Let’s first get out of the way that we recognize that for many students, some level of debt will be incurred and that that debt is what made it possible for the student to attend college to get a degree and ultimately, raise their prospects in the future. So, we aren’t purists that say you should not go to this college or that college if it means taking on any level of debt. The better answer is to be thoughtful and methodical in your approach to determine which college you should attend. Determine the total cost of schools, what monies are available such as scholarships and grants and other “free” monies to offset your costs, what levels of debt each college under consideration would incur, and what you see as their overall value relative to each other.
Before You Ponder Student Loan Debt, Ponder the Total Cost of College
Student loan debt is only one part of the cost of attending college. You need to calculate the total cost of college across the four years. And that cost is more than just tuition and room and board. You need to factor in all of the other costs that go into attending one school versus another. For instance, if all things else being equal (meaning that if two schools could be identical in all ways), one college required you to have a car while another had acceptable public transportation alternatives, the latter would present a better value as you wouldn’t likely need to incur as much cost as having a car with insurance, gas and parking-related charges.
Looking at the total cost for college is important because its cost has an impact on you and your parents if they are offering to help. For instance, if the total cost for college was $100,000 over four years and your parents had offered to cover that expense, how does that cost affect their savings and ability to retire or pursue any goals they have? It’s only reasonable and mature that a student ask their parent(s) what the impact is to them for paying the level of money.
What if a student wasn’t getting any financial support from parents at all? That $100,000 takes on a whole new meaning in terms of how the student looks at paying for school.
Kick Off a Monumental Funding Drive
The next part of understanding the potential cost is of course, applying for any and every scholarship and grant that the student may be eligible for. This is all about reducing the impact through “free” monies. And don’t rely only on possible funding sources the college might suggest but looking for other scholarships and grants by organizations around the country that you could potentially attract. Every bit helps.
This should be a goal for students and parents alike regardless of how much the parent(s) are contributing. The cost of college is high and there is no reason to leave money on the table that could offset costs for either the student or the parent(s).
Calculate the Amount Needed in Student Loans
Once you have an idea as to the total cost for each college you’re thinking about and the amounts of any scholarships and grants you’ve been awarded (or are highly likely to be awarded), the next step is to see what’s left over for paying. This is where your parent(s) may contribute to the cost of college. Whether your parent(s) do contribute or not, this remaining amount is what you will have to fund and if you have no other resources to pull from, student loans may be necessary.
Assess the Impact of Student Loans on Your Financial Future
Next, you will want to create a budget outlook based on your future earning potential to see how student loans affect the quality of your life and ability to save for the future.
Lenders will always talk about “Debt-to-Income” ratios as a key measure to look at when evaluating an application to lend someone money whether that be for a mortgage, a car or other major purchase. Debt-to-Income is a simple calculation. Say, you borrowed $50,000 through college and your monthly payment at 6% for 10 years = $555. Let’s say you started your career with a job that pays $60,000 gross (before taxes) a year or $5,000 per month. Your Debt-to-Income ratio of student loans would be:
Debt-to-Income Ratio = Monthly Student Loan Payment/Gross Monthly Income
= $555/$5,000
= .111 or 11%
So, in this scenario, your debt-to-income ratio means your student loans make up 11% of your gross income each month.
Is that an acceptable amount if the student had no other debt? Actually, it can be. Though it varies across lenders, anything under a Debt-to-Income ratio below 20% is definitely attractive when considering a prospect for a loan. Sallie Mae cites a range of 10 to 15% of monthly income for general guidance on their website. Our own stances is that 15% is too high so that as long as the student was diligent in making payments and their credit worthiness is good (or at least not flagged as bad in any way), the student won’t be hobbled by student loans when it comes to borrowing for other types of purchases.
But this isn’t the whole story. We also need to look at what the overall cost of living might be too.
For instance, let’s say the student lives in a more affluent part of town and the cost of living is so high that that $555 monthly payment means the student can barely get by. Though the student’s debt-to-income ratio is low, it doesn’t matter one bit if the student is unable to save because their cost of living is too great. A not-so-informed student may consider refinancing their student loans over a longer period to reduce their payments. A smart student may see the need to relocate and budget their spending so that they have money each month left over for savings and possibly to accelerate paying off their student debt.
Look at Student Loans in a Bigger Context
One last perspective here is the combination of the two factors. Let’s use the debt-to-income ratio of 11% again. However, let’s say you do have some money left over because you made better choices in the cost of living and live within a reasonable budget. However, now you’re looking at buying a house. Let’s say the house costs $250,000 and at a 4% interest rate, your monthly payment over 30 years would be $1,194.
Your debt-to-income ratio combining your student loan debt and mortgage debt would be:
Debt-to-Income Ratio = Monthly Debt Payments/Gross Monthly Income
= ($1,194 + $555)/$5,000
= $1,749/$5,000
= .3498 or 35%
Now, you can see how your overall debt-to-income ratio is much higher which is to say more of your monthly income is going toward servicing debt. From a lender perspective, you’re probably in a range where you don’t want to go any higher from a credit worthiness standpoint.
From a quality of life perspective, the student is running the risk of becoming cash tight and less able to save or build wealth given the level of debt servicing. What was once thought to be a reasonable level of student loan debt now feels like it’s constricting the student’s finances. Of course, some level of a mortgage payment is no different than what would be paid in rent. However, the costs usually go higher and include greater property taxes, higher cost of utilities, upkeep and maintenance as well. And then making more money each year can help. However, raises and promotions and the like are partially offset by any rise in costs such as healthcare costs and other increases in the cost of living.
Conclusion
So, in this last example, we hope you see that your end goal should be to minimize the level of student loan debt you incur and its impact on your future ability to save. By taking a methodical approach to evaluating the colleges you are interested in, you will have a window into their overall impact on you and your parent(s). You may still have the burdens associated with student loan debt depending on your end choices, but you can take comfort knowing that you made better choices to make your situation after college bearable versus brutal.
You Can Do This. We Can Help
If all of this seems a little daunting to undertake, this is what College Pathing helps you to do. We apply sound calculations to get at the total cost of college, identify the net impact of any scholarships and grants and parent contributions to get at what if anything, may need to be borrowed, and help you understand the future impact of the cost of college on your ability to save and build wealth when you leave college.