August 2, 2011

Student Loans Are Good For You

Student loans are tending to get a bad reputation nowadays.    Some people wrongfully think that student loans are the 'next bubble'.   Many news reports give us the false impression that 'many' students have 6 figure student loan debts when in reality only a small minority of grads are that much in debt.   As college gets more and more expensive people are taking on higher amounts of loans.   On top of all that add the bad economy and difficult job market.     Put all this together and it can make sense to question if getting a student loan to finance college makes sense at all.  Many people have decided that the best way to go is entirely debt free by working to save money and not getting any loans at all.   On the face of it that seems smart, cause who wants to pay loans if they can avoid it?

I however think that student loans are getting a bad reputation.   Student loans should be viewed as a great helping hand to get you into a good career sooner rather than later.   They can also make good sense financially, and in fact student loans can end up benefiting you financially in the long run.

If you're pursuing a career field that typically pays a good wage then using student loans to finance college can make very good sense.

Basically I look at it as a choice between two things :    
Would you rather be a 18 year old saving up money for college while working for $8-12 an hour or would you rather be a college graduate paying off a loan for the college bill while making $20-$30 an hour.      The choice there seems clear to me.

OK, so the title of this article shouldn't be taken too far to excuse any/all student loans.   Of course you don't want to take on too much student loan debt and not all student loans are created equal.   Private loans aren't very good terms compared to the government sponsored loans.   Taking on more debt than your post graduate career can reasonably afford is a recipe for disaster.   I'm also going to set aside the topic of college major choice today and just assume that your choice of major is one that will justify the financial expense of college in the first place.

I'll walk through some examples of the options to illustrate how loans can benefit you financially in the long run.

To make this simple lets just ignore financial aid altogether.  Thats not realistic since most students get some form of financial aid and very few of us pay the full 'retail sticker price' for a college degree.    But I'm going to ignore financial aid just to make a simple comparison of loans versus saving up cash.   Of course there are many people who only get loans offered in their financial aid awards so this isn't too far from reality for them.

Work and save up cash first: 

Lets say you are able to get a reasonably ok job straight out of high school that pays $35,000.   Thats probably higher than most 18 year olds can get with no experience, no training and only a high school diploma.   Lets also assume you live pretty frugally for several years while you save up money to go to college.   About $5,000 or more of your income will go to taxes.   You'd be pretty skimpy to live off of $15,000.   If you were able to save $20,000 per year then you'd be doing an awesome job.   At that rate if you saved all that money then you'd probably be able to save up just about enough to fund 4 years of college if you work 4 years full time first.  College costs about $14,000 average for 4 year public universities, but the rates have been going up considerably so its a moving target.  Saving $20,000 per year for 4 years should give you enough.   In this scenario you would work for 4 years and save up cash then go to college for 4 years fully self financed.   The end result is that you'd graduate from college at age 26 with zero debt.

Work full time and go to school part time:

Another way to go about self financing school is to go to school part time on the side while holding down a full time job.   This method would still take you around 8 years give or take since you'd be in school much longer if only taking part time classes.  The end result would still be that you'd be graduating around age 26 with zero debts.

100% finance school with student loans :

Lets say you go straight to college right out of high school and pay for the entire bill using student loans.     If you do this you'd graduate around age 22 with about $61,000 in student loans give or take.   You could then work the next four years with average starting income of about $50,000.   You'd have to pay about $10,000 in taxes.   If you lived very frugally then you'd maybe get by on about $15,000 of spending.  This would leave you about $25,000 to pay down your student loans.  Thats a lot of money to pay down your debt.  If we assume a 7% interest rate on the student loans and you pumped all your extra cash into paying down the debt then you'd be debt free in around 3 years give or take.   At age 25 you'd be debt free.   If you continue that path of saving $25,000 a year then by age 26 you'd have $25,000 in the bank.

3 scenarios and their end results :

Work first then go to school full time :  New college graduate and debt free at age 26
Work full time and go to school part time : New college graduate and debt free at age 26
Go to school full time paying with loans then work and pay off loans :  College grad with 3 years work experience and debt free at age 25

Clearly choice 3 is the best choice.   You're debt free 1 full year sooner and by age 26 you'd have $25,000 in the bank and 4 year head start in the workplace versus someone who self financed with cash.

Based on this comparison student loans would put you $25,000 ahead financially by age 26!    This is basically the difference between getting that $50,000 job sooner rather than later.   It goes back to my original simple comparison between an 18 year old saving money from their $8-$15 /hr job and a college grad paying a loan with their $25-30/hr salary.

Now remember that I'm totally ignoring financial aid other than student loans. The average college student with debts graduates with abut $25,000 in loans nowadays.   If you were to throw financial aid into the equation then that further complicates the situation.   Working and saving up a lot of money would undercut your financial need based aid since you wouldn't have the need.   A student who makes $35,000 a year and has $25,000 in the bank would not be deemed to have much financial aid need compared to a student who doesn't work and has $0 in the bank.

There are some other minor holes in the analysis.  For example you can't just borrow $61,000 in student loans unless you get private loans and those are not subsidized and interest accrues during school.  But on the other and most 18 year old high school  grads don't make $35,000 a year nor live extremely frugally.

Of course I'm not going to argue that it makes sense to get yourself into $100,000 of student loan debt to go to an expensive private school that nobody has heard of.   But a reasonable, moderate amount of borrowing via student loans to pay for college can be a very smart choice.   My opinion is that student loan debts should not be more than your expected salary level at graduation.

Bottom Line :  Student loans help you get into college quicker and then get into a higher paying paying job quicker and in the long run they can help you financially.

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