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Student loans can help, but beware of long-term cost

The Atlanta Journal-Constitution (August 2015)
By Kristin M. White - For the AJC


Excerpt from “It’s the Student, Not the College: The Secrets of Succeeding At Any School—Without Going Broke or Crazy,” copyright Kristin M. White

Today, students are often turning to loans to cover college tuition costs. This path, however, comes with many strings attached. It has been shown that young adults with excessive debt are risk-averse and less likely to buy or rent a home, afford a car payment, start a business, get married, have children, or otherwise move forward in their lives. The Gallup/Purdue survey … found that only 2 percent of young adults with $20,000 to $40,000 in debt rated themselves as “thriving.”

The decision about student loans is the first major financial decision that many young people will make. Here is some important information for prospective college students to consider: If you are like most high school students, you’ve given very little thought to the magnitude and logistics of college financing and what it really means for you and your family. Your reference points are limited, and you may not fully understand how loans work, what typical entry-level job salaries are like, or how your parents would have to adjust their lifestyles in order to accommodate high college tuition payments.

You might accept the idea of taking out student loans without understanding exactly how that will affect your life in the future. Student loans can empower you to get an education that can lead to success, but it’s important to understand what a reasonable debt level is, and to evaluate funding options to be sure that you can manage your loans.

If you are considering student loans, it is crucial that you start with any federal loans that you are eligible for, before taking out loans from private lenders. Even children from wealthy families who do not qualify for financial aid will still be allowed to take out an unsubsidized Stafford loan. This means that they are eligible for a Stafford loan with an interest rate of 3.86 percent in 2014, instead of rates as high as 9 or 10 percent offered by private lenders. You must file the FAFSA in order to qualify for the Stafford loan. Many families who know that they won’t qualify for aid but do plan to take out loans miss out on the low Stafford rates because they do not file the FAFSA. Students taking the Stafford loan have this lower rate, and they have some protection if they are unemployed, but they are limited to borrowing $5,500 the first year, $6,500 the second year, and $7,500 in subsequent years.

Now that you know about this basic fact about student loans, let’s look at a typical scenario that you might consider.

Let’s say you are considering two college choices. After your parents have paid their agreed-upon amount, you are left to fund either $5,000 a year at College A or $15,000 a year at College B. College B costs only $10,000 per year more, and that doesn’t sound like a big difference to you.

Because you filed the FAFSA, you are eligible for an unsubsidized Stafford loan of $5,500, at a rate of 3.86 percent. If you choose College A, you take a $5,000 loan each year. You do not have to start paying off this loan until you graduate, but interest starts accumulating as soon as the loan is drawn. At graduation, your total debt will be approximately $21,800.

If you choose College B, you will take a $5,500 Stafford loan the first year, at 3.86 percent, but also a $9,500 loan from a private lender who charges approximately 9 percent. Due to interest accruals, at the end of year one, you have $16,100 in debt. You will continue to take the maximum that you can from the Stafford loan over the next three years and to cover the rest with the more expensive private loans. At graduation, your total debt will be $69,900 — far more than you may have expected, given that the cost to attend College B is “only” $10,000 per year more than College A per year.

Now, take a moment to think about what your life will be like at the age of 23. You will have graduated from college, and hopefully you will have a job in your intended field. Do you know what typical starting salaries are? Salary examples on the high end are those of engineers and software developers, who could make $60,000 a year right out of college, and investment bankers or consultants, who could make over $100,000 including their bonuses. On the lower end, a job in public relations might pay only $30,000, and if you are among the many college graduates who are able to land only minimum-wage, part-time, or unpaid positions in the still-tough economic climate, you’ll be making considerably less. Do you plan to have a car, a smartphone, or your own apartment? Do you hope to save for a down payment on your own home? You will make monthly payments for these lifestyle choices, but you will still have your student-loan debt with you.

For example, if you chose College A and have a standard Stafford repayment plan offering a 10-year loan term, you will be paying $219 a month. If you chose College B, with a 10-year loan term for your private loan as well, your monthly loan payments will be $810.

Let’s say you got that engineering job paying $60,000 a year and your monthly take-home salary after taxes is about $3,500. If you chose College A, the monthly loan payment would be quite reasonable. Even if you chose College B and have to pay $810 a month, it would be expensive but still possible with your high income. However, if you have the lower-paying job in public relations, your take-home pay is only $2,000 per month. If you are burdened with an $810-a-month loan payment every month for the next ten years, it will be difficult to live independently and meet other financial goals in your life.

It is important to understand that when you take out a loan, you are paying more for college than students who did not take out a loan are paying. In ten years, after you have paid off your loan to College A, you will have paid $4,500 in interest expense. If you chose College B, you will have paid $27,200 in interest alone! If you are unable to make payments and default on your loan, interest will accumulate and your debt will grow and grow. While the example above may seem simple and obvious to adults who have been dealing with mortgages, car payments, or credit-card bills for years, it can be eye-opening to a teenager.

A recent Wells Fargo survey of 1,141 young adults between the ages of 22 and 32 found that half of the responders had financed part of their education with student loans. Fifty-two percent said that their debt was “their biggest financial concern” and 42 percent found their debt “overwhelming.” These students wished that they had known more about financial planning, with 79 percent of them responding that basic personal finance should be taught in high school. The topic of “how loans work” was identified as one of their top three interests.

Kristin White is the owner of Darien Academic Advisors in Connecticut and an educational consultant who helps students and families evaluate colleges, boarding schools and independent day schools, while also helping them navigate the admissions process. In the past ten years, she has worked with hundreds of families from 19 countries and 20 states. She is a graduate of Georgetown University and has an MBA from the University of Texas-Austin, and is also the author of “The Complete Guide to the Gap Year: The Best Things to Do Between High School and College” published by Jossey-Bass in 2009.