The True Cost of Taking a Loan
“There are two ways to conquer and enslave a country. One is by the sword. The other is by debt.” – John Adams
As a ‘high income professional’ dentists have an overwhelming tendency to dive into more debt than arguably any other class of Americas. When you add up the student loan, the practice loan, the ‘nice house’ mortgage loan, car loans, etc — well, dentists take a LOT of loans out
We all understand that interest can eat you alive over time. If you borrow $500,000 to buy a practice — it is clearly understood and accepted that you will be paying interest on that loan payment; and when all is said and done you will have paid much, much more for that practice than $500,000. The same goes for your other debts (house, student loans, etc). We negotiate back and forth with banks to get the best rates and haggle over a few percentage points. A 4% loan vs a 6% loan can be a huge difference when spread out over the years. Let’s take a look at a few very simple examples of the impact interest has on loans — and then I will tell you why if you are just looking at the principal and the interest payments on these loans you are missing the big picture.
Let’s look at the example of taking out a $500,000 to buy a practice. Cool! You are a practice owner for the mere price of a $500,000 bank loan! I am sure it is a great practice that you just bought and are now the owner of. Interest rates fluctuate year-by-year and location-by-location, so for this example I’m going to pick some arbitrary interest rates. Let’s say your interest rate on the practice loan was 5.2% and is spread out over 10 years.
After 10 Years You Will Pay:
Total Payments: $642,275
So, to borrow the $500,000 for your practice, you are doing it at a cost of $142,275. A 6-figure cost is attached to borrowing the money. But….we are missing something.
But we still must factor in a much bigger and more critical cost that is often overlooked.
Your interest payments are tax-deductible. Your principal payments are not. Every dime of your payments that are going towards the principal must come from AFTER-TAX dollars.
Practically what does this mean? Let’s assume that in your tax-bracket you are paying 33% to taxes. Well, that needs to be accounted for when paying your $500,000 principal.
$500,000/0.6666 = $750,075
This simple math means that if you are paying a $500,000 loan principal at pay 33% taxes, you will need to make $750,075 take-home pay in order to pay back that loan. That is an additional $250,075. This dwarfs the money lost on interest. Let me repeat that: The amount of money you need to pay the government on the taxes for your loan, will dwarf the amount of money you pay the bank on your loan.
The reason for this is because: the loan you took – for your practice, for your school, or for you house — is treated as income. Even though you didn’t go to work to ‘earn it.’ Instead of paying the income tax the moment you receive the loan — you are paying the income tax on the back-end effectively; thus it is paid with after-tax dollars and cannot be written off.
So all in all for a $500,000 loan, at 5.2% interest, spread out over 10 years; 33% tax rate, you will need to pay:
Total True Cost of a $500,000 Practice Loan: $892,350
The same math applies for your 25-year, $300,000 student loan. Student loans are paid with after-tax money and the principal is not deductible.
Total True Cost of Your 25-year, $300,000 Student Loan at 6% Interest, 33% tax rate
Total True Cost: $729, 871
Keep this in mind when taking out any loan. In the example above, maybe you think dental school is worth a $300,000 price tag, but is it worth a $729,871 price tag? Maybe that practice was worth $500,000 — but was it really worth $892,350? Because that is how much pre-tax income you will need to make to pay the loan back.
Only you can answer that.
–DeAngelo S. Webster, DDS
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Dental Student, Employee Dentist, or Residents wanting to be a practice owner soon? Take Practice Launch CE for 22 CE Credits and let me work with you to help you become a successful practice owner. Email me at PracticeBiopsy@gmail.com with questions about the program.