to one. If you are a medical student or healthcare provider you can review my post on why buying a home may not be the wisest decision right out of training here.

7. Have you factored in the cost of property taxes and homeowners insurance? Many people assume that buying a house is much better than renting because they know friends or family members whose monthly mortgage is similar to their current rent price. They figure that if they are going to pay the same amount each month then they might as well put that money towards their own home. Although I can understand this thought process, it is flawed.

   There are other monthly/annual costs on top of the mortgage that you must consider. Two of those costs are property taxes and homeowners insurance. Unlike renting, people who own a home must pay yearly property taxes. The amount they pay in property taxes varies by state and is listed here. It ranges from 0.27% of the home value in Hawaii to 2.44% of the home value in New Jersey, with the average being around 1%. For example, if you bought a home valued at $200,000 in my home state of Florida (where property taxes are 0.98%), then you would have to pay $1,960 annually (which is an extra $163 dollars per month) in property taxes.

   Homeowners insurance (which insures your home against unforeseen damage or accidents) works in a similar way. It also varies by state and is listed here. Generally speaking, states with a high risk for natural disasters like earthquakes, floods, tornadoes and hurricanes charge the most. For example, in my home state of Florida, which has a high risk for hurricanes, homeowners insurance is the highest the country at about $3,500 a year (which is an extra $291 a month). Thus, when you factor in property taxes ($163/month) and homeowners insurance ($291/month), most people in my home state of Florida are paying an extra $454 a month IN ADDITION TO their monthly mortgage payment.
   

8. Do you have an emergency fund for inevitable maintenance repairs? In addition to paying a monthly mortgage, property taxes, and homeowners insurance, there are other expenses you may have to pay for as well. The biggest of these added expenses is repairs. As you continue to live in the home your air conditioner might need fixing, the plumbing pipes might get clogged, or some other appliance could stop working as smoothly. When you are renting, the owner of the apartment complex covers these costs. When you buy a home, you pay these costs yourself. Unfortunately, these repairs can be expensive and put a serious dent in your pocket. The best way to prepare for these expenses is to set aside money each month in a “repair fund” to reserve for for future repairs and maintenance. Along with paying for repairs, you must also cover the cost of landscaping and general upkeep. These repair and maintenance expenses are not inconsequential and must be factored into your decision to purchase a home.

9. Do you have money saved for furniture and initial expenses? As a general guideline, more space requires more furniture. Unless your parents have extra furniture lying around or franchises with Rooms-To-Go, there is a good chance you will need to purchase more furniture and other items when you first buy your home. Although you would have had to furnish an apartment if you had chosen to rent instead, homes are typically bigger and thus require more “things.” You will need bedroom and living room furniture, decor items, and costly appliances like a washer/dryer and refrigerator. Although you don’t have to purchase all of these items at once and many people host a “housewarming party” to get their friends and family to chip in, the cost of these initial items is rather large and as a homeowner you are responsible for buying most of them.
   

10. Will buying a home actually save you money in taxes? If you are like many young professionals, you may be searching for ways to lower your tax rate. In fact, someone may have mentioned the “mortgage interest deduction” you can get when you buy a home. Although it is true that the mortgage interest deduction can save people money in taxes, this benefit is often overestimated. It certainly does not equate to the amount of money you pay in transactions costs, yearly fees, and added expenses when you purchase a home. Plus, it usually only benefits people who purchase really expensive homes. Let me explain.

    Whenever you pay your mortgage each month the payment includes the principal (the amount you borrowed from the bank) and interest (the fee the bank charged whey they loaned you the money). During the first few years you have a house, the portion of the mortgage that is “interest” is quite high and can often be around 75% of your entire monthly payment. The government allows you to deduct this interest from your taxable income. However, you can only take this deduction if you opt out of the standard deduction and choose to “itemize your taxes.” Most people don’t have an expensive enough house (or pay enough in mortgage interest each year) to make itemizing their taxes a good idea. Plus, even if you were able to take advantage of this tax benefit, it only saves you money at your marginal tax rate. I realize that this is starting to get a bit complicated so I will spare you the details. My point is that unless you are buying a really expensive home, the chance of you saving a lot of money in taxes each year by owning a home is low, especially with the recent changes in our tax code.

To summarize, the decision to purchase a home should not be taken lightly. There are a ton of factors and added costs associated with buying a house that people who rent rarely have to consider. You cannot simply compare the average mortgage price to the average rent price and think you are making a sound financial decision. You have to factor in several other costs such as the down payment (although medical doctors can usually get a pass on this) and high transaction/closing costs that are 3% of the purchase price. You also have to make sure your credit score is high enough, your income in steady enough, and your debt is small enough to get approved for a loan.

Once you’ve done this leg work, you need to factor in annual property taxes (another 1% of the home price), homeowners insurance (another few hundred dollars a month), and inevitable maintenance repairs. Lastly, you should run the numbers and see what purchasing a home really costs, keeping in mind that it may not save you as much in taxes as other people may lead you to believe. After considering all of these factors, you must be honest with yourself and ask: can I truly afford to buy a home.  If the answer is yes, congratulations! If the answer is no, re-evaluate this process next year when you are in a better financial position.

My goal is not to discourage you. I just want to make sure you are aware of all of the financial costs associated with buying a home so that you can make an informed decision for you and your family.

Tell me, do you plan to buy a home or keep renting?

Your FICO Credit Score: How to check it, understand it, and improve it

As you get older and start “adulting” you will begin to hear a lot about your “credit score.” Here’s a crash course of answers to common questions so that you can learn some of the basics.

Question 1: What is a FICO credit score?

Your credit score is a 3 digit number that determines your reliability as a borrower. Although there are several different types of credit scores, the FICO credit score is the most well known and used type of credit score. FICO stands for Fair Isaac Corporation (that’s the company who invented the formula).

Question 2: Why should I care about my credit score?

You should care about your credit score because it plays a huge role in your ability to live as an independent adult. Before you rent an apartment the company will check your FICO credit score. If the score is too low they may not let you rent the apartment. If it is just “okay,” they may still let you rent the apartment but may instead charge you a larger deposit to do so or require you to have a cosigner.

Apartment buildings are not the only people who check your credit score. Car companies, phone companies, and banks do the same thing before they loan you money to buy a car, allow you to purchase a home, or provide you with a contract for your own cell phone plan. Once again, if the score is below average companies will charge you a higher interest rate to borrow money, if the score is really low, they may not loan you the money at all.

Question 3: How can I figure out my credit score?

There are estimates and “official” scores. Getting the official score may cost you money, although there are a few companies who can give you a free reporting a couple times a year. Nevertheless, you can get your credit report from annualcreditreport.com and get your official FICO score from myFICO.com. Unless you are about to purchase a new car or buy a home, getting a ballpark estimate of your credit score should suffice. You can usually get a free estimate of your FICO score from your bank. In fact, this feature can usually be added to the credit card statement you get from your bank each month.

Question 4: What is a “good” credit score?

As a rule of thumb, anything under 500 is dismal. It will be tough for you to borrow anything from anyone, let alone rent an apartment, buy a car, or secure any type of loan or credit card.

Anything above 760 is great. With a credit score above 760 you should be able to rent an apartment with ease and secure a loan for a car or home with no problem. Banks will probably reach out to you and ask if you’d like credit cards and you’ll start receiving notices of different low rate loans you qualify for. Simply put, banks will want to work with you because they know they can count on you to repay the loan.

Credit scores between 500 and 760 are on a sliding scale. The higher it is the easier time you’ll have securing loans for whatever you need them for (ie. small business ventures, a car, a new home, etc). The lower the credit score, the harder it may be for you to secure loans. In this case, you may have to pay a larger interest rate to borrow money and you may even need to have someone cosign your [car, home, or small business] loans.

Question 5: How is my FICO credit score computed?

Your FICO credit score is based on a combination of factors but there are 4 main components:

1. Your credit history. This is the length of time you’ve had access to credit (like credit cards, bank loans, etc). The longer your credit history, the better. In other words, someone who has had their credit card for 10+ years is going to score higher in this area then an 18 year old college student who just opened her account. Your credit history accounts for 15% of your credit score.

2. Your debt compared to your total credit limit. This is the amount of credit you’ve used compared to the amount of credit you have access to. The lower the percentage the better. For example, if you have a $16,000 limit on your credit card and your credit card balance is $8,000 then you’ve used half of the credit available to you so your percentage is 50%. However, if your limit is $16,000 and you’ve only charged $4,000, then your percentage is 25% which is much better. You get more “points” for having access to credit and showing the self-discipline of not using much of it. Why does this matter? Well because the mere fact that you have a high credit limit shows that banks don’t mind lending you money. The fact that you haven’t used much of that money shows that you are more diligent in your use of credit. Thus, this factor plays a large role (30%) into computing your credit score.

3. Your credit mix.  This includes the types of credit you’ve had (which is 10% of the score) AND the timing of when you received this credit (another 10% of your score). Credit card companies like to see that you can repay a variety of loans. Even though showing that you can pay off your credit card balance is great, companies also like to see that you can be relied upon to make fixed payments toward something for a certain length of time. If you have only had credit cards then you will not score as high in this area as someone who has paid off a car loan and is actively paying a mortgage or student loans consistently. Moreover, if you’ve just received different types of loans you won’t score as high in this area as someone else who has had various types of credit for a longer length of time.

4. Your track record of paying your bills on time. By paying your bills on time, I mean paying them a few days before they are do. Credit card companies want to know that they can count on you to give them their money when they ask for it and not a moment later. The more consistent you are at paying your bills on time, the higher you will score in this area. In fact, your track record is so important that this area is weighted the most in calculating your credit score (35%).  

Question 6: How can I improve my credit score?

1. Pay off your debt. As you pay down the debt you owe you will decrease your ratio of credit used to credit available which will increase your credit score. Plus, you will improve your payment history. Both of these factors combined account for 65% of your FICO credit score.

2. Be on time with your payments. If you don’t have the income to pay back all of your debt right now, you are not alone. Many of us have credit card debt or student loans that we are still working to pay back as well. Even if you can’t pay off your full balance at once, focus on making on-time monthly payments a few days before your bill is due. Doing so will improve your “payment history” which will improve your overall credit score.

3. Increase your credit limit. If you are already making on-time monthly payments on your credit card then another way to increase your score is to increase your credit limit. For example, if you have $2,000 in credit card debt and a $6,000 limit, the ratio of your credit used to credit available is (2,000/6,000) 33%. However, you were to increase your credit limit from $6,000 to $8,000. Then all of a sudden your ratio of credit used to credit available is (2,000/8,000) 25% which is better. The easiest way to increase your credit limit is to simply call the bank and ask for an increase. Most credit card companies will re-evaluate your case every few months and automatically increase your limit if you are eligible, but calling the bank yourself might speed along this process.

To summarize, your FICO credit score is a 3 digit number that tells companies about your reliability as a borrower. It ranges from 300-850, the higher the better. If your credit score is too low you may have a hard time renting an apartment, buying a car, or even getting your own cell phone plan. You can get a free estimate of your credit score from your credit card company, but official scores may cost you money. Generally speaking, your FICO credit score is based on 4 main factors: your credit history, the total debt you have compared to your credit limit, your credit mix, and your track record of paying your bills on time. If you want to improve your score prioritize paying off your debt, increasing your credit limit, and making on-time payments when your bills are due.

Do you have any questions? Is there anything more you'd like to know about your FICO credit score?