First, will be okay...eventually...

I know, it all sounds impossible. But more people are going to college than ever. And while many of them are accumulating debt faster than Congress, you can still get through this without an impossible financial burden. Just remember, that there will likely be no single source of money, you will have to be realistic on selecting the right school, and your major means everything. So, relax and start the journey, one step at a time...

Friday, September 23, 2011

Student Loans: Path to Riches or Road to Serfdom?

All loans are financial vehicles where you leverage someone else's assets to (hopefully) invest in something that will have returns to you that outweigh the borrowing costs. For a business or government entity, that can mean issuing bonds to raise money to develop products or infrastructure that enables growth and returns which are greater than the net cost of the bonds, over time.

For student loans, that means that the returns in future employment, made possible by your college degree, will outweigh the student loan payments over your life. That calculation must include un/under-employment risk; that is, the debt is certain, but the long-term wage benefit is not, so the student loan should have substantial positive financial impact or you should have never signed for them in the first place. As explored in a previous post, the main factors in that calculation are the cost to obtain the degree, the value in the marketplace of your degree, and the employment opportunities in your field.

A recent ABC News report on student loan defaults has some very telling stories. There is a 24-year-old graduate of New Jersey's Fairleigh Dickinson University (tuition, fees, and basic room & board of $42,188 for undergraduate, and $38,700 for tuition for education graduate studies). She earned her Master's degree in Education, but hasn't found a full-time job as a teacher. Having financed most of her college education with student loans, she owes "close to $100,000", and works two part-time jobs as a substitute teacher and as a tutor at a learning center and pays what she can on her loans.

So let's do the math.

The total tuition and room & board cost for her Master's Degree education is $207,452, boldly assuming she graduates in five years (and not including living expenses while in graduate school). Assuming she receives the average grants for a private four-year school, the National Postsecondary Student Aid Study (NPSAS) indicates that her actual bill is $98,308 after grants (based on the average ratio of grants-to-tuition). That means she essentially financed her whole education through loans (no savings and current income). Not a good practice.

The average salary for a public school teacher in New Jersey (where Fairleigh Dickinson University is located) is $64,089. Based on a 6.8% annual interest rate at a 10 year term (the current federal student loan terms), her monthly payments are $1131, or 18% of gross income - way too high. Assuming single filing status with standard deductions, this is about 29% of her net income after state and federal income taxes, Social Security, and Medicare. And her two part-time jobs are not likely providing the equivalent (in salary) to an average full-time job.

Another way to look at this is that after taxes and student loans, a $64,089 salary would leave $2,825 per month for rent, utilities, food, medical insurance, transportation, and savings, leaving very little room for any discretionary expenses. And she likely won't qualify for a mortgage or perhaps even a car loan with debt ratios so high (especially if she continues to "pay what she can" on her student loan, which will drive down her credit score).

So was her education worth the cost? Maybe for her personal satisfaction, if she finds a job and her personal goal was to become a teacher, but not financially. At least not the way she financed her education and her choice of school. If she instead attended Rutgers University, an excellent public university in New Jersey with a masters-level education certification program, the total cost of her education would be $110,464, and her net price after grants (assuming average values from the NPSAS) would be $67,874, a reduction of 31% in needed funds. This would already reduce her student loans to a monthly payment of $781, if she had no savings or income to contribute.

The better approach would be to have some minimal savings and income to offset her costs while in school, to minimize her borrowing. With just a contribution of $100 per month in a 529 Plan for 12 years (starting when she was in first grade), she would have had $20,601 for her education expenses, reducing her monthly student loan payment to $544, a more manageable 14% of net income. Then she would even be able to save a little money!

Perhaps the more troublesome comment in the article is the quote from the mother of another college graduate in a similar situation:
"I didn't think of student loans," she said when she was helping her daughter choose a school. "I told her to go where she wanted. I wanted her to go somewhere she would be successful and not somewhere she would hate. We would deal with the student loans after the fact."
This isn't just poor planning, it is poor parenting. Why saddle your children with this debt? Why not teach them the consequences of their actions, and not just worry about it later when the bill comes due?

I certainly have sympathy for people in these situations, and I am not picking on any individual highlighted in this article (as their circumstance is all too common), but I think just a little bit of financial literacy and planning would avoid a lot of this. Running the numbers as above on total cost, projected loans, and anticipated employment in your field is a great first step.

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