Pay off that line of credit?

During medical school you likely received a line of credit- probably from RBC. It may still be with RBC or you may have switched it to another bank - perhaps National Bank or CIBC?

Now that you are done residency and your income has increased significantly you are probably considering paying it back. Well before you do so, here are some things to consider?

Will you lose access to the funds?
If you pay back the line of credit will you still be able to access the funds at a later time? The bank may allow this for the first couple years after residency, but what about after five years? This line of credit may be converted in to a loan and you may lose access to the funds.

Imagine a scenario where you have a $200K line of credit maxed out, paying interest at prime of 3.5%. You also have $200K in cash, earning nothing. So you pay off the line of credit to save that 3.5% (7K per year!). 

A few months later you see a home to purchase and you need that $200K back for the down payment - uh oh! The bank has frozen your line of credit limit and now you do not have those funds available. (Imagine if you are on a parental leave or a fellowship year, this could really result in a real cash crunch!)

Tip: Before paying off that line of credit, check with the bank. Many banks have a professional line of credit that you may qualify for, which has similar terms to the student line of credit. Make sure you have that set up prior to making a quick decision to pay off that line of credit.

Invest or pay off the line of credit?
Let's say that you have a great investment available to you that will earn you 5% and your line of credit is sitting at 3.5%. Well this looks like a sure thing, why pay off the line of credit when you can earn 5% in investing? 
Well there are two key considerations. 

The After Tax Return Is that 3.5% tax deductible? (hint: it likely is not, but there may be a way to make it). What is the AFTER-TAX return on that 5%? If your tax rate is close to 50% it could be only 2.5% - ouch! This is a loss of 1% a year! If the loan can be made tax deductible though then you could be making 1.5% (5% - 3.5%) and be left with a whopping 0.75% return after taxes!

The Risk - Would you rather a 3.5% risk free return (through savings of interest costs) or a 5% return riskier return (assuming after tax 5% return)? Personally, I would probably go with the 3.5% risk free return.

Personal desire to pay back the debt
There are two kinds of debt. The debt people feel like they want to get rid of  so they can sleep comfortably, and the debt people are OK with maintaining. The debts tend to be related to their original status as either good debt or bad debt.  (Read more: Good Debt Vs. Bad Debt | Investopedia)

My views on this is that if you really just want to get rid of that debt, go for it! Ignore what I said above and just make the right decision for you. Maybe it is eliminating the debt completely or moving it to a level that if you needed to pay it off you could. 

In the medical field your sleep is more important than the additional returns you could get by not paying off the debt and investing your excess funds.

Want to discuss this more or have other items you would like to see in our articles? Book a call with us on our website http://www.taxfordoctors.ca or email michael@taxfordoctors.ca