Saturday, July 5, 2014

A new perspective on student loans

A Yahoo! finance article (link at end of this post) describes a pretty clever way to picture your student loan debt. Rather than some relatively large, abstract figure like $20,000; think of it in terms of what your monthly payments will be when you graduate.

"Old Economy Steve" may give you advice that was fine for his generation, but not so good for yours



Indiana University (with seven different campuses, with a total of 95,000 undergraduates--that's a lot of students!) decided to tell students every year, before they take out new loans, what their monthly loan payments will be once they graduate. This simple, clever approach resulted in students taking out 11% less money in federal Stafford loans, according to this article.

My reaction:
First, it bugs me that people were apparently taking out more loans than they needed to. If they decreased their Stafford loans by over 10%, the students must have found ways to make do with less loan money--which they should have been doing anyway! Why would you borrow more money than you absolutely have to? Never forget that you have to pay loans back, with interest.

Second, I like Indiana University's approach: put it in terms people can easily understand. People in general are lazy thinkers about this kind of stuff. When you're interested in something, you want to think about it. But if you're not interested--like in the legalese of terms for loan repayment--most people would much rather kick the can down the road. "Oh, I have $40,000 in loans? I have tuition due for next semester--I'll take out another loan. I'll get a good job and repay it eventually!"

But you can't count on getting a good job after earning a bachelor's degree, especially not in the current hiring climate. Then, you're saddled with massive loan debt and working a low-paying, part-time job--if you're working at all!

Telling people what their monthly loan payments will be is an excellent idea, and should be a mandatory part of the process of signing up for a loan. But, of course, that won't happen--because then people would take out less money--just as these students at Indiana University campuses did!

So, unfortunately, you will have to do this for yourself. Before taking out a loan (whether it's for tuition, for a car, or for a mortgage), figure out how much it will cost you on a monthly basis. When you see how much you'll have to pay back, how long it'll take, and how much interest you'll pay, you might think twice about incurring that expense!

A clear and flexible loan calculator is here: http://www.calcxml.com/calculators/loan-payment-calculator. Or, if you'd rather do it yourself with paper and pencil, use the following formula:


  Loan Payment Formula
(graphic from www.financeformulas.net/Loan_Payment_Formula.html)

Here are the facts about a hypothetical $30,000 loan (the average student loan debt nationwide in the U.S. for recent graduates) at 4.66% (the average interest rate) over 10 years (the standard repayment period for student loans). You'll pay $313/month, for a total repayment of $37,588. That's $7,588 in interest on a $30,000 loan!

If you want to minimize the interest you'll repay, you can go over and above this minimum $313/month payment. You could pay this loan off in 5 years, with only $3,689 in interest--but it'll cost you a much steeper $561/month! This is over $6500 per year--which could get you a decent used car. Every year!

Feel like rushing to the bank to take out a student loan?

So, forget what you've heard about "good debt" and "bad debt." Your money doesn't care whether you took out a loan for your education, or for a top-shelf Rolex. Debt is debt, and the longer you take to pay it back, the more interest you'll pay.

Old Economy Steve just doesn't get it: college is not a trivial expense anymore, and you may not end up getting a job that pays more than $25,000 per year--if you're hired at all! When you're faced with the prospect of paying over $300 per month out of such a meager salary, can you justify taking on lots of debt in order to get an education?

UPDATE 7/22/2014: I found a MarketWatch (Wall Street Journal) article reviewing the findings of a study by the San Francisco Federal Reserve Bank--college graduates aren't getting paid as much as they used to, for the same jobs! This obviously varies by field, but the point remains: taking out massive loans is a bad way to finance your education, especially considering these findings! Link here: 
The original findings from the San Fran Fed Reserve Bank can be found here: http://www.frbsf.org/economic-research/publications/economic-letter/2014/july/wage-growth-gap-recent-college-graduates/

Leave your thoughts in the comments below!


Link to Yahoo! article here:
http://finance.yahoo.com/news/students-u-university-borrowed-31-040100874.html

The New York Times has a useful student loan calculator! You can find out more about it here:
http://twocents.lifehacker.com/this-calculator-tells-you-the-average-student-debt-by-u-1635122693