College education can be great, but amassing debt to get one can hurt your financial future
The average college student in the United States walks off the stage at graduation with a handshake from the head of the school and $30,000 of student loan debt wrapped up in their diploma.
For some students, the debt will be well worth it. It will allow them to obtain a degree in a field with relatively lucrative pay and enjoyable work. For others, the debt is a burden that reduces financial security now and in the future.
Using savings and investment math that is not always intuitive, a $30,000 student loan balance could ultimately “cost” more than $200,000.
Student loans commonly come with a 10-year expected repayment period. If the interest rate is 4 percent (some student loan rates are higher), the monthly payment to complete a $30,000 loan in 10 years would be $304.
Because of this debt payment, the average student debt holder would have to forgo saving $300 per month that could otherwise fund a retirement account.
Assume they paid down the debt from age 23 to age 32 and then invested the $300 per month for the next 30 years. At a 5 percent compounded annual return, that savings would grow to $245,609. That’s a modest sum that will help in retirement. It is light in comparison to the amount they could have had if they didn’t have student loan debt and were able to start investing $300 per month 10 years sooner. In that case, the projected balance would be $446,569 — more than $200,000 more for the individual without student loans compared to the average college borrower.
If the student loan debt is higher than average (more than $30,000) or comes with a higher interest rate, the savings difference is more dramatic.
Most teenagers trying to decide where to go to college don’t think about the costs of paying back their loans when they take them out. Their pride or friends have steered them to choose a college, and they work backwards to answer the question about how they will afford it.
The idea that $30,000 of debt could have an opportunity cost many times that due to missed savings and investment growth doesn’t register when your concept of money is limited to how many coffee shop visits you can make between pay checks from your part-time job.
The student loan crisis has begun to draw attention. Often, the focus is only on the size of the current debt and the number of people who struggle to pay it back.
According to the U.S. Federal Reserve Report on Economic Well-Being, 54 percent of students use debt to finance college. About 20 percent of existing student loan borrowers are behind on their payments. Since the cost of education has far outpaced general cost of living increases over the past 30 years, recent students have had to borrow increasingly more than prior generations for a similar education.
There is less room for error now in deciding where to go to college, what it will cost, what your field of study should be and how that all translates to career income and ability to repay debt. Beyond how attractive the campus is, when choosing a college, it is critical for many students to understand how they expect to pay the cost that remains after they complete their education. Especially for students who don’t expect to enter high-earning careers, debt should be minimized or avoided by choosing a less-expensive college.
As the father of a current high school senior curious about what the college costs will be, I also see how tempted young people can be to attend a college that might be offering a scholarship but not enough to cover the gap between what the family can afford and the net price of the college.
A student might have a strong connection to a private college with a $60,000-plus total annual cost. That college might offer a $25,000 merit award that feels generous to the student and creates even more of a draw. But if it still requires a large loan (often for parents in addition to students), people need to understand the financial reach and the stress this can cause later.
It is not only saving for retirement that could be limited by the amount of debt. It is also clear that young people with debt are following a different life time line. They marry and have kids later, delay the purchase of a home and postpone other important life milestones.
Education can provide tremendous opportunity. It can be the pathway to prosperity from even humble beginnings. But inadvertently paying too much when less expensive alternatives are available can have long-lasting impact.