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Low Interest Rate Traps

| August 20, 2014
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While our economy is still in a "Land of Make Believe", despite the "mini-crash" today and with interest rates still at historic low levels, now is a good time to remind ourselves of a couple tempting financial missteps:

Taking on New Debt

Debt is debt!  When you borrow money to buy that second home, nice boat, or remodel the kitchen, it is easier to justify considering the lower monthly payments at 3% - 6%.  That $110,000 Sea Ray 300 Sundeck boat you have always wanted is only $729 month (240 months @ 5% no down).  Affordable, right?

Whether or not it easily fits within your budget is one thing, but the low interest rate does not negate the fact that you now have a $110,000 liability on your balance sheet.  Depending on the depreciation and resale factors, you may also be draining your net worth with such a purchase if you end up "upside down" on the value.

Neglecting Existing Debt

Your mortgage is under 3.5%.  Your practice just scored a low interest rate on a needed new piece of medical equipment.  Your local bank just quoted you 1.99% on a new car loan.  Life is good for medical professionals!  Perhaps because the emotional benefits of paying off debt is difficult to quantify, paying off low interest rate loans is not usually a priority for most physicians.  Professor Obvious states: "Once a debt is paid, you have freed yourself of future recurring interest cost and an outstanding obligation."  While this seems like a trite concept, the point is that funds that have been previously used to pay interest, no matter how low the rate was, can be used for other purposes.  Unfortunately physicians and financial advisors, CPAs, and estate planning attorneys tend to be over analytical and miss the "happiness factor" of getting out of debt and owning your abode and other assets.  For the strictly number-oriented person or over analytical physician, this can be a sticking point.  After all, why pay off a 3.5% mortgage (that after tax is costing you around 2.5% or less)?

A physician would never remortgage their home to invest in a mutual fund.  In fact, it is now accepted by FINRA, the SEC, and other regulatory bodies in the financial services industry that a financial advisor that encourages a client to leverage their principle residence equity to make a security investment is akin to committing malpractice.  yet I hear the rationale that funds are being deployed to other "investments" rather than paying off a low interest rate mortgage.

Life is Good!

From a financial planning perspective, avoiding new debt and retiring existing debt obligations as soon as possible gives a physician and his or her family more options.  Taking a locum tenens position, retiring early, and working less hours are just a few of these options.

Assessment

With a little consideration and restrain on your personal debt situation, even at these low interest rates, financial freedom and the resulting empowerment is achievable earlier.

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