By Matt Miner
June 1, 2018
Mr. Meru’s Million – Part 2
Today we continue our review of the Wall Street Journal article “Mike Meru has $1 Million in Student Loans. How Did That Happen?”
Yesterday’s farcical post, which I admit I really enjoyed writing, gives way to today’s clear-eyed look at WSJ's question: what happened for Mike Meru? We’ll take a look at three different hypothetical budgets for a family in this situation, and I’ll share my thoughts on how best to move forward from here.
In addition, I want to add that although I have written a silly poem about this article, this is a serious topic, especially for student loan borrowers, but also for taxpayers. And I want to say that I bet Dr. Mike Meru is a good guy. He loves his family (I love mine too), He lives in the mountain west (I mourn its absence in our family’s life), and he is providing orthodontic care to folks who need it (in our family, we buy orthodontic care, and are glad it’s available).
The Past: What Did Happen to Mike Meru?
Well, a few things have happened to Mike Meru. First, he fell prey to Fancy School Selection Bias. Then, while he was at school, the siren song of consumerism resulted in too much spending. Lastly, he did not treat his debt as if it were a swarm of killer bees attacking and poisoning him to death.
According to the Journal’s article, Mr. Meru borrowed $601,506 by the time he graduated from the Orthodontics Advanced Education Certificate Program at USC. The program website indicates this Certificate will adds about $350,000 to your total cost of attendance. USC has a reputation as an expensive place to earn your degree. Mr. Meru violated the first principal of education affordability: Choose a program you can afford!
Secondly, some of this amount was driven by the decision part ways with the inherited Buick and plump for the ‘Cedes at $390 per month. Mr. Meru also stopped commuting and took up residence in an $1800-per-month apartment. These decisions themselves are not what really drove the debt amount. But given what we read throughout the article, they are likely emblematic of a willingness to consume like an attending while still being a student.
Finally, and most deadly, Mr. Meru treated his $601,506 student loan balance as if it was really no big deal. In the WSJ article, Mr. Meru indicates that he took the forbearance option on his loans in 2012, thereby compounding interest into his principal balance. According to the Journal, “Mr. Meru said he earned little his first year out of school and needed all of it to support his family.”
At the same time, his family borrowed $400,000 to buy a home, demonstrating that the deferral decision wasn’t really a choice between paying the loans and not paying them, but rather a decision to consume some pretty nice housing rather than making loan payments. With the $400,000 mortgage, the Merus added yet more debt to their already catastrophic debt burden.
The Present: Three Budgets
From here, I took the reported $225,000 salary in the article, applied tax rate assumptions, and also figured in charitable giving of $22,500 per year to derive the following budgets.
If a family in this exact situation chose to live on $5500 per month (I promise: it's doable), I estimate they could put $82,851 per year toward the debt. Given this, the $1.06M balance, and an imputed interest rate of 6.27%, it would take this family 27 payments totaling $2.23M to pay off this loan. Ouch.
If the family really went bananas on its budget and cut the spending down to $4500 per month, the annual loan payment would be $95,000. It would take 20 payments totaling just less than $1.9M to pay off this loan.
Finally, if a family pays the income-based repayment amount of $19,080 per year + a $700,000 income tax bill at the end (the tax on the forgiven loan amount), the total repaid would be $1.12M, with virtually all of this happening as part of the income tax payment at the end.
All of these analyses ignore time value of money, but in any case, the income-based repayment plan wins on an NPV-basis as well as a gross-repayment basis. Therefore, from a planning perspective, the income-based repayment is the way to go.
The Future: More of the same, or maybe something different?
The past is past, and there’s no use crying over spilt milk. However, if you’re concerned enough about your student loan burden to be featured in the WSJ because of your loan balance, and if you “helped start a national dental-student movement to lobby Congress to lower rates on grad students”, then you should bring all of that passion and energy to bear on putting your family on the best possible footing going forward.
To begin, get help with your budget, from a caring CFP® or CPA. Set your monthly outflow at a level to achieve at least a respectable 20% savings rate going into long-term, tax-advantaged retirement savings. Even while you do this, be aware that at a $225,000 income, a 50% savings rate is very achievable. At a 50% savings rate, you’ll just look like a family that earns $85,000 per year, rather than one that earns $225,000 per year. I’ve done it. It doesn’t hurt. In fact, it’s kind of fun.
Create a sinking fund for this $700,000 tax liability that is looming in the future. You will need to put about 15% of your gross income toward this fund ($225,000 X 22 years X 15% = $742,500 at 0% interest). When the loan balance is forgiven at the end of your income-based repayment plan, you want to be ready to pay the IRS in full, all at once. The Internal Revenue Service is a MUCH less friendly lender than the Federal Student Aid office of the Department of Education.
Mr. Meru, if you’ll permit me to speak to you for a moment as a friend: The habits that got you here won’t get you there. Learn about personal finance. The White Coat Investor is a site designed for “those who wear the white coat.” Jim Dahle does a great job with tons of content there. In fact, Jim and I exchanged Twitter messages and he told me he’s sent you his book and offered to meet you for dinner. Take him up on this! He hasn’t offered to meet me for dinner; honestly I'm jealous! My concern for your family is that the same head-in-the-sand attitude that brought you to this place will persist.
Finally, throughout the article, there are comments about rising tuition and other costs not fully under your control. Here’s the unvarnished truth about such things: They are going to continue to happen! Job losses happen! Accidents, and disability, and illness happen! Sometimes people die. You must get yourself in a situation where you have prepared for any ordinary planning scenario and where you are not fully exposed to economic shocks.
For example, the income-based payment plan could be done away by a populist government, or to postpone the insolvency of Social Security.
Tax rates could easily be higher at the time of forgiveness than they are right now. Then, even if the program were intact, your tax bill could be much larger than you anticipate.
These are just two of the obvious concerns with betting on the come, twenty-two years down the road. There are many others we could name.
For these reasons, if you find yourself able to significantly increase your income, you might choose to either accelerate the repayment of these loans, even though that would cost more, or at the very least, to significantly bolster your reserves. Either of these choices gives you greater control.
It is very possible for a family in this situation to live a reasonable lifestyle now, meet its repayment obligations to the DOE, and save for the future. But to do this will require a level of discipline and planning that will feel very different than what has gone on up to this point. All the best to you Mike, and please let me know any way I can help.