Halloween is a time for children and grown-ups to let imaginations run wild and that can be a bit scary at times but fear and worry related to student loan debt can haunt parents and children well beyond October 31st. In today’s post, Doug Spencer, CFP®,a resident financial planner at Financial Finesse, writes about some important borrowing decisions and alternatives to consider. Who knows? They just might help you or your kids avoid a visit from the dreaded Three Headed Debt Monster.
In the spirit of Halloween, are student loans a trick or a treat for you or your student? Many experts still contend that the financial rewards of a college education more than pay for cost plus accrued interest. On the flip side, some think tanks are arguing that a married couple that both have “average” student loan debt will end up with over $200,000 less wealth than their counterparts without student loan debt. So who is right? That depends upon three important factors: how much you are borrowing or have already borrowed, what your expected income is and whether the loans are necessary to accomplish your goals.
We have all heard about the value of a college education. Recent data from the Bureau of Labor Statistics tend to back up that argument. If the average college grad makes about $1,000 more per month than the average employee, that would add up to roughly $480,000 of increased earnings over a 40 year career.
Borrowing some money if you have to in order to get that degree makes sense. Even an associate’s degree or some college with no degree shows a large increase in earnings compared to someone who only graduated high school. No matter what education you pursue, having a marketable skill — be it an attorney, a doctor, an architect, a plumber, an electrician or a teacher — is the key to earning a somewhat stable and sustainable income.
How Much to Borrow
So how much student loan debt is too much? There isn’t much hard data out there on the subject but some industry experts say that a student should not have more debt than their first year’s expected income. While that seems like a reasonable guideline for what is sustainable, what about that $200k in lost wealth?
It will all depend on your ability to pay the loans back. According to recent reports, the average student loan debt is $28,950. If a recent graduate has federal student loans fixed at 3.4% for 10 years then they would have to make monthly payments of $261.79 and the total cost would be $31,414.80. That would be expensive but reasonable for a registered nurse, accountant or engineer making roughly $55,000-$60,000 upon graduation. The student loan payment would be approximately 8% of their take home pay each month and the total cost is around one half of expected annual income.
However, if you are a performance arts or education major who might expect a starting salary of $35,000 — $37,000, it is a different story. That same payment is almost 12.5% of your take home pay and the total cost is nearly a full year’s salary. That level of debt is manageable but will require good money management and delaying major purchases as well as possibly postponing other goals such as graduate school, buying a house or starting a family.
So we’ve concluded that education pays, but student loans can also limit our ability to turn that increased income into financial freedom. For every $1,000 that a student borrows and repays at 4.66% for 10 years, the opportunity cost — what they could have made if they had invested that monthly payment amount at a hypothetical rate of return of 7% — would be about $13,600 by the time they are ready to retire! As interest rates eventually creep up, that opportunity cost will get even larger.
Working in School
How can someone find ways to reduce their need to borrow? As in most cases it comes down to earning more money or spending less. Many majors allow for a student to work part-time and still take a full-time schedule. Even a job paying $8/hour for 15 hours a week would generate about $3,000 — $3,500 during the course of a school year. That doesn’t include working full-time during the summer months. That money can be used to offset the cost of books or incidental spending.
On the flip side, some majors are so time-intensive that working during school is very difficult. Many technical education programs are designed to be very short in length and are not built to accommodate someone working. In those cases, someone might be better off staying at home and working for a year or so to build up an education nest egg. If you were able to stash most of your paycheck at $8/hour for 40 hours a week over 15 months, that could give you approximately $18,000. That may only pay for one year at a state university but it is an entire year debt-free.
The more you can expect to earn in your career field, the less waiting makes sense. For many career paths, a one year delay for little to no student debt is something worth considering. If you are going into a field such as medicine where you have higher incomes but more school and fewer earning years, it probably does not make sense to delay starting school.
Another alternative is to find ways to cut costs. It is never fun to live on less, especially when there are people there telling you that you qualify for this loan or that loan. It takes an enormous amount of discipline for anyone, young or old, to turn down the ability to get money now and worry about the bills later. There are ways to live in college without borrowing all of the money that you are approved for.
Have a roommate(s). Over the last 20+ years, more and more student housing has been one bedroom units or living arrangements where no one has to share a bedroom or bathroom. I get that. I had to share a bedroom for two of my four years in college and a bathroom for all four years. It isn’t fun but it is a huge cost savings.
In the town where I went to college, when you compare rents for two BR units that have one bath vs. two baths, the difference in rent is about $150 a month. $75/month for 4 years is $3,600. If you are willing to share a bedroom, the savings are even more dramatic.
Eating two more meals a week at the dorm/apartment instead of fast food could save another $2,000. If you start looking at other convenience purchases or shopping your plans for cell phone, cable/Internet and car insurance, you might be able to find similar savings. Some small changes like these won’t impact your life much but could save you $10,000 or more in future student loan debt. Based on earlier estimates, that could build a $136,000 nest egg down the road!
Many students are looking at options such as community colleges and online classes to help keep their tuition and/or housing costs down for the first two years of school. As a former college freshman who couldn’t wait to leave home for college and a parent who can see an empty nest not too far down the road, I understand that no one likes the idea of living at home or at least no one does until you check the potential savings. In my home state of Kansas, it could save my kids about $11,000 per year for two years if they start their college education at the local community college. Even if all they do is take 15 credit hours over their senior year of high school and a couple of summers at the community college, it could save $5,500 in tuition, fees and room and board. (That may not be an option for some students, especially if they are in a major or a university that frowns on lots of transfer credits.)
So in the end, student loans are a tool and like any tool, they can be used to build things of great beauty or bring destruction. It is all in how you use them. Before you borrow any money from any source, know what you plan to study, how much it will cost, and what you can expect to earn when you are done. If you have a specific and potentially lucrative plan, then borrowing may be OK, but you should still try to cut unnecessary costs to keep the loans as small as you can. If you are pursuing a less financially rewarding career or you just aren’t sure yet, then the less borrowing you can do the better.
This article was written by Scott Spann from Forbes and was legally licensed through the NewsCred publisher network.