Navigating the World of Student Loans

Q:

I’m collegebound and beginning to look at financing options. Given the sometimes alarming headlines about student-debt levels, should I be worried about overextending myself?

A:

The headlines are indeed alarming:

• “The Student Loan Debt Crisis Is About to Get Worse” (Bloomberg).

• “Student Loan Debt Statistics in 2018: A $1.5 Trillion Crisis” (Forbes).

• “The Student Debt Problem Is Worse Than We Imagined” (The New York Times).

However, student debt doesn’t have to be overwhelming. In fact, when used responsibly, it can lead to a more secure future.

That’s because debt often fits into one of two categories: bad or good.

Borrowing at a high interest rate to buy a depreciating asset — like using credit cards to pay for clothing or other consumer goods — is the kind of bad debt that can undermine your financial stability.

Borrowing at a reasonable rate to buy an asset with the potential to appreciate, on the other hand — like securing a mortgage to purchase a first home — is the kind of good debt that can actually pave the way for a better future.

So which camp does student debt fit into? Potentially either, depending on the amount of debt, the terms of the debt and your ability to pay it back. Let’s take a look at how you can manage student debt so it works in your favor.

Consider your future income

The first rule of any financial transaction is to go in with your eyes open. When you’re contemplating a student loan, think carefully about your future earnings prospects.

Although personal circumstances vary, one useful rule of thumb is to limit your total loan balance to no more than the amount you will reasonably earn in your first year on the job. If you’re planning a career in social work, for example, this might mean borrowing no more than $50,000, whereas a doctor might justify as much as $200,000.

Better yet, do the math not just for the first year but for the entire life of the loan to better understand how much you’ll be paying each month — and for how long. There are a variety of student loan calculators available online, including the U.S. Department of Education’s repayment estimator.

Minimize your loans

Besides attending an in-state public university, which is much less expensive, on average, than an out-of-state or private university, there are several other ways to keep a lid on your debt:

• Graduate in four years: Although obvious, it still bears pointing out that a five-year plan costs 25% more than a four-year plan.

• Hunt for scholarships: Online resources such as fastweb.com and petersons.com can help you beat the bushes, surfacing even obscure sources of funding.

• Look for no-loan schools: If you have a stellar academic record and your family is of moderate means, consider colleges that offer “no-loan” financial aid packages, which are meant to significantly reduce or even eliminate the need for student loans. These are generally offered by the top schools in the country, including Harvard and Stanford (both of which cover most costs for families earning less than $65,000). It may not be a free ride, but it can constitute substantial savings.

• Maximize federal funding: If you do have to borrow, use federal loans first. They generally offer lower interest rates than private loans and often offer better repayment terms.

• Start at a community college: Sometimes referred to as a 2+2 program, this strategy involves attending a community college for two years and then transferring to a college or university for another two years, which can help cut costs considerably.

Manage your debt wisely

Some 69% of 2018 graduates had student loan debt, owing $29,800 each, on average. No matter how big your student loan burden, however, here are four steps you can take to manage or even reduce it.

1) Automate your payments: If you sign up for automatic loan payments, you may qualify for a reduced interest rate. Be sure not to miss a payment due to, say, insufficient funds, however, lest the benefit disappear.

2) Plan your payments: As soon as you graduate, make a list of all of your loans and monthly payment amounts and then factor them into your post-college budget. Most loans have a six-month grace period before payments begin, but if you have a job lined up and are able to start sooner, consider doing so. Conversely, if your federal-loan payment seems unmanageable relative to your income, look into lower-payment options such as a revised pay as you earn program, which generally limits your payments to 10% of your discretionary income, or income-based repayment, which caps payments based on family size and income.

3) Save on taxes: If you make less than $85,000 ($170,000 for married couples) in 2019, you can deduct up to $2,500 of student loan interest from your taxable income, even if you don’t itemize.

4) Tap your employer: If you’re still looking for a job, consider one of the many companies that now offer student loan repayment assistance. Note, however, that any such assistance will count as taxable compensation.

There’s an ongoing debate about whether higher education is worth the cost. To me, that’s a closed subject, not only because studies have shown college graduates earn more than those who don’t get a degree, but also because the value of your education goes beyond the expenses incurred. Whether you pursue a degree in engineering or literature, you’re broadening yourself in unquantifiable ways. Just don’t break your personal bank to do it.•

Carrie Schwab-Pomerantz, Certified Financial Planner, is president of the Charles Schwab Foundation and author of “The Charles Schwab Guide to Finances After Fifty.” You can email Carrie at askcarrie@schwab.com. The opinions expressed in this column are those of the author.

© 2019 Charles Schwab & Co. Inc., Member SIPC

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