I tend to have mixed feelings about student debt. While being a strong advocate for bettering yourself, the burden from expenses for college education can cause major problems down the road.
The most troubling part about student debt is that people don’t really understand what it’s going to mean for their financial future. While high schools attempt to prepare students for college, they only focus on the academic aspects, rather than the social and financial portions (sounds like a theme, eh?).
At the end of 2016, NerdWallet did a study on the types of debt in American households. They found that Americans owe a combined $1.23 trillion in student loans, which is more than auto loans and credit card debt. NerdWallet also found that, on average, households with individuals carrying student loan debt owe more than $48,000 in student loans.
Well crap. If that doesn’t make your stomach turn, let’s look at what this all means for you and your student loans.
YOU’RE GOING TO PAY MORE THAN YOU THINK
Yeah, $48,000 sounds like a lot, but it’s actually going to end up being even worse than that. Once you factor in that 5% interest rate, that amount will become much more. Actually, if you make the minimum payment each month for 10 years, you’ll end up paying around $61,000 instead of the $48,000 you thought you had.
If you’ve applied for a student loan, you probably also had the option to defer payments. I’m sure you looked at that and thought something like “wow, that’s perfect for me. I can’t afford these payments while in college!” While it is pretty convenient for you, it’s even more convenient for the government or from the bank you’re taking the loan from.
They’re going to charge you interest while you’re in school. You aren’t making payments either, so it constantly grows. If you take out a 5% interest loan for $12,000 your first year, by the time you graduate, it will be $14,586. During your time at school, you’ll owe an extra $2,586. The only way around this is to be eligible for a subsidized government loan based on financial need or if you can find another lender that won’t accrue interest (good luck). Other than that, you’re stuck with it. Sorry.
Here’s what your loans will look like after 4 years in school with 5% interest and $12,000 per year:
Your $48,000 in loans has already grown to $54,308 by the time you graduate. Your education has already cost you an extra $6,308.
Minimum payments on your hard-earned loans will be around $575 per month, or $6,900 per year. These payments will continue on for the next 10 years… meaning you’re spending $69,000 on your education.
Yikes. Did you realize your loans were going to make you spend almost 50% more than what your school actually charges you? Good thing we have trust funds from our parents to cover this.
I’m less than happy to tell you that spending an extra $21,000 and $575 per month isn’t the only problem that student loans can cause you. In the immortal words of Billy Mays:
“But wait, there’s more!”
YOU’LL HAVE TROUBLE QUALIFYING FOR OTHER LOANS
Banks and other sources of loans will be very careful to make sure you’re able to repay the loan. Is your goal to move to New York City and buy a condo and start your new life? Well, most banks won’t give you a mortgage if your income and debt payments don’t meet their requirements. That pricier condo might be out of reach.
Most banks will look at your debt-to-income ratio, which is basically a measure of how much you earn compared to how much you spend per month on debts. A pretty typical guideline for many large loans, like a home mortgage, will require a 43% debt-to-income ratio. This means that all of your combined debt payments must add up to less than 43% of your pre-tax income.
We can use 2015’s average starting salary and say you’re making $50,000 per year, which means $4,167 per month. Based on this information, your monthly $575 payment already eats up 14% of that. Best case scenario, you have no additional debt, and you can still afford about $1,200 per month in mortgage payments. This will buy you, at most, a $300,000 house. Not bad, but you’re never going to get any additional loans or credit cards, or afford anything decent in NYC.
That $300,000 house doesn’t make much financial sense for you. With your mortgage, insurance, taxes, and student debt payments, you’re only going to have a few hundred bucks left to spend after taxes. Don’t forget, you need to pay for utilities, your car insurance, phone, internet, and health insurance.
Oh, and food. That’s kind of important, too.
Which one are you going to cut? You’re also never going to be able to retire, so that’s something else to consider. Do you enjoy vacations? Not anymore.
When you begin to struggle to pay for everything, you also won’t be able to qualify for any decent credit cards to make payments on (also racking up more debt, but that’s not my point). Nobody is going to lend you money now, or in the future, because you can’t and don’t pay your bills. That extra $575 going to student loans will leave you with no spending money. You’re digging yourself in a hole.
And then guess what? When you get into so much debt you have to file bankruptcy, all of your debt will be cleared… except for your student loans. You’re stuck with them until you pay them off. Definitely something to think about.
WHAT SHOULD YOU DO?
Sorry for making this such a scary and intense topic, but it kind of can be. If you want a college degree, your options for avoiding student loans are to get enough scholarships to cover your tuition, have someone who will pay for you to go, or somehow earn enough money to be able to pay for all of your expenses.
There are some ways to reduce expenses, however. They are pretty obvious and commonly talked about, but I’ll just rattle off a brief list. First, you should definitely do your best to be awarded scholarships. Whether you’re in high school or college, your performance can help to put you in a position for more awards. Some scholarships are also only available to college juniors and seniors, so it’s not too late.
You could also attend a community college for your first few years. This will cut your expenses to a fraction of what they would be at a major university and your credits will often transfer along with you. You can generally spend 2 years at a community college and then transfer to a university and it won’t hurt your career or your future. It will, however, help your finances.
If you have already graduated with student loans, I would strongly advise you to try to pay down the highest interest loans first. Anything about 5% will be really costly to you in the long run. Do what you can to pay more than the minimum to get these knocked out.
After paying down higher interest loans, you could then look into consolidating all of your remaining loans into one loan. Most banks will take a weighted average, so any higher interest loans will end up bringing up the rate you pay across all of your loans (which is another reason you want to pay off those higher interest rate loans first). The total amount you owe will likely be the same, but if you’ve been able to build your credit since requesting the loans, you may be eligible for lower interest rates, meaning you pay less over time and your monthly payments are reduced.
For now, do what you can to improve your credit score. I won’t go in-depth here (maybe another article for the future), but there are plenty of resources out there to explain how to improve your credit score. Basically, never miss a payment, keep credit card balances low and don’t open up more credit cards.
VERDICT ON STUDENT LOANS
Student loans are a necessary evil for most people. Chances of finding a good job without a degree have become exceedingly slim, making prosperity, retirement and financial freedom more difficult. I believe that in most cases, a college education is needed, regardless of whether or not you need to take out loans.
Make sure that you (and your friends, siblings, etc.) understand what you’re getting into though, because most people don’t. Be prepared to spend hundreds, if not thousands, each month after graduation for a decade or more.
Understanding the finances behind acquiring student debt is critical to the first years after college. Decide what steps you’re willing to take to reduce the long run cost of your education and then follow through with them.
Accepting that you’re taking on debt is easy, tackling it is much harder.
How much student debt did you/are you going to graduate with? What’s your strategy for paying them off? Was your debt worth it? Leave a comment below if you have any tips that others can follow!